Tuesday, September 8, 1998
What earnings are worth
Looking for comps
The longitudinal pipeline
How much does it take?
Increasing the velocity of a product technology
Sidebar: What is small cap?
Sidebar: Testing the Mother Lode
One of the problems with biotech, as we've written many times
over the years, is its love affair with science. Unlike their nerdy counterparts
in high tech, whose fiddling with computer programs and appliances can result
in a marketable product in six months, fooling around with science is more likely
to result in a marketable product only in 10 years, if at all.
As everyone knows, in the biotech sector there is too much
science masquerading as companies, too many companies in aggregate, and too
many companies still being formed based on a single scientific idea coming out
The sorry state of public equity financings for biotech this
year - only $589.3 million has been raised in IPOs and $549.4 million in conventional
follow-on offerings - is indicative of more than the changes at mutual funds
that have caused them to focus on larger-cap stocks. Investors have become disillusioned
with the various biotech business models that were concocted over the past 5-6
First, the capital markets became skeptical of product companies
when they produced too many failures based on too many poorly designed clinical
trials, or trials of compounds that should have been abandoned at earlier stages.
Now they have become disillusioned with discovery platform models, as it appears
that the majority of those service-oriented businesses - with some significant
exceptions - won't be able to generate sufficient long-term revenues to achieve
the kinds of profits and growth rates that investors demand.
For a time it appeared that Europe was immune to the investor
flu, but the London stock market this year has punished biotech in ways unthought
of a year ago. "Investors are shunning biotech because the first 30-odd London
listed companies have just delivered belly flops as they've entered the pool,"
said Chris Evans of Merlin Ventures, who is one of Europe's most successful
biotech entrepreneurs. "There have been dozens of bad clinical announcements
and costly management issues. And the science seems to be failing all over the
place due to lousy compounds being hyped up in the clinic in the first place."
While Continental Europe has still to feel the cold chill of
clinical disappointments, that prospect is now being discussed (see A2).
Thus, for the first time in the memory of the many newcomers
to the industry, the capital markets for biotech have become dangerously small.
At the same time, frustrations rise as the industry clearly
has built significant value, and the sector is in the midst of an explosion
of targets and compounds that should ultimately result in a plethora of new
drugs. There is a great deal of powerful and useful technology out there that
should aid in the drug discovery and development process - but much of it is
too scattered to enable anyone to bring its full power to bear.
Thus the issue for companies is how to bridge the gap between
the potential of biotech and the goals of investors and companies alike for
sound businesses with long-term growth potential.
This year, the Back-to-School Commentary will argue that this
requires getting back to basics - thinking about the fundamentals of corporate
formation and development that are requisites for any company in any business
that wants to do more than just survive.
Instead of building companies around a single - usually tiny
bit of - technology or scientific insight, getting back to basics implies accumulating
and bringing to bear the numerous tools and technologies that any single company
must possess in order to be successful.
This does not deny that there are truly fundamental technologies that fit the
definition of "product platforms" out of which numerous drugs can be derived.
Rather it is a reminder that there are not many technologies that fit that bill,
and even companies based on such broad technologies cannot survive on those
As an aside, this thesis provides a microeconomic argument
for industry consolidation, in contrast to most such arguments that start from
a macroeconomic perspective, which is the perceived sheer excess of biotech
companies. The secret to making consolidation work is to provide a microeconomic
rationale for it. That rationale is the goal of developing a drug for an unmet
clinical need, and the need to find and combine technologies to get there.
However, this Back-to-School Commentary is not focused on consolidation,
nor does it have any interest in consolidation per se. Rather, this is about
creating sustainable companies that have a reasonable chance of creating enough
scale to become an interesting long-term story on Wall Street or The City of
London or other global equity markets. The principles espoused here should apply
to green fields startups, as well as struggling companies wondering where to
Benchmarks for viability
Obviously, there is no single answer to what makes a successful
company - clearly there are successful companies that have started out with
royalty streams, while others have started with proprietary products, others
have begun as discovery platforms and are maturing into product companies. Still
others have developed deep and broad information-based services.
But if sustainability and scale are the critical attributes
of success, then some common benchmarks can be identified:
• The ability to reach significant market valuations.
• A product focus.
• A technology or technologies capable of producing multiple products.
• A longitudinally complete pipeline with no significant gaps between Phase
III and preclinical compounds.
• A research and development process focused on developing real products
for real medical needs.
• A deep management team.
• A financing plan that is realistic with respect to the amount of capital
that will be required over time.
• A profit plan that plausibly layers income over a relevant timeframe to
show how profitability, viability and long-term growth can be achieved.