The spin on spinouts

The latest spate of spinouts in the biotech sector last week reflects the increased popularity of hiving off new companies and subsidiaries. Although the strategy has been associated with mature companies that want to off-load R&D from their earnings statements, in fact a surge of spinouts by still unprofitable companies has a wide range of other rationales.

In strict accounting terms, a spinout refers specifically to the distribution of a subsidiary's shares to the parent company's shareholders. But in more common parlance, the term is used loosely to label entities created by covering technology with a tracking stock or placing it into a separate legal entity such as a subsidiary.

Using this broader definition, at least 31 such entities have been announced since the beginning of 1998, and they include the well-known special purpose R&D limited partnership as well as a few tracking stocks.

However, more than half of the parent companies in the list are not profitable, suggesting that their motives must lie elsewhere than in earnings protection.

In many cases, the subsidiary is a vehicle for obtaining third party financing for a project that eventually will become a separate business.

Tracy Lefteroff, partner in charge of Global Life Sciences Industry Services at Pricewaterhouse Coopers LLP, said that these companies generally are "looking for an orderly liquidation of technology while maintaining value." If a technology has value, the parent often can realize a greater benefit by retaining ownership of a piece of the technology without having to raise the money to develop it, he said. By creating a subsidiary and selling off ownership as the technology matures, the parent achieves a higher return than it would see if it simply sold the undeveloped technology.

But spinoff stratagems go beyond the desire simply to tap into third party finance. For example, Scott Morrison, director of life sciences for the Pacific Northwest at Ernst & Young LLP, noted biotech companies often form subsidiaries because they have identified a project that has a risk profile different from that of the core technology and is therefore inconsistent with the risk profiles of the existing shareholders.

Indeed, interviews with these companies reveal a host of other reasons, including use of subsidiaries to monetize assets over time as part of an effort to finance the parent. Subsidiaries also are set up to extend the reach of a core technology by placing it in a different context or improving its management. Still others have been formed to facilitate potential M&A, to broaden its investor base geographically, or obtain access to academic research in other countries. Companies have set up foreign subsidiaries to take advantage of state sponsored entrepreneurism as well.

Discussions with companies also reveal that issues of timing and market receptivity help to dictate their thinking as to when a spinout might be optimal.

Spinouts as core strategy

Spinouts are an integral part of Axys Pharmaceuticals Inc.'sstrategy to expand the uses of its platform technology and provide sources of finance to the parents.

President and CEO John Walker cited Xyris Corp. (San Diego, Calif.) as his "first and best" example of the strategy. It was created with third party capital from Bay City Capital. The company applies AXPH's platform - from gene identification through chemistry - to develop products for agricultural biotechnology.

Xyris last week signed a letter of intent to acquire Global Agro Inc. (San Diego, Calif.) to create Akkadix Corp. The merger would broaden Xyris' intellectual property base in genes for plant traits and provide it with a source of germplasm(see A9).

AXPH (South San Francisco, Calif.) expects the eventual

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