April 4, 2011
Biotech IPO Setbacks Strain Industry's Capital Needs
Venture capitalists are struggling to steer biotechnology holdings to strong initial public offerings, a trend that undercuts their ability to finance companies through costly clinical trials.
Venture firms hoped a robust market for biotech offerings would emerge as the financial crisis eased, but that hasn't happened yet. While five venture-backed biotechs have gone public this year, most have raised less than they hoped, and some have seen their shares sink below their offering prices.
AcelRx Pharma Inc., for example, went public in February at $5, compared with price talk of $12 to $14, and now trades at $3.38. On Friday, underwriters managed to price Tranzyme Inc.'s offering at an expected offering size, but had to slash the price to $4 from an expected low-end of $11 while boosting the number of shares in order to get it out.
Venture investors do not count on IPOs to cash out of biotech holdings, as often done with technology companies, but they do see the public markets as a vital option for companies that need a big cash infusion. Weak demand for these offerings is restricting access to capital, depressing valuations of late-stage venture rounds, and giving corporations the edge in partnership and merger talks, investors say.
If the public-financing market does not improve it could also cause some venture firms to scale back in biotech, or even drop of it out altogether. That's what health-care investor Cross Atlantic Partners said it would do with its next fund, despite seeing some of its best exits through biotech investing. The New York firm, which told VentureWire last year it was aiming to raisent $100 million for Fund IV, said it decided to pull out from biotech because the rewards came too slowly.
For various reasons--including firms' own inability to raise funds--biotech investment is already slipping, with less money going into the field each of the last three years.
Investment in biopharmaceuticals fell for the third straight year in 2010 to $3.4 billion, down 20% from the year before and the lowest total since 2002, according to VentureSource, which is owned by VentureWire publisher Dow Jones & Co. If biotechs can't tap public investors for cash to run critical, value-creating clinical studies, the industry could lose its appeal for some venture investors.
A key problem is that few generalists these days are willing to take the risk of backing IPOs from biotech companies, which usually have no products or revenue at the time of their offering. As a result, these companies are often pitching to a small group of specialists who have supply-and-demand on their side. This is forcing many of them to cut their offering prices and to bring their venture backers into the deal.
The situation has venture investors thinking especially hard before taking a drug-maker public. One fear is that a company will cap any near-term buyout bids by going out at a valuation below what its venture backers see as its true worth. And that concern comes atop the perennial worries about the costs and scrutiny that come with a Nasdaq listing.
"We're being very selective about when and how we take our companies public," said Michael Carusi, general partner of Advanced Technology Ventures. "If we can finance them through other means, that's been our inclination right now."
Public investors aren't inclined to jump at a biotech offering unless they think it will be the last before a major milestone, like regulatory approval. Earlier-stage biotechs face a rough and unpredictable road.
Tengion Inc., which went public in April 2010, knows this as well as any. The developer of replacement organs and tissues focused the first $140 million it raised privately--from Bain Capital, Quaker BioVentures, and others--on a treatment for bladder dysfunction caused by a neurological disease or condition. It shelved plans for Phase III trials, however, after finding, in early 2009, that the surgical technique in this treatment was leading to complications. This led it to shift to a larger market, bladder cancer, but with a more nascent product.
Tengion went public at $5 but saw its share price slip soon after. In February, after a possible merger deal fell through, it warned that if it wasn't able to raise money soon, it may wind down. Staving off a collapse, it secured $31.4 million from Medtronic Inc. in March and is now funded through May 2012, more than enough time to get a look at data from the first five bladder-cancer patients in its Phase I trial. It hopes this study of its lead product, the neo-urinary conduit, will catalyze further fund-raising.
"There are very few, if any, great biotech success stories that haven't had near-death episodes," said Chief Executive Steven Nichtberger. "We're thrilled with the outcome [of] the PIPE."
Biotechs with advanced products have an easier story to tell, but even these companies can struggle. Pacira Pharmaceuticals Inc. considered a partnership to fund the launch of a post-surgical pain medicine, Exparel, but when the offers weren't to its liking, it decided to go public to build its own U.S. sales team.
Pacira submitted Exparel for U.S. approval in September and filed to go public in November. Since it ended the year with cash to last through July, when the Food and Drug Administration is expected to rule on the drug, it was not desperate. And since Exparel combines two agents used in FDA-approved products, it felt the drug presented relatively little risk.
Public investors, worried about regulatory uncertainty, saw it differently, and wanted a discount as a result, according to CEO David Stack. After setting out to sell 4.25 million shares at $14 to $16 in January, Pacira instead sold six million shares at $7 at its February IPO. "We expected them to drive a hard bargain, and they exceeded our expectations," Stack said.
Pacira, which raised $7.5 million of the $42 million from its venture backers--HBM BioVentures, MPM Capital, OrbiMed Advisors and Sanderling Ventures--sought to keep insider participation to a reasonable level. As a company looking to expand its shareholder base, it didn't want to rely on those investors to take a high percentage of the offering.
"We tried to avoid that by having a forthright discussion with our bankers even in advance of us going on the road," Stack said. "We worked with our investors to have a formula for how they were going to participate."
A standout among recent biotech IPOs is Aegerion Pharmaceuticals Inc., which went public in October at $9.50 and now trades at $16.29. Aegerion was already testing its lead product, lomitapide, in Phase III trials when it filed to go public in August. The drug targets a rare and dangerous genetic disease, homozygous familial hypercholesterolemia, which affects about 6,000 people in the U.S. and Europe.
Because lomitapide serves an unmet need, investors are less worried that the drug will face regulatory delays. And since it's aimed at a small population, Aegerion will be able to go to market with a modest sales team, said President William Lewis.
Aegerion still had to cut its offering price, but that's not always something to fear, according to Lewis, who formerly headed capital markets investment banking at Wells Fargo Securities. Aegerion had sought to go public at $14 to $16, sold five million shares at $9.50 at its Oct. 22 IPO.
"We took a little bit of a step back in price to make sure we got the best investors," Lewis said. "For us, it wasn't about the IPO price, it's about where [the] price is going to be in 12 to 24 months. The advantage of top-shelf investors [is] they buy and they hold."
Aegerion, whose venture backers included Alta Partners, Index Ventures, and others, now also counts mutual-fund company T. Rowe Price among its shareholders.
Some venture investors aim to capitalize on the market conditions through public investments. Safeguard Scientifics Inc. is tracking selected biotech stocks with market capitalizations under $100 million with an eye toward backing some that need a boost to reach an important milestone, said James Datin, managing director of life sciences.
"Clearly, with capital being tight we think there's some good buys out there," Datin said.
Capital may be tight today, but that could change if a few of the recent biotech IPOs start to gain traction or are bought by larger companies, said Carl Gordon, general partner of OrbiMed Advisors. A few more success stories would lift investors' mood.
"Things could always change," he said. "We're going to need some more good news in this sector--a few more IPOs that make people a lot of money."