News Feature

Nature Biotechnology 24, 240 - 242 (2006)

Where the money is

Michael Fitzgerald1

  1. Boston

It was US investors that largely bankrolled the biotech industry over the past 25 years. Is all that about to change? Michael Fitzgerald investigates.

Where the money is

Robert Dale ©

Packing a punch. US investors are still second to none for biotech.

Ask nearly any biotech CEO which capital markets have figured most prominently in biotech financing over the past 25 years and he or she will tell you, quite simply, the US capital markets. To be sure, the importance to biotech of venture capitalists and private equity investors cannot be overestimated; private investors breathe life into struggling startups. But make no mistake, it has been the long-term capital flowing from the likes of the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) and, most importantly, the NASDAQ stock market that has played the pivotal role in making the US biotech industry by far the world's largest in both market value and product sales. It is no secret that most biotechs based outside of the US have created, or plan to create, a US base of operations in part to gain access to these capital markets one day. As a result, US capital markets play a pivotal role in the fate and fortune of most of the global biotech industry.

But will US capital markets be as important ten years from now? Up until a few months ago, the answer would have most certainly been, yes. Now that the numbers have been tallied for the US and Europe, which account for over three-quarters of the world's biotech financing, some say the answer is no longer clear cut. So from where in the world will the money be flowing into biotech over the next decade? Will it lead beyond New York City, home of the NASDAQ, NYSE and AMEX? Contrarians say, yes; veterans say, unlikely.

Contrarians' lament

Last year was a banner year for European biotech investing. In fact, 2005 marked the first time in the 30-year history of biotech that more biotech firms went public in Europe than in the US.

Contrarians point out that there were more initial public offerings (IPOs) in Europe than in the US—23 offerings to 18. European firms raised slightly more money, too: $916 million compared with $900 million in the US (Fig. 1). Veterans, of course, note that these European numbers include a $200-million IPO of the 76-year old French pharmaceutical maker Ipsen based in Paris. Still, both contrarians and veterans can agree on one thing: these financing numbers stand in sharp contrast to 2004 when 34 biotech firms went public in the US and only 12 floated in Europe.

Figure 1: The amount of capital raised by biotech through IPOs over the past ten years.

Figure 1 : The amount of capital raised by biotech through IPOs over the past ten years.

(a) IPO capital by geographical region. (b) IPO capital by major public market. 'Other' includes companies going public in Asia or in other unidentified markets. Sources: BioCentury and Nature Biotechnology.

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It wasn't the first time that firms raised more money in European IPOs than in American; it happened at least once before, in 1998. But never before had the actual number of IPOs been higher outside the US. In the past decade, the smallest gap was in 2002, when five companies went public in the US compared with three in Europe. The biggest gap in the past decade? That was in 1996, when 58 companies went public in the US compared with only 14 in Europe.

Don't expect that kind of gap again, says G. Stephen Burrill, head of Burrill & Co., a San Francisco biotech merchant bank. Burrill predicts "robust" international markets over the next ten years that will continue to see more companies go public than the US equity markets. Part of the reason for this is the development of the global market for biotech.

The industry is essentially 30 years old now and has become a more global business. Consequently, with each passing year there are more biotech firms getting up and running outside of the US. In the past, biotechs tended to go public in their home markets first. Burrill says that regional exchanges like the AIM (Alternative Investment Market) in London, Mother Index in Tokyo and the SWX (Swiss stock exchange) in Zurich have developed into respectable markets for companies that want to go public and create a presence in these markets.

"The savvy company will go public where they can get the best value," Burrill says, adding that the US does not always offer the best value for a biotech firm—regardless of where the firm was started and is now largely based. Burrill points out, for example, that a biotech firm that is selling products in Japan might well find it can get the best value going public in Japan. There is some basis for this assertion. Last year, MediciNova, which is based in San Diego, did in fact go to Japan to float its public offering and managed to raise almost $170 million in its IPO on the Osaka Securities Exchange.

The wisdom of crowds

Burrill is just as quick to assert, however, that "everyone would love to be on the NASDAQ," adding that as a result, "the US will most likely continue to be the dominant place" for capital for many years to come. "The NASDAQ is the gold standard, and will remain so," says Peter Hoffmann-Fischer, managing partner of Catalysis Capital Partners in London, formerly with Robertson Stephens. NASDAQ, he points out, is now a globally accepted form of stock. "If you [want to] be a global player, you need global paper," says Hoffmann-Fischer. He says that international cross-border investors often find NASDAQ paper more attractive than paper from a European exchange.

Although S. San Francisco's Genentech switched from the NASDAQ to the NYSE, the NYSE does not have the same cachet in the biotech business as the NASDAQ.

Burrill and Hoffmann-Fischer speak for the chorus

Although the US is far from the only country that produces excellent biomedical science, the US capital markets—most notably the NASDAQ—stand alone in their ability to finance biotechs on an increasing scale, in a relatively stable and rational manner, year in and year out.

Likewise, then and now, the US has seen arguably the most diverse array of companies and institutions investing in biotech, from General Foods in Rye, New York, to pension funds to engineering groups like Fluor in Irving, Texas. The stability and diversification of biotech's investor base in the US has also reassured venture investors, notes Frederick Frank, vice chairman and a director at Lehman Brothers in New York. And likewise, the entrepreneurial culture in the US further solidifies in the minds of investors the notion that there will always be a steady supply of biotech investment opportunities; in other words, investors view biotech in the US as a viable asset class.

It has not hurt that US biotech companies like Thousand Oaks, California-based Amgen; Genentech; Framingham, Massachusetts-based Genzyme; Cambridge, Massachusetts-based Biogen; and the like, have proved themselves hugely profitable investments over the years. Even though most biotechs flop, investors in the US have proved over the years that they hold out hope that any biotech at any given time can be the next Genentech.

"[Genentech's 1980 IPO] made headlines," says Frank. "All the venture capital firms that had supported Genentech obviously did extremely well." That set a tone for U S investors.

It has been argued that the risk-reward calculus in US capital markets has been and likely always will be very different from that in Europe, where most of the rest of the world's biotechs are built.

"You've got to understand that fundamentally, Americans are forward-looking gamblers," says Stelios Papadopoulos, vice chairman of S.G. Cowen and Co. "Europeans are far more analytical-retrospective historians. I grew up in Greece and every time you have a conversation, you have to look back two-and-a-half thousand years."

Papadopoulos argues that biotech was simply too fraught with risk to have emerged in Europe, and the subsequent size of markets, levels of trading and volatility and the diversity of financial instruments available stems from the difference in mind-sets. Although European investors have become more sophisticated, he sees no signs that there will be any fundamental cultural shifts.

Sophisticated instruments

It's not just IPOs that attract investors in the US, so-called secondary offerings—financings that occur after a company has gone public—are also hugely popular there (Fig. 2). The number and value of secondary offerings in US capital markets dwarf those in Europe. In 2005, US secondary offerings produced more than $5.4 billion for biotech firms compared with a mere $6 million in Europe.

Figure 2: The amount of capital raised by biotech through follow-on offerings over the past ten years.

Figure 2 : The amount of capital raised by biotech through follow-on offerings over the past ten years.

(a) Follow-on capital by geographical region. (b) Follow-on capital by major public market. 'Other' includes companies going public in Asia or in other unidentified markets. Sources: BioCentury and Nature Biotechnology.

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Immensely popular private investments in public equities (PIPEs), which create either special classes of stock in a company or debt that can be converted into stock, are also far more common in the US than in Europe—and this won't likely change in the next ten years, either.

Last year, US capital markets raised more than $1.9 billion in PIPEs for biotech firms compared with $475 million in Europe and a mere $87 million in Asia. The discrepancy was even bigger in 2004, with $2.4 billion in PIPEs in the US and $278 million in Europe, with only $25 million in Asia.

And these are just public investments. Another reason US capital markets are so strong is because the country has such a vast and experienced private investment pool of capital. For example, in 2005, private biotechs raised some $7 billion in US capital, which was up from $5 billion in 2004. Some $3.5 billion of that was invested by venture capitalists, down slightly from $3.7 billion in 2004, according to data from Burrill & Co. In Europe, venture capitalists invested $794 million and $828 million in biotech in 2004 and 2005, respectively. Life sciences venture investing now makes up 40% of all US venture investing.

"The pool of money is so much deeper [in the US than anywhere else]," says Mirko Scherer, CFO at GPC Biotech, a Martinsreid, Germany biotech firm. "In the United States, you started out with Amgen and Genentech, and there have been many others, that have made investors rich. In Europe, there is Actelion. [Other than that], success stories have been few and far between. The European biotech industry hasn't been making people rich."

But what about 2005?

But, what to make of 2005? Why did European IPOs outstrip those in the US? The explanation most often heard among investors is that there was simply a bumper crop of European biotech firms that were ready to come to market. Conversely, the US market, some argue, was overly jittery in 2005 while investors weighed the impact of interest rate hikes, rampant energy costs, political pressure to reign in prescription drugs and Whitehouse Station, New Jersey's Merck's Vioxx (rofecoxib) scandal. Several observers simply write up Europe's apparent IPO edge over the US as a fluke that does not portend a trend as the fundamentals that drive biotech investment in the US remain vastly superior to those elsewhere in the world.

The US, for example, will remain the largest market for biotech drugs for at least the next ten years; it has the deepest pools of capital and the most diverse base of investors; and it has by far the most opportunities for continued financing. These are important factors for an industry where the length of time to build a company has increased past the point where private equity is able to bring many companies to the point of break-even cash flow.

That need for more cash to get products to market has driven some European biotech firms to try to buy their way into US capital markets by acquiring US firms or operations. Last year, for instance, UK firm Cyclacel, headquartered in Dundee, bought Seattle, Washington's Xcyte Therapies in a reverse merger. Meanwhile, the German firm GPC Biotech has both acquired Waltham, Massachusetts-based Mitotix (in 2000) and was able to list on the NASDAQ in 2004.

Spiro G. Rombotis, CEO of Cyclacel, said the firm was acquiring Xcyte and moving its headquarters to New Jersey after its own efforts to go public on the NASDAQ had failed. He said that he had very little interest in floating a public offering elsewhere. "Most of our competitors are based in the US and financed there. We need to be on a level playing field with them."

Likewise, Rombotis thinks it helps his firm to use US accounting standards and to be compliant with Sarbanes-Oxley rules on reporting, which he says are "an improvement" over governance systems elsewhere. Mostly, though, Rombotis says that his company's products require more capital than he was likely to find in Europe. "For ongoing capital access, the US is the place to be," he says.

Rombotis mentions two more subtle reasons why being public in the US helps. It gives him better leverage when negotiating with potential partners in the pharmaceutical industry, precisely because he has other options for cash; it also helps him with recruiting. "We've found it difficult to attract experienced talent. A US listing has extra importance for us, because they know they can get options, and so it's a very important recruiting tool."

GPC Biotech's Mirko Scherer says that in a 2004 secondary offering, the firm felt it was imperative to raise one-third of the capital in the US to build presence for a concerted push to investors in 2006.

He adds that it was clear that "if we were going to build a relatively large company, we had to come to the US" to gain access to its capital markets. Although its largest investors are European, Scherer believes that the chance to do secondary offerings is a normal part of business in the US, and "very difficult" in Europe.

What could topple the king?

Despite the expectation that the US's capital strengths will remain supreme, a few variables could sufficiently boost capital markets outside of the US to challenge America's preeminent spot as the capital markets' center of the universe.

For starters, there has been a shift in capital markets for early-stage biotech firms. It has become increasingly difficult for early-stage biotech firms without products and sales—or at least late-stage product prospects—to go public in the US. S.G. Cowen's Papadopoulos says that this might indeed be a normal cycle in US biotech investing. But it might also represent a permanent shift driven, he thinks, by a broadening of the type of investors who want biotech stocks, but don't understand the science well enough to absorb the risks.

It is entirely possible that some other country's capital markets could in the next ten years move aggressively to fill this void and capture, and then endear themselves to, a generation of early-stage biotechs. (It won't likely be a single country in Europe as Europeans are even more wary of early-stage biotechs than their US counterparts.)

There is also growing interest by governments to replicate US success in biotech. For starters, governments in places like Germany, Canada, Italy, China, Japan, Israel and elsewhere are helping biotech startups, through direct investment, research and tax credits and other incentives. That at the least makes it easier to finance an early-stage biotech.

What is far from certain is whether any of these efforts will translate into capital markets that will (in a substantive and sustainable way) challenge those of the US. Save perhaps for Japan, Asian stock markets do not have the liquidity and volume needed to draw biotech firms. Even fast-growing economies like China and India lack consistent volume in their stock markets. China, in fact, in the past year made it harder for Chinese investors to take their profits offshore. Though both China and India have signed on for the World Intellectual Property Organization, neither country has legal mechanisms to enforce intellectual property protection. Domestic firms are as much at risk as foreign ones. This is a 'deal-killer' for biotech investments.

No one that Nature Biotechnology spoke to around the globe thinks any of the European exchanges will be a real competitor to the NASDAQ anytime soon, despite the fact that bourses in the UK and Switzerland are popular in Europe as a starting point for financing public biotechs.

Some have suggested that the Euronext exchange could become a force to be reckoned with. The Euronext combines bourses from Paris, Brussels and Amsterdam. Bringing the AIM or the SWX into this pool of capital might advance European capital opportunities for biotech firms. But Peter Hoffmann-Fischer and others argue that what Europe needs is a 'fresh start' market not hampered by preexisting ways of doing things.

For now, at least, the only legitimate threat to US capital markets, where biotech financing is concerned, is the US government. "Healthcare costs are rising, and at some point the government may just say 'enough is enough'" and start to set pricing, says Eric Schmidt, managing director at S.G. Cowen. Schmidt thinks this could happen in the next decade. If the US government were to set drug pricing, that could stifle biotech innovation here.

But Lehmann's Fred Frank, who has long warned of the day when price controls come to the US, says it will take more than this to erode the dominance of US capital markets. For at least the next ten years, it will take something mighty indeed to derail the US biotech money juggernaut.