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Cover Story


Those were the days my friend.

We thought they'd never end.

We'd clone a gene and form a company.

We'd raise some venture cash

And do our IPO in a flash.

'Cause selling dreams

Requires no p-e.

Biotech investment pro Richard M. Beleson of Capital Research Co. has entertained industry executives for years with his satirical songs. And this chorus from his recent Biotech Bear Market Ballad is particularly apt: Nearly 20 years into the gene-splicing revolution, the industry has ballooned to well over 1,000 public or private companies that have raised about $20 billion. Yet no one has cured cancer or produced a bioengineered miracle of loaves and fishes for a hungry Third World.

The industry is still peddling dreams, and it did raise $4.7 billion in public and private capital in the 12 months ended last June. But investors are getting leery, and the money flow is drying up. Except for a handful of top-tier companies with proven products, biotech stocks have plunged: The Amex Biotech Index is off more than 50% from its zenith in 1992. Ernst & Young estimates that only 50% of all biotech hopefuls have enough money to last 24 months, and most of those are still years from having a product. After a giddy run in the early '90s, "the market is disillusioned" with biotech, declares Karen Firestone, who manages Fidelity Investments' $500 million Select Biotechnology Fund. From Wall Street's perspective, "the technology hasn't worked, and the likelihood of success is lower."

After a decade as the highest-flying of America's high-tech industries, biotech faces a reckoning--and it's going to be ugly. The billions in investment have created an industry choked with copycat, capital-hungry companies lacking the critical mass of technology to survive. The vision that industry backers had of the path to riches no longer holds sway: Biotechnology, while immensely valuable, is not the shortcut to success in the drug game its advocates once thought it would be.

Instead, the industry has been hamstrung by uneven management, driven by greed to lure new investment and form companies that have little prospect of succeeding, and wracked by product failures. Even if the market warms up again, consolidation is inevitable. "Seventy percent of these companies need to go out of business," argues Lisa B. Tuckerman, who from her Montana base analyzes biotech for the New York investment management fund at Spears, Benzak, Salomon & Farrell. More and more executives in an industry renowned for its optimism agree. The best of the technology will survive, but primarily inside large drugmakers, not in an independent industry. "Nobody's going to make it alone," contends Genentech Chief Executive G. Kirk Raab, who came to that realization in 1990, when he sold 60% of his company to Roche Holdings Ltd.

Such talk was heresy just three years ago, when investors were enthralled with biotech. They showered the industry with $8 billion in public and private capital from 1991 to 1992. Aided by low returns from rival investments, by Amgen Inc.'s roaring success, and by a wealth of new technologies, the stock of almost any company with "gen," "cell," or "immune" in its name went one way: up. Venture capitalists, flush from almost 90 initial public offerings in those years, pumped out still more startups.

Yet investors were sowing the seeds of a future crisis. Biotech companies generally need 7 to 10 years and $100 million to $150 million to bring a new drug to market. During the 1991 bio-bull run, most newly public companies--plus older ones teetering on the brink--raised about three years' worth of money. Barring spectacular progress, chances were slim to none that the market would pony up as much or more money when that grubstake ran out. After all, to support even 50 companies with 50 products from lab to market would require at least $5 billion in total capital. And instead of great advances, in recent months the industry has produced high-profile product failures (chart).

NOTABLE SUCCESSES. Momentarily, at least, those gaffes have obscured biotech's stunning contributions. When venture capitalist Brook H. Byers of Kleiner Perkins Caufield & Byers (KPC&B) says that biotech has been "for human biology what the Italian Renaissance was for art," he isn't indulging in hyperbole. The technology has brought a vast array of techniques and tools to drug development and medical research. Today, "every pharmaceutical company is heavily involved in biotechnology," says Stephen K. Carter, senior vice-president for worldwide affairs at Bristol-Myers Squibb Co. And even when the final product is a traditional, chemical drug, increasingly, biotech will have played a role in testing the agent or providing insight into the disease it aims to fight.

As for products, biotech's list is short but impressive: Of the 24 top-selling drugs worldwide, 4 are derived from biotech. One of Schering-Plough Corp.'s best-sellers is alpha interferon, a $500 million-a-year product that it licensed from gene-splicer Biogen Inc. in Cambridge, Mass. The blockbusters that have emerged from Amgen--EPO to battle anemia and G-CSF to

fight infections in immune-suppressed patients--have turned the Thousand Oaks (Calif.) biotech pioneer into a cash machine: Amgen is generating $110 million in cash per quarter, even after plowing 19% of its $1.5 billion in annual revenues into research and development.

Thanks to biotech, too, fewer people die of heart attacks today because of Genentech's blood-clot-busting TPA. And that company's Pulmozyme makes breathing easier for cystic fibrosis patients, including Kimberly Myers of Half Moon Bay, Calif. By helping clear her lungs, she says, Pulmozyme gives her "the ability to stay out of the hospital and do more," such as concentrating on her career as a race-car driver. Millions of tests each year for everything from ovulation to AIDS are based on biotechnology. Meantime, a million or more people may have avoided getting hepatitis because of genetically engineered vaccines and blood-screening tools.

FALSE HOPE. Lab wizards also are unraveling what the 100,000 or so human genes do, promising eventual cures for diseases from cancer to rare genetic disorders. And as large drugmakers struggle to reenergize moribund antibiotic research, biotech outfits are at the forefront in fighting antibiotic-resistant bacteria. "There is tremendous innovation, and the accelerating pace of the science is incredible," says Dr. Janet Woodcock, director of the Food & Drug Administration's Center for Drug Evaluation & Research. "It's almost impossible to believe that the investment being put in is not going to pay off."

With ordinarily dispassionate regulators talking like that, why are industry executives singing "those were the days"? Because recent product-development setbacks have challenged an assumption upon which the financial structure of the industry was based--that by creating a more efficient path to new drugs, biotech entrepreneurs would take over the pharmaceutical business.

In 1976, when venture capitalist Robert A. Swanson and scientist Herbert Boyer formed Genentech, most large drugmakers were randomly screening thousands of chemicals each year looking for the drug equivalent of the needle in the haystack. Scientists knew that the body has its own storehouse of proteins that carry out important functions such as lowering blood pressure or fighting infection. Genes are nature's recipe for manufacturing those chemicals. So when Boyer and colleague Stanley Cohen found a way to slip a gene into cells that could then churn out huge quantities of the desired protein, it seemed like the perfect way to make great drugs--not just find them.

This approach worked for the pioneers. Drugs such as gene-spliced insulin, growth hormone, and the anemia-fighter erythropoietin had few side effects and moved efficiently through regulatory channels. In hindsight, though, those treatments, which replace well-understood substances the body manufactures, were easy targets. When companies pursued more complex villains, such as cancer, heart disease, and neurological disorders, all bets were off. Often, animal tests don't indicate how humans will respond to drugs for such diseases. And deciding just what protein would make a drug might mean picking through thousands.

Sepsis is a good example of the challenge. If you are severely burned or injured or have late-stage cancer, there's a decent chance you'll join the 600,000 Americans who develop sepsis each year. It's a massive infection that floods the bloodstream with toxins, leading to shock and, for 100,000 patients a year, death. The U.S. health-care system spends $10 billion annually treating these people. That sounded like a great market to Xoma, Centocor, Cortech, Chiron, and Synergen, which poured hundreds of millions into research on sepsis drugs. But they all failed. Sepsis, it turns out, is more complex than once thought: It involves a chemical cascade of events that can't be easily altered by a single drug.

AIDS research swamped other companies. Biotech tools have improved understanding of the disease, but the industry has yet to produce vaccines or effective treatments. Biogen, Genentech, and Immune Response have all suffered expensive setbacks in AIDS programs.

As the challenges have become more daunting, the industry has splintered into narrower segments. Some companies, such as Cor Therapeutics Inc. and Cephalon Inc., target specific disease areas such as cardiovascular or neurological problems. Others specialize in technologies: So-called antisense companies work with strands of DNA to try to block the function of deleterious genes. Others are unraveling how cells communicate with one another. And more than two dozen companies are racing to deliver genes to treat everything from genetic disorders to cancer (page 92) even though that field is years from a product.

ONE-IDEA OUTFITS. The trouble is, many of these are one-product companies. "A clustering of six ideas that could make one solid company inevitably turns into six companies," says Cor Therapeutics CEO Vaughn M. Kailian. And few of these startups have the resources to do the biology, pharmacology, physiology, and other research needed to succeed.

That helps explain why most of the drugs that biotech companies have put into clinical trials aren't working. Biotech analyst Sarah Gordon-Wilde at Amerindo Investment Advisors Inc. says that only about 10% of biotech drugs that enter clinical trials and about 50% of the drugs that proceed through the final level of testing may get approved--the same as for traditional chemical drugs. "The industry was valued so high and had such a premium because it was believed biotechnology would have a much higher `hit rate,"' she says. Unless startups have an efficiency edge over better-funded drugmakers, they have got to be preternaturally lucky to stay alive.

Look at Synergen. In 1991, the Boulder (Colo.) company was sitting on $300 million in capital. It was developing Antril, an antisepsis drug that some analysts believed could be a billion-dollar blockbuster, and its stock zoomed to a high of $75. Management exemplified the hubris for which biotech execs are legendary: When a Wall Street analyst criticized the company, Chairman Larry Soll sent him a package containing a tin of Shinola shoe polish and a gag-store pile of plastic dog poop, with a note suggesting the analyst couldn't tell the difference.

Not long after, however, Synergen revealed that its test results showed that Antril did not work as well as expected, although the company thought it showed promise for some patients. The board forged ahead anyway, building a manufacturing plant, hiring a sales force, and pushing Antril into another phase of more expensive tests. Synergen had blown through $165 million by the time it announced in July that it had stopped testing because the drug wasn't working. Management axed 60% of the workforce and is trying to find buyers for what remains of the company, say former Synergen executives. And Soll? He has told colleagues he wants to open a coffee shop in the San Juan Islands. The company declined requests for interviews.

The Synergen debacle underscores a major problem: The intense pressure to please investors and raise more R&D funds, some charge, is prompting unwise decisions on how soon and how thoroughly to test potential drugs. By the time Antril showed poorly in its first big trial, for example, evidence was building that sepsis might be too complex to treat with one agent. Other companies with failures, including Regeneron Pharmaceuticals Inc. and Magainin Pharmaceuticals Inc., have also been chided for not adequately evaluating agents earlier in the process and for rushing too quickly into big, expensive tests.

RUSH JOB. "Shortcuts are the longest road in this business," warns Raab of Genentech. He believes products should be taken into large trials only after intense attention to smaller, thorough tests. He concedes that Genentech rushed some of its earlier trials with its clot-busting heart drug TPA. That's one reason it had to spend $50 million on subsequent tests after the drug was approved to show it saved marginally more lives than competing agents.

Who's to blame for creating this financial Jurassic Park, where the bio-creatures reproduced too quickly and now fight for survival? Start with venture capitalists, the same folks who get the credit for getting the industry off the ground. "Returns have been disproportionately high for the venture capitalists and disproportionately low for the public," observes G. Steven Burrill of the San Francisco biotech merchant bank Burrill & Craves. By getting in early, then mostly cashing out when companies go public, the venture capitalists succeed even if companies don't. The big returns they collected from IPOs let them attract still more capital. The result: Even as existing companies faltered, they kept starting new ones.

Venture capitalists say that mentality is changing. In recent months, they've formed far fewer companies. And some have even started to invest more in later-stage, public outfits. Brook H. Byers, whose firm has started 50 life science companies since 1976, maintains that venture capitalists didn't conspire to overload the industry. "We've trained ourselves as decision makers and judges of quality" on a deal-by-deal basis, he says. More to the point, he insists that KPC&B tells 80% of the entrepreneurs seeking funding that they would be better off merging with an existing outfit or selling their technology. Venture capitalists aren't the only ones who got carried away. Universities looking for income from patents and licensing deals encouraged their scientists to form companies--and those researchers, wanting to run their own shows, resisted selling their discoveries.

FREE PLUG. Investment banks also played a role in this greed-fest. Binging on fat fees during the bull market, they had little incentive to keep long-shot companies from going public. Plus, some companies confide that certain investment banks won business by promising companies so-called research coverage--promotion--by the firm's biotech analysts. Ex-analyst Denise M. Gilbert isn't sorry she left the Street to join the biotech company Affymax Inc. after the bull market was over. She tired of trying to provide analyses on scores of stocks that tended to move "on a perception of an expectation." Also, "there was never an incentive to put a sell on a stock."

Management quality has been spotty, too: In the early days of biotech, many scientist-founders were accused of working on too many projects, sometimes going after human drugs, veterinary drugs, and agricultural projects simultaneously. More recently, a wave of pharmaceutical executives have entered the industry and adopted a "swing for the fences" mentality, notes industry consultant Mark Edwards at Recombinant Capital. They're increasing risks by focusing on just one or two projects involving potentially lucrative drugs for highly complex diseases. The hangover from all these excesses has left the market hostile to both IPOs and secondary offerings. As a result, Byers predicts, "maybe the top quarter" of companies will remain independent, while the rest will merge or go out of business.

Fidelity's Firestone believes the next 12 months will be critical for the industry. During this period, product approvals from the Food & Drug Administration and results from clinical trials are expected on a dozen key products (table). Good news--and the enthusiasm it would generate--could rally the biotech sector and reward both the companies involved and others with access to more capital. If current trends continue, however, the news will be mixed or glum. That will hasten bankruptcies and mergers--which might themselves be rickety if the partners lack enough cash.

The wild card in how biotech consolidates is the large drugmakers. When biotech appeared in the late 1970s, big pharmaceutical companies were boosting profits mainly by churning out "me-too" drugs and raising prices. Many initially rejected biotech, while a few brave pioneers made tentative investments. But health-care reform and pressure from managed-care companies have put the me-too strategy on the endangered species list. And traditional chemistry has run dry. So even though biotech may not be more efficient, mastering those tools has become essential to developing breakthrough drugs that will command premium prices.

Don't look for big drug outfits to do many outright acquisitions unless the stocks get insanely low. Bristol-Myers and Eli Lilly tried that with Genetic Systems and Hybritech, respectively, in the 1980s, and it didn't pay off. For one thing, entrepreneurial scientists bristled at all the bureaucracy and bailed out.

There are other models, however: On the heels of the Genentech-Roche deal, a few biotech companies, including Genetics Institute, Immunex, and Systemix, sold a majority of their shares to big drug houses but retained publicly traded stock. Edward V. Fritzky at Immunex Corp., now 54% owned by American Cyanamid Co., says that "the model for biotech used to be entrepreneurial and independent. Today, it's entrepreneurial and highly collaborative."

Straight licensing deals can pay off for both partners, as Chiron and Biogen show. And large partners who have invested in Centocor, Protein Design Labs, CellPro, Cephalon, and Ligand Pharmaceutical, for instance, are offering resources, including cash and expertise, to get access to promising products. Such deals will continue: "Biotech's only got about $1.5 billion in partnering funds today, but big pharma is spending $25 billion in R&D" each year with marginal results, notes Burrill. "It's more efficient and increases flexibility for big pharma to contract out more research instead of carry a huge R&D infrastructure."

Those deals force a new reality on shareholders. The smaller outfits get research payments and royalties rather than blockbuster profits. Still, it's a far less risky and expensive way to build a business. "I hate the home-run model," says Synergen co-founder Larry Gold, now chairman of Boulder (Colo.)-based Nexagen. He has made sure his company spreads risk. Nexagen has technology for generating large numbers of potential drugs that it's selling to different pharmaceutical companies.

One major hitch for biotech, however, is that for the moment, the big drugmakers are engrossed in their own takeover deals and drug-distributor acquisitions. Besides, biotech bargaining power erodes daily. Why should big companies cut deals now if by waiting a few months they can get a lower price? Many large drug houses are now negotiating from the posture, "You need a deal real bad? Here's a real bad deal," says Recombinant Capital's Edwards.

FIRE SALE. Many small outfits may end up licensing or selling their technology for peanuts. "They're having to take the crown jewels to the pawn shop," says PaineWebber Inc. analyst Linda I. Miller. Whether big drugmakers can push those technologies any faster than the small fry is anyone's guess, but their size gives more leeway to try.

A few optimists still believe that all biotech needs is some fine-tuning--and a string of hits--for Wall Street to be resmitten. Most seem to be entrepreneurs running private companies, such as Louis G. Lange, CEO of CV Therapeutics, which is working on cholesterol-lowering drugs. He believes the market will come back on the strength of investors seeking jackpots. "If I was an investor, I'd say there's only about four worth investing in," he says. "But I'm talking about four that could go to the moon."

Like most entrepreneurs, Lange is sure that his company will be one of the four. But as resources are stretched thinner in biotech, no one can count on salvation. Indeed, investors have finally realized what most gamblers eventually do: After a while, it doesn't pay to focus too much on any one hand when it's the long odds that are killing you. SOME BIOTECH WINNERS...

Company 1993 Revenues Earnings

Product Millions Millions Stock price

AMGEN $1,500 $383.3 53 1/4

EPO to fight anemia;

Neupogen, an immune stimulator

BIOGEN $149.3 $32.4 52 1/8

Alpha interferon for hepatitis and cancer,

Hepatitis B vaccine (both licensed); diagnostic technology

CHIRON $317 $32.4 67 3/4

Hepatitis tests (licensed to Ortho); Interleukin-2, an anticancer

agent; Betaseron, multiple sclerosis drug

GENENTECH* $649.7 $58.9 50 7/8

Human growth hormone; TPA for heart attacks;

Gamma interferon for a childhood immune disorder;

DNAase for cystic fibrosis

GENZYME $274 -$6 35 1/2

Ceredase and Cerezyme for Gaucher's disease

*65% owned by Roche Holdings Ltd.


If key products move forward, analysts predict the industry could

rally. If not, biotech stocks will drop more. Look for news on

these products...


Conducting pivotal trials on Integrelin, which treats disorders

that follow heart attacks


Testing Beta interferon to slow progress of multiple sclerosis


Awaiting approval of ReoPro to prevent blood clots


Completing key tests on Betakine to treat macular holes, a condition

of the eye that leads to blindness


Testing Thyrogen as a treatment for thyroid cancer and hyaluronic

acid as a product for surgical adhesions


Awaiting key data on a new vaccine for childhood diseases such as

whooping cough


Awaiting approval for wound-healing product


Awaiting approval on a cell-separation system to aid in bone marrow



Awaiting approval on WinRho, a potential blood-disorder treatment



Joan O'C. Hamilton in San Francisco

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