NATURE BIOTECHNOLOGY VOLUME 16 SUPPLEMENT 1998 63

FINANCE

This inability to show sustained marginson sales is changing investors’ attitudestoward biotechnology’s propensity for longdevelopment times, large cash consumption,and substantial technological, medical, andregulatory risk. In the early 1990s, manyinvestors indulged these risks because theybelieved that if a company could simply get itsproducts to market, they would realize sub-stantial, venture-type investment returns.Unfortunately, this assertion proved false formany investors.

As a result, the prevailing financial mantraon Wall Street is, “Why take the risk?” Thishas resulted in diminished access to capital fora majority of the 330 public and 1,500 privateUS biotechnology companies. Investors nowincreasingly view biotechnology as “publicventure capital” at a high price. These in-vestors are exhibiting a genuine “Show me themoney” investment mentality.

The bottom line is that biotechnology canno longer use its youth, or the hype of itsfuture potential, as an excuse. The vast major-ity of institutional investors believe it shouldhave grown up and produced more pre-dictable, sustainable operating results by now.

Wooing them backBiotechnology must offer investors some sub-stantive changes, the most viable strategybeing industry-wide consolidation. There arenumber of factors driving this necessity. First,too many companies are chasing too few and,in fact, a shrinking number of investment dol-lars. Second, not enough qualified seniormanagement exists to staff the 1,800-oddcompanies. Third, too many companies arecompeting for the same niche disease mar-kets, such as CMV retinitis and Kaposi’s sar-coma. Fourth, the likelihood of an extraordi-nary number of patent lawsuits is becominggreater as more products are launched usingsimilar technologies. Fifth, too many compa-nies do not possess diversified portfolios tohelp offset the technology, regulatory, andmarket acceptance risks of a product launch.

Strategic combinations can address all ofthese issues. Unfortunately, most merger andacquisition activity to date has occurred notbecause of potential synergies that may be

They may lack passion and romance, butthey’re still getting hitched in record num-bers. Indeed, pharmaceutical companies areannouncing mergers and alliances in businessjournals frequently enough to rival spring-time wedding announcements in the societypages. Yet in the midst of all this matchmak-ing, biotechnology firms are often left waitingin the wings, hoping to catch a bouquetthrown by an institutional investor ratherthan seeking out a complementary partner.These weddings suggest that the businessmodel governing biotechnology investmenthas changed—perhaps permanently.

Grow up!Gone are the days when institutional investorsthrew money at early-stage biotechnologycompanies with abandon. Today, with the pro-liferation of biotechnology firms, fewinvestors have the inclination, the informa-tion, the technical capabilities, or the time toseparate the rising stars from the “also-rans.”Also, many investors now view early-stagefinancing as too risky. The alternative, invest-ing in numerous “inexpensive” later-stagecompanies—some that even have productsnear or on the market, or lower-risk platformtechnology companies, offers far fewer risks.

But even these later-stage companies arehaving a tough time selling themselves.Investors have learned through experience thatit is difficult to gauge a biotechnology prod-uct’s sales potential. Companies with annualsales as high as $50–100 million have had dis-mal valuations because their margins are sim-ply not high enough. Institutional investorswant to see a clear path to quality earningsthrough the tried-and-true Wall Street modelof sustained and predictable product sales,gross margins, and earnings growth.

realized, but rather as a way to save one orboth of the companies involved. A mergershould be considered only if the transactionsolves several critical operating, financial, reg-ulatory, and/or commercialization problems,and aligns the combined company morefavorably with the traditional Wall Streetmodel. Alternatively, creating a broad-basedtechnology platform capable of attractingpartnerships with other product companiesthat can move the company closer to earningsgrowth is also a favorable strategy.

Since the logic is compelling, why don’tmore of these transactions occur? In somecases, the boards of directors of emerging lifescience companies, often comprised of ven-ture capitalists, are exquisitely sensitive todilution, as it affects the ability of theseinvestors to cash out at attractive prices. Inother cases, senior management wants to pro-tect existing jobs. For still others, an emotion-al attachment between entrepreneurs and thecompanies they have created overshadowslogic. Finally, some boards and their manage-ment teams do not appreciate the urgency ofcreating shareholder value on a sustainedbasis in the near or immediate term.

ConclusionsManagement may have difficulty adoptingthe cold, analytical approach exhibited by bigpharmaceutical company executives whenassessing the wisdom of a merger or a busi-ness collaboration. But to compete success-fully in today’s investment arena, biotechnol-ogy companies need to look at the future andrealistically evaluate their business plans.

Answering such questions as, “Will thecompany be able to achieve sustained prof-itability and quality earnings in the next fewyears?” or “Are the products differentiatedenough to remain successful over the longterm?” or “Do we have enough cash on handto get the job done if access to capital underreasonable terms is denied?” will give you asense of where your company stands. If theanswers are negative, then a strategic M&A orother form of business collaboration shouldbe considered. If you did not catch the bou-quet at the last wedding, perhaps it means youneed a whole new set of friends. ///

Where have all the investorsgone?: The case for consolidationTo get Wall Street interested again, bioentrepreneurs need to build collaborations that can produce predictable product sales, gross margins, and earnings growth.

Robert S. Esposito and Marc J. Ostro

Robert S. Esposito is national partner-in-charge and Marc J. Ostro is senior managingdirector at KPMG Peat Marwick LLP, HealthCare Transaction Services, P.O. Box 7468,Princeton NJ 08543 (resposit@kpmg.com).The views and opinions are those of theauthors and do not necessarily reflect the views and opinions of KPMG.

© 1999 Nature America Inc. • http://biotech.nature.com©

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