Small-Cap Biotech Faces Financial Woes

The biotechnology sector, like other industry segments, has been hit hard with the recent volatility in global financial markets. This situation is particularly true for smaller companies, which are facing cash-flow pressures and lower stock valuations.

“We know that finance has been the industry’s umbilical cord for the past 40 years…the implosion of financial institutions has served to sever the cord and now the biotech ‘infant’ is left to fend for itself,” said G. Steven Burrill, CEO, Burrill & Company, a San Francisco based private merchant bank, in a Nov. 3, 2008 press release. “The more mature and blue-chip biotech companies will do just fine since they have plenty of cash, product revenue streams, strong pipelines and Big Pharma partners. It is the large universe of small public companies and private companies looking for venture capital who will feel the most pain.”

Many publicly traded smaller biotechnology companies face cash-flow pressures. “The prognosis for the almost 200 publicly-listed biotechnology companies that have seen their market cap drop to less than $100 million will find the next 12 months challenging since they are often trading at almost no multiple to their cash,” said Burrill, in the Nov. 3 release. “These companies will need to find ways to extend their runway and stretch out the funds that they have remaining.”

A review of recent financial data shows the recent difficult times for the biotechnology industry. The collective market capitalization of the biotechnology industry was $375 billion at the close of November 2008, down 10% for the month, down 20% since the end of September, and 16% year-to-date, according to Burrill & Company. November’ decline followed a decrease in October, in which the collective market capitalization of the biotechnology industry closed at $417 billion, a drop of 10% for October. At the end of November, Genentech’s (South San Francisco, CA) market capitalization was $79 billion compared with $87.5 billion at the end of October, according to Burrill & Company. Amgen’s (Thousand Oaks, CA) market capitalization was $59 billion at the end of November compared with $63.4 billion at the end of October. Gilead Science’s (Foster City, CA) market capitalization closed at $41 billion at the end of November, also down from $42.2 billion at the October close.

Relative to other industries, however, the devaluation of the biotechnology industry has been less severe. In the first half of 2008, the biotechnology industry's market capitalization reached a record $521 billion, according to Burrill & Company. “In the subsequent five months, the industry lost 18% of its value, better than the Dow and NASDAQ, which shed 22% and 33% of their value, respectively, in the same five month period,“ said Burrill in a Dec. 1, 2008 press release.

Analyzing biotech’s monthly performance, the Burrill Biotech Select Index, a price-weighted index tracking 20 biotech blue-chip companies, finished October down 10% and November down a further 7.6%. In comparison, at the end of October, the Dow Jones Industrial Average fell 14% and NASDAQ market declined 17%.

The large biotechnology companies have not been immune to a devaluation in their stock prices, but analysts are optimistic on these companies' underlying fundamentals. “Although the past two months have been ugly, with biotech’s blue-chip companies shedding 17% of their value, their fundamentals of strong sales and robust pipelines will see them recover, but it will take some time,” said Burrill in the Dec. 1 release.

For small-cap biotechnology companies, the outlook is more sobering as certain indices show. The Burrill Small Cap Biotech Index dropped 13% in November 2008 and 34% since the end of September 2008. Among the 370 publicly-listed biotechnology companies tracked by the monthly Burrill Biotechnology Report, 54% have a market capitalization well below $100 million.

“We are starting to see a clear pattern evolving for these companies,” said Burril in the Dec. 1 press release. “Companies are shrinking to conserve cash and extend their runway. Unfortunately, headcount is their biggest expenditure, and as a result of the negative capital markets, many programs have been put ‘in the refrigerator’ until better times prevail.” The Burrill Biotechnology Report identified 15 North American biotech companies that announced restructuring in November.

Mergers and acquisitions are expected to increase for those companies with cash as well as for companies facing low stock valuations that may become attractive acquisition targets at low prices.

“There will also be reverse mergers, many of these will be into public shells or ‘burnout’ companies that have seen their product fail, but still with cash in which the mergee believes that this vehicle will increase their funding options and provide a pathway to liquidity for their venture capital/private equity investors,&ldquo said Burrill, in the Dec. 1 release. “If not restructuring, biotech companies will be acquired at bargain basement prices,” Burrill noted.

As of the end of October, 30% of the public biotechnology companies tracked by the monthly Burrill Biotechnology Report were facing the prospect of NASDAQ delisting notices until NASDAQ announced that it had suspended its minimum bid price and market-value requirements for continued listing for three months in response to the continuing market meltdown. Even this extension, however, may not be long enough as the consensus appears to be that the industry is facing a long downturn.

On Nov. 24, 2008, the semi-annual ranking of the NASDAQ Biotechnology Index took effect. The re-ranking resulted in three securities being added to the index. All securities are classified according to the Industry Classification Benchmark as either biotechnology or pharmaceutical. The securities that meet the classification criteria then must meet other index eligibility criteria including listing on the NASDAQ Global Market or the NASDAQ Global Select Market and meeting minimum requirements for market value, average daily share volume, and seasoning as a public company. The index is ranked on a semi-annual basis in May and November.As a result of the reranking, several companies were removed from the NASDAQ Biotechnology Index. These were: Cell Therapeutics (Seattle)deCODE genetics (Reykjavik, Iceland), Dynavax Technologie (Berkeley, CA) EPIX Pharmaceuticals (Lexington, MA), ISTA Pharmaceuticals (Irvine, CA), MDRNA (Bothell, WA), Nuvelo (San Carlos, CA), Orchid Cellmark (Dayton, OH), and Penwest Pharmaceuticals (Danbury, CT).

Three companies were added to the NASDAQ Biotechnology Index. These included Celera (Alameda, CA), a diagnostics company that delivers personalized disease management through a combination of products and services. The company operates a clinical laboratory that provides testing services and develops, manufactures, and oversees the commercialization of molecular diagnostic products. Also added were Micromet (Munich, Germany), which develops antibody-based drugs for treating cancer, inflammation, and autoimmune diseases, and Optimer Pharmaceuticals (San Diego, CA), a company that discovers, develops, and commercializes anti-infective products.

“When the markets do return in late 2009/early 2010 we are likely to see a very different industry than exists today,” said Burrill. “Already we are seeing that companies with limited cash are starting to cut their work forces and even eliminate research and drug development projects in a desperate effort to extend their runway. Some might have to sell themselves at less than favorable prices since it is a buyer’s market.”

“We are not writing biotech’s obituary,“ he said. “In fact, these stressful times will force companies into looking at what they have and how those assets can be monetized. They will also have to look further afield for financing and potential partners such as the BRIC countries-Brazil, Russia, China and India.”