Biotech: America's Dream MachineJoan O'C. Hamilton
Los Angeles stockbroker Richard Bock had one heck of a 1991. The 58-year-old biotech stock specialist for Sutro & Co. racked up 200% to 300% gains for most of his clients and made "more money than I've made in my life." Now, Bock is looking at million-dollar homes. His clients say he earned his fortune: Several call him a "walking encyclopedia of the field." But lately, when he's knee-deep in literature from some 250 public biotech companies, he wonders why he bothers. "It doesn't pay to be too smart," he says, "when 95% of the investors have no idea what they're doing."
Last year, anyone could have made out in biotech: If in January you had invested in one of six companies with "immune" in its name--Immunex, ImmuLogic, ImmunoGen, Immunomedics, MedImmune, or Immune Response--you'd have had a 60% to 1,200% gain by December. Biotech stocks as a group soared 100%-plus, three times the rise in the Standard & Poor's 400-stock index.
This is surely a passing phenomenon, set off in part by the flight from sagging real estate values, busted banks, and low-yielding bonds. Should industry leader Amgen Inc. stumble, says Phillip J. Whitcome, CEO of Neurogen Corp., "it would not only be Armageddon for Amgen but for everybody." Already, 1991 highfliers Immune Response, MGI Pharma, Chiron, Synergen, and Centocor have slid well off their highs. U.S. Bioscience Inc., based in West Conshohocken, Pa., lost half its $1.2 billion market value one day in February after a Food & Drug Administration committee sought more data on the company's cancer drug, Ethyol. On Feb. 19, Centocor's stock quickly dropped 9 points after the FDA raised questions about Centoxin, its drug that fights blood infections called sepsis.
But the speculation over when the market frenzy will end overshadows an inescapable truth: The supercharged stock runup isn't just for investors. It's a coming-out for the industry, too. More than 50 biotech babies have gone public since 1991, while another 50 public companies raised new equity. The tally, which rises daily as companies file for more public offerings, had hit $4.5 billion by late January, more than the industry raised in the previous decade and enough to fund mountains of new research. Just 15 years after the industry was created, "it's as if biotech is being reborn," says Gordon M. Binder, Amgen's chief executive.
Indeed, biotech, which manipulates the very processes of life, has emerged as the driving force in medical technology. Biotech companies are developing novel drugs that will target traditional diseases more precisely than conventional drugs do. Some of these will treat, and perhaps even conquer, incurable or inherited disorders such as AIDS, multiple sclerosis, and Alzheimer's. Old-line drugmakers have gotten the message. It's getting much harder to come up with effective new varieties of the chemical-based drugs in which they specialize. So the Mercks, Roches, and Sandozes of the world are recharging their product portfolios by buying stakes in biotech companies and inking joint ventures. They're getting some pointers in the lab, too, where a marriage of biotech with chemical synthesis may soon lead to innovative "superdrugs" that will be discovered without the lengthy, trial-and-error approach used to find conventional treatments.
Seeing such potential, even the laissez-faire Bush Administration wants to bolster one of the few U.S. high-tech industries that still holds a commanding world lead. On Jan. 31, the Administration unveiled its "Biotechnology Initiative," a plan to increase federal support for basic biotech research by 7%, to $4.03 billion annually. In making that announcement, D. Allan Bromley, the President's science adviser, observed that since World War II, technologies derived from physics, chemistry, and the physical sciences have dominated world economies. But in the future, he predicted, that role may go to biotech.
HOME STRETCH. Unquestionably, the industry is building momentum. Pioneers Genentech, Amgen, Chiron, Biogen, and Centocor are either in the black or on the home stretch toward getting there. Biotech-related drugs, vaccines, and tests now rack up more than $4 billion in annual sales worldwide. Biotech companies won 5 of 30 product approvals the FDA issued in 1991, and may win five more this year. Vector Securities International Inc., a Deerfield, Ill., investment bank, predicts that another 20 new drugs, or new uses for drugs already on the market, could be approved by the mid-1990s.
That could be just the beginning. Smith Barney, Harris Upham & Co. biotechnology analyst Denise M. Gilbert figures that publicly held biotech companies have 100 drugs in human trials and more than 400 products in some stage of development. The potential, adds Gilbert, "is staggering." By the year 2000, according to several forecasts, $50 billion worth of biotech products should be on sale around the globe. "We've gone from 10 years of mostly dream and mythology to reality," says A. Grant Heidrichs III, a Palo Alto (Calif.) venture capitalist with the Mayfield Fund.
That's quite a turnaround from just two years ago. Then, says Brooke Byers of Kleiner Perkins Caufield & Byers, a San Francisco venture capital firm, "we were wondering how we were going to fund this industry." Wall Street was fed up with biotech. Genentech Inc., the industry's standard-bearer in the 1980s, had stalled. By 1989, it seemed unlikely that sales of TPA, its drug for preventing heart attacks, would grow beyond $200 million a year, 80% shy of what optimists had once predicted. Genentech's stock plunged, taking the industry with it. In early 1990, Genentech executives, in part citing an inability to fund all the promising research in their labs, sold 60% of the company to Roche Holding Ltd. for $2.1 billion.
But when Genentech faltered, Amgen took over. On the strength of EPO, its anti-anemia drug, and G-CSF, its cancer-fighting agent, the revenues of the Thousand Oaks (Calif.) company more than doubled last year to $699 million. Its profits soared 2,400%, to $98 million. The Street has rewarded that growth with a $10 billion market valuation. And on Jan. 1, Amgen joined the Standard & Poor's 500. "Amgen shows that biotech isn't a pipe dream," says Howard E. Greene Jr., chairman of Amylin Corp. in San Diego. "If you have a big idea that works, it creates tremendous value."
Biotech has always represented a big idea. It was in the mid-1970s that molecular biology first suggested revolutionary cures and enormous markets. Scientists were learning to replicate and alter natural proteins from plants, animals, and humans. Advocates predicted that biotech would soon yield superhardy crops or improved livestock. And they envisioned legions of microbes digesting pollution. Most of those goals are still just dreams (page 72 56 ).
But in medical biotech, the miracles have begun. They can be traced to 1976, when venture capitalist Robert A. Swanson and University of California at San Francisco scientist Herbert W. Boyer sketched out a business plan for Genentech in a San Francisco tavern. By the early 1980s, Genentech and contemporaries such as Biogen and Cetus had become expert at coaxing large quantities of valuable natural proteins, such as insulin or interferon, from cellular factories. The process was called gene-splicing, or recombinant-DNA technology. It was the first fundamentally new drugmaking approach to come out in decades.
Traditionally, big drug companies had screened thousands of chemicals to find one that would cure disease. This costly, time-consuming process often created drugs with undesirable side effects. The gene-splicers believed that drugs derived from the body's own immune system and other natural methods for fighting disease would provide more precise cures with fewer side effects. Companies such as Centocor Inc. and Hybritech Inc. used another technique to churn out monoclonal antibodies, the body's defenses against bacteria and viruses.
The early companies found valuable drugs this way--sometimes more valuable than first imagined. Alpha Interferon, for instance, was first approved to treat a rare cancer called hairy-cell leukemia. But it has since found an $800 million worldwide market as a treatment for herpes and hepatitis, and it's being tested against AIDS. The market for other protein drugs, including insulin to treat diabetes, human growth hormone to treat growth deficiencies, and Genentech's clot-busting TPA, is well over $2 billion. At least a dozen promising gene-spliced drugs are now being tested in patients, including a drug to speed wound healing from Celtrix Laboratories, an infection-fighting agent from Synergen, and an anticancer drug from ImClone.
By the mid-1980s, however, it was clear that protein drugs have weaknesses. They are expensive and hard to make. And they are large molecules that break down quickly in the body. So they must be injected to do their work. That's fine for life-threatening conditions. But most drug industry profits come from products that treat chronic ills such as hypertension or pain, where pills are the easiest method of delivery. That's why biotech companies like superdrugs. In theory, these will be discovered and designed using advanced techniques of biology. But they'll be made by old-fashioned chemical synthesis and taken as pills. It may be the late 1990s before the first superdrugs reach market. But already, they're transforming biotech's culture. "Gene jockeys" once flatly rejected chemistry techniques for making drugs. Now, they are hiring chemists.
Almost in mirror image, conventional drugmakers have decided that biotech tools are too powerful to be left to startups. They began building internal biotechnology groups in the early 1980s. These haven't been hugely productive. But they ensure that nowadays, when investors bet on biotech, they aren't putting their money on some fringe idea. They're wagering on whether the Davids have the creativity, drive, and resources to better the Goliaths at the same game.
The wunderkinder are speeding off in many directions (table). And unlike their predecessors, some are targeting classes of disease instead of specific technologies. At least a dozen companies, including Alkermes, Athena Neurosciences, Neurogen, and Regeneron, are focusing on disorders of the central nervous system--from Alzheimer's to Parkinson's and Lou Gehrig's disease. Companies such as Icos, Cytel, ImmuLogic, and Anergen are after drugs that treat inflammatory and auto-immune disorders, such as rheumatoid arthritis. At least six others--including COR Therapeutics, Gensia, and Arris--want to cure cardiovascular disorders, while Curative Technologies is developing drugs to speed wound-healing.
There are numerous ways to attack any disease. So, some researchers say, this broader approach helps identify the best potential treatments. "Ask me my program, and I'll tell you our targets," says Vaughn M. Kailian, president of COR Therapeutics Inc. The South San Francisco company has raised $51.5 million to exploit insights into cardiovascular disease. Its first product, now in tests, inhibits blood clots in patients who have suffered heart attacks.
ERRANT GENES. Still, some new technologies are so promising that it's crazy not to focus on them. Consider "antisense" technology, the central strategy of Gilead Sciences, Isis, and Genta. Its aim is to sabotage disease-causing genes by sending in chemicals, modeled after DNA, that stop these genes from working. Another group, including startup Tularik Inc. in Menlo Park, Calif., and Oncogene Science Inc., wants to exploit transcription factors, or chemicals within cells that turn genes on and off. In theory, antisense and transcription technology could short-circuit cancer and disorders such as Huntington's disease and sickle-cell anemia. Says Michael Riordon, president of Gilead: "If you focus on disease without a powerful technology, you may just make incremental advances."
Another high-octane technology, developed by Vertex Pharmaceuticals Inc. and Agouron Pharmaceuticals Inc., marries biotechnology and computer-aided drug design. These companies use biotech to dissect the structure of proteins in the body called receptors. Receptors, which sit on the surfaces of cells, act as gatekeepers that let certain agents enter and influence cells--kill or infect them, or change their behavior. Practically all drugs, even chemical ones, work by linking up, or binding, with these receptors. Once Vertex and Agouron understand the biology of a given ailment, they use computers to design chemical drugs that do the job. Agouron already is testing a psoriasis drug on humans.
Eventually, some therapies now in the lab might even eclipse the need for drugs as we know them. Companies such as Genetic Therapy Inc., which raised $14.5 million in an IPO last year, and Systemix Inc., based in Palo Alto, Calif., hope to one day transplant cells in patients that might permanently fix disorders. One approach to gene or cellular therapy would be to insert healthy cells that would churn out, for example, the enzyme missing in the inherited disorder ADA deficiency, which results in a severely weakened immune system. Another approach might transplant genetically altered cells that make large amounts of natural agents to kill viruses or cancer cells right in the body. Eventually, scientists might be able to correct flaws in existing genes.
Such dramatic progress, coupled with the bouyant stock market, is giving small, technology-rich companies unprecedented leverage with drugmakers. Typically, a few years ago, a pharmaceutical house might have given a young company $1 million a year for five years in research support in exchange for the right to sell the startup's drugs and pay royalties as low as 5%. Most early biotech companies didn't even sell their first products: Biogen, in Cambridge, Mass., was typical: Schering-Plough Corp. bought rights to its alpha interferon treatment for cancer and viral infections.
STUNNING PRICE. No more. Today, biotech companies command steeper equity prices, much higher cuts of the profits, and longer-term commitments. This new bargaining clout testifies to the power of biotech. The pipelines of pharmaceutical companies are crowded with compounds that only incrementally improve existing drugs. Biotech is now "the engine of drug development," says Hubert J.P. Schoemaker, chairman of 12-year-old Centocor.
For that reason, big drug manufacturers such as Glaxo, Sandoz, and Pfizer are spending hundreds of millions on research and equity investments in small companies. Last fall, Linda Sonntag wowed the Street by selling 60% of Systemix, a cell therapy company with no product sales, to Sandoz Ltd. for $392 million.
Flush with cash, biotech companies can also do more. In the past, capital shortages have forced them to do "triage," says John S. Saxe, head of Synergen Inc. in Boulder, Colo. That meant choosing just one of several promising projects to take out of the lab. But now, they can back several horses. Saxe's company, which last year raised more than $300 million, is testing its drug Antril against septic shock and five other diseases, including leukemia and asthma. Without the cash the company might have delayed or forgone testing for some of those markets.
More important, if one project bombs, the company won't disappear with it. Neurogen, in Branford, Conn., has high hopes for an anti-anxiety drug it calls NDC91-1. The $50 million deal it signed in February for Pfizer Inc. to pick up development and marketing costs gives Chief Executive Whitcome peace of mind. "If the first compound doesn't work," he says, "you have the wherewithal to survive."
SKIRMISHES. Still, survival requires beating big odds: Only 2 out of 10 companies are likely to stay independent, says Max Link, CEO of Sandoz Pharma Ltd. Land mines lurk everywhere. Drugs that work in the lab or in mice may not work in people. In the early 1980s, Alpha Interferon destroyed most cancer cells in test tubes, but worked more selectively in humans. Or a drug that works miracles in some patients may be lethal for others. The cancer drug Interleukin-2 causes fluid retention, which has killed some patients.
A good patent may guarantee 80% gross margins. But a patent skirmish can bring disaster. Last year, Genetics Institute Inc. lost an appeal over a patent infringement on Amgen's anemia-fighter, EPO. Genetics Institute ended up selling 60% of itself to American Home Products Corp. for $666 million.
The prolonged U.S. regulatory process precludes foreign-made clones from stealing a market. But regulatory snafus can torpedo even the most promising companies. Cetus Corp. suffered such a setback with its flagship drug, Il-2. Cetus had $150 million in the bank. But when the FDA requested more data on the drug last year and delayed its approval, Cetus' board sold out to its Emeryville (Calif.) neighbor, Chiron Corp., for $650 million.
At this stage, no one can predict which companies will triumph. One key to prosperity, say fund managers and analysts, is a broad product line. Beyond that, George Rathmann, Amgen's founder and now chairman of Icos Corp. in Bothell, Wash., stresses such elusive notions as having smart people in the lab and the boardroom: "It's not enough to have a core technology," he says. "You need a body of coherent, leading-edge science, and people who say: 'We're gonna build a business.' " Promising all that, Rathman raised $33 million in private funding to start Icos in 1990.
Indeed, capital is still the critical variable. The biotech companies that went public in the latest spree raised some $35 million on average, enough to hold them for three to four years, says Mark Edwards, managing director of Recombinant Capital, a San Francisco biotech research firm. Still, it costs more than $150 million to bring a drug to market. So "in two or three years, these companies will have another extraordinary need for funds," says G. Kirk Raab, Genentech's CEO. In a perverse way, the recent cash infusions could cause pain for everyone down the line. Says Stelios Papadopoulos, managing director of PaineWebber Inc.'s health care group and a biotech investment banker: "The more companies you have, the more money you need." And the more competition there will be for it.
The ability to return to the market will depend in part on getting a company's story out to investors, brokers, and fund managers. But today, "we have a crisis of coverage by sell-side analysts," say Papadopoulos. Smith Barney's Gilbert figures she's trying to track 50 companies.
Only those companies that make good on their promises will get analysts' attention. And only those that do so will easily raise more money. Thus, "by the middle of the decade," says broker Bock, "half these companies will have merged out." That may disappoint investors trying to find the next Amgen. Still, many companies that have sold out so far have netted their stockholders a handsome payoff.
There's also another problem skulking in the future. Once biotech companies have a product to sell, they tend to charge a big premium: TPA, for example, costs $2,200 per dose, while a full year's treatment with EPO can run $5,000. Such prices are on a collision course with efforts to control escalating U.S. health care costs.
William R. Magruder, who oversees pharmacy purchases for Premier Alliance Inc., a buying cooperative of 48 teaching hospitals based in Westchester, Ill., says 20% of his members' drug budgets go for a handful of biotech drugs. Magruder's study of Centocor's Centoxin, scared him. Some studies show that the treatment could cost $24,000 for each year of life saved. "Can we afford to spend that kind of money?" he asks. At some point, the answer will be no. And since big profits are what make the risk worth taking, the cash machine for biotech companies may then shut down.
Today, those concerns seem far away. Donald E. Guinn, the retired chairman of Pacific Telesis Group has directed Richard Bock, his broker, to plow his high-risk funds into biotech for the long term. Of course that's easy to do when, like Guinn, you're sitting on a 300% one-year gain. Still, even if investors desert when yields look better elsewhere, Bock believes that the industry will thrive. After all, it's hard to find a more alluring dream: to cure disease, feed the masses, safeguard the environment--and make a fortune in the bargain.
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