Homeland Security Becomes an Opportunity for Biotech Firms

Times Staff Writer

With private investment in the dumps, small biotechnology companies in need of funds have a new mantra: homeland security.

The federal government is poised to spend billions on biodefense initiatives, a huge potential windfall to a cash-starved industry. So, as the country moves toward war with Iraq, small biotech firms are scrambling to enlist in the fight against terror.

Take Metrigen Inc. of Berkeley, a genomics research firm that nearly shut its doors last fall after burning through $35 million in private capital. Kept alive with a $2-million infusion from angel investors, Metrigen is racing to develop a detection device for anthrax, smallpox and other exotic microorganisms that could be used as terrorist weapons. Chief Executive Nathan Hamilton, who also is the lead investor, thinks the company could have a product in 12 to 18 months.

"We have the right application and an attractive opportunity," Hamilton said.


Investment Shortage

Opportunity -- no matter how remote -- was the operative word at a biodefense investment conference in Livermore, Calif., last week that drew 250 attendees. Among them was Franklin Rice, vice president of VistaGen Therapeutics Inc. of Burlingame, Calif., a stem-cell research company. Rice wasn't sure what VistaGen could contribute to homeland security. But as a privately held biotech firm, VistaGen is "always looking for funds," he said.

Nowadays, what small biotech company isn't? The industry attracted $2.8 billion in venture capital last year, down from $4.6 billion in 2000. The shortage of private investment won't end soon.

That's because private investment follows trends in public markets, and the story there is ugly. The biotechnology sector has lost more than half its market value since 2000, said Benjamin Chin of the San Francisco investment boutique Burrill & Co. The outlook for 2003 remains grim.

"We're telling our portfolio companies to batten down the hatches and conserve cash so they won't need any funding until 2004, when, hopefully, the sun is shining," said Nicola Campbell of BA Venture Partners, a $500-million fund backed by Bank of America.

In such a climate, government investment in homeland security offers an alternative to private capital. So much so that James Woods of the Oakland law firm Reed Smith called the federal initiative, which includes $6 billion for new drugs to treat such pathogens as anthrax, "the newest VC on the block."

How much of the federal money ends up in the bank accounts of small biotechs remains to be seen. Chris Nolet of Ernst & Young in Palo Alto said much of the money would go to companies with existing products that can be adapted to fill an immediate need.


Eggs in the Basket

Cepheid Inc. of Sunnyvale, Calif., is one company that made the shift to biodefense, Nolet said. Formed in 1997, the firm built devices that could identify germs by analyzing each microbe's DNA, or genetic code. Though still not profitable, the company has sold hundreds of its machines to government agencies and is awaiting word on a potentially lucrative contract to supply the U.S. Postal Service as part of a consortium led by Northrop Grumman Corp. On Friday, it raised $5 million in a stock offering, though its shares fell below $4 on Nasdaq -- a sign Cepheid isn't yet out of the woods.

Indeed, biodefense can be a risky business, venture capitalists said. Increased competition in the sector means some companies won't find a buyer for their products. And when the demand for biodefense supplies eases, companies focused on that business will have to find new markets. Cepheid, for example, is marketing medical diagnostic equipment to hospitals to diversify.

For all the risks, some companies find the opportunity too great to ignore. Last October, Anacor Pharmaceuticals of Palo Alto, was just one of five firms to snag a share of a special $60-million appropriation from the Defense Department's Defense Advanced Research Projects Agency, or DARPA, for anthrax research. Just 7 months old at the time, Anacor received $21.6 million of the funds.

Anacor, which also is working on drugs for everyday bacterial pests, probably wouldn't exist without DARPA backing, said investor Paul Klingenstein of Aberdare Ventures, a San Francisco venture capital firm. The odds are against successful drug development, and the amount of capital required is huge. DARPA funds "changed the whole risk profile of the company," Klingenstein said.

Other companies are likely to follow a path similar to Anacor's, so long as the biodefense spigot remains open. John Carney, manager of the pathogen countermeasures program for DARPA, said grant applications are up fourfold.

Said Metrigen's Hamilton: "We can help the country and the government, and they can provide a way for us to start out."

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