BUSINESSWEEK ONLINE : OCTOBER 16, 2000 ISSUE
FINANCE Biotechs Are Cloning Money Why is the sector so hot? It has promising drugs, private financing, fast money--and too few shares The first thing Taylor J. Crouch learned as the new chief executive of biotech company Variagenics Inc., was two phrases: ''down round'' and ''nuclear winter.'' The first meant he wasn't going to get enough money from a round of venture financing; the other that nobody else in the industry was either. Those were the old days--of 1999. At the time, Crouch thought of Chase H&Q Life Sciences' ( CMB) annual conference, which brings together biotech execs and Wall Street money managers, as more of a ''morticians' conference.'' About the same event in January, 2000, Crouch says: ''I couldn't get through an elevator ride without a banker asking me if I needed more money.'' A player in the sizzling genomics field, Variagenics ( VGNX) has since pulled off a better-than-expected mezzanine, or mid-level, financing that raised $20 million, and an $81 million initial public offering in July. Having $100 million in the bank, and a stock price trading at 60% above its offering, is a far cry from when he had to borrow money to make payroll, says Crouch. PART SCIENCE. The biotech sector, after languishing for nearly a decade, is in the chips. The Amex Biotech Index has soared 115% so far this year, after a 55% rise in the fourth quarter last year, and shows few signs of waning. The climb is part hype, part science. Many biotechs are entering late-stage clinical trials that put their innovative drugs just one step from the commercial market. And the shares have been helped by momentum investors looking for new action after the Internet rout. Despite recent jitters, biotech's greatest bull market is still shoveling cash into companies: IPOs, convertible securities, and secondary offerings have hit historic peaks this year--at per-share prices that have delighted biotech execs. Consider Protein Design Labs, a Fremont (Calif.) company that develops monoclonal antibodies for the treatment of cancer and autoimmune diseases. It raised more than it expected with its $150 million convertible offering in February and with a subsequent $355 million secondary deal in September. Last month's issue was priced at $92 per share but leaped to $118. ''Investors seem to agree that we have a good story,'' says Robert L. Kirkman, vice-president for business development. Some 420 biotech companies already have shares trading. But only 40 will show a profit this year. Meantime, another 900 are still private, waiting their turn to go public. With more money chasing shares of only a few profitable companies, many funds and wealthy investors are seeking private equity stakes before companies go public. The question is, does all the scrambling and top-dollar deals signal a market peak and an end to biotech euphoria? Some companies admit they're being opportunistic. Says George Scangos, CEO of San Francisco-based Exelixis ( EXEL), a genomics company: ''You live life under the fear that the markets will get worse in a year when you need more money. So you get it while you can.'' And the getting has been good so far. The industry raised $8.6 billion in the third quarter, twice as much as in the same quarter last year. IPOs accounted for the biggest jump: 29 companies raised $2.4 billion--a twenty-twofold increase over last year's third quarter, reports Burrill & Co., a merchant bank in San Francisco specializing in the sector. Those IPO shares have shot up an average of 69%. But the range is wide: Dyax Corp.'s ( DYAX) shares soared 191%, while Regeneration Technologies lost 41%. Venture capitalists no longer have private equity to themselves. Commercial banks, hedge funds, and mutual funds are jumping into the fray. Mutual funds have generally avoided private stakes for liquidity and pricing reasons. Now, if a fund's charter restricts private investments, its managers are launching new funds without such constraints, including hedge funds that can short biotech stocks and use leverage. Among them are the $50 million Kinetics New Economy Partners and the $100 million Orbitex Life Sciences & Biotech Fund ( ORHBX). ''Investors are looking for more sophisticated vehicles. There will be more of these,'' predicts Timothy F. Bepler, who runs Orbitex Health & Biotech Fund--and racked up 104% gains so far this year. Private equity investors are ''falling all over themselves to get into late-stage financings,'' says Faraz Naqvi, manager of the Dresdner RCM Biotechnology Fund ( DRBNX), which also boasts triple-digit returns this year. Naqvi's fund can't invest in private equity--a ''mistake'' when its charter was written, he says. But Dresdner is considering a new venture fund. ''Basically, you go in for a quarter of the proposed [IPO price],'' Naqvi says. ''Your $100 may be worth $400 in literally the span of a few months.'' Biotech fever has even spread to local governments. State-run venture funds are cropping up in Pennsylvania, North Carolina, and Maryland. New York City taxpayers recently anted $25 million for the Emerging Industries Fund, to be managed by Paramount Capital, that will invest $10 million in biotechs that agree to create local jobs. ''Returns are important,'' insists Michael G. Carey, president of New York City Economic Development Corp. ''But the emphasis is on fostering an industry.'' CRITICAL MASS? The biotech boom has caught a lot of venture capitalists off balance. Many shifted in recent years to funding Internet, software, and telecom companies, which get to market--and pay off--faster. Of the $41.5 billion in venture dollars disbursed last year, only $1.4 billion went for biotech, reports Venture Economics Information Services. Now, some VCs are scrambling to get back into their game. ''The $500 catered-lunch crowd on Sand Hill Road may be trying to jump in again, but I don't think they'll be successful at doing it,'' remarks Robert T. Nelsen of Arch Venture Partners in Seattle, a biotech venture firm managing $325 million. In the first nine months of 2000, VCs have invested $2.1 billion in biotech, twice what they did all last year. The avalanche of money has got some observers worried. ''When deals are most pricey is exactly when there is the most venture-capital money. Then the returns start to drop,'' warns Charles Harris, who runs Harris & Harris Group Inc., a Nasdaq-traded venture fund. Steven Newby, manager of GenomicsFund.com ( GENEX), contends risk has reached critical mass. He won't touch private-equity deals. ''These [biotech] guys are almost working out of the trunk of their car,'' he says. ''They've seen Internet gold, and now they're seeing biotech gold.'' The biotech market will continue to be choppy in the short term. It suffered a three-month, 34% drop in the spring, in tandem with the dot-com bust. A failure in clinical trials or political pressures to cap drug prices could stall growth. Still, G. Steven Burrill of Burrill & Co. advises investors not to get ''lost in market mechanics and hype. What is going on is very fundamental.'' Indeed, the macropicture for biotech stocks has its pluses. The industry's main governing body, the Food & Drug Administration, has adopted a lighter regulatory hand to fast-track key biotech drugs. Meantime, the graying of America will kick up demand. And looming patent expirations at large-cap pharmaceutical companies will push them to establish strategic alliances with biotechs or acquire them outright. Sure, 2000 could turn out to be a replay of the 1992 biotech market, which soared until some promising new drugs failed to work and put the whole sector in the tank for eight years. But the industry is more mature now, says Jean-Francois Formela, principal of Atlas Ventures, whose $1.6 billion portfolio funds 50 life-sciences companies. ''While momentum players--who don't care what the human genome project is--have inflated the cycle, the likelihood is that value is being created,'' he says. If the biotech pundits are right, the industry's next nuclear winter may be a long way off. By Mara Der Hovanesian in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Biotechs Are Cloning Money CHART: Biotech Shines Even in a Weak Market TABLE: Mutual Funds Invest in Private Biotech Ventures INTERACT E-Mail to Business Week Online

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