Is It Time for the Mating Dance Yet?

With a consolidation wave in view, cash-rich biotechs are taking out their wallets

Biotech was one of the last sectors to feel the pain of the stock-market rout. But now the Nasdaq Biotechnology Index is in the gutter too, down 51% from last year's all-time high. With the downturn comes a sobering reality: Capital markets have dried up, and the share prices of many of last year's high-flyers are trading in the single digits.

So is it time for a massive consolidation? Well, maybe not massive. But cheap stocks will probably translate into an increase in merger and acquisition activity.


  The industry has gone through a number of bottoming-out phases in its short 30-year history. The difference now is that many companies are entering this slump with big war chests. Last year was a record-breaker for biotech fundraising. The buzz created by genome-sequencing projects helped companies raise an eye-popping $32 billion, according to Burrill & Co., a merchant bank focused on life sciences. In the first quarter of 2000, with the biotech craze at its height, companies rustled up $12 billion, compared with a meager $2 billion raised in the first quarter of 2001. "It's one of the nice things about the industry right now -- most [companies] have plenty of cash," says Jim McCamant, editor of Medical Technology Stock Letter.

And buyout targets for all that money are plentiful. Many small companies that missed out on raising funds last year will likely buckle under the heavy cost of doing drug research eventually. "If you missed the window last year, you probably deserve to be bought out," says Paul Knight, an analyst with Thomas Weisel Partners. "Most are O.K. to weather 2001, and maybe part of 2002. But if this persists into 2002, we would definitely see lots of interesting consolidation."

With share prices down so far, potential buyers are busy scouting acquisition prospects. Lehman Brothers analyst Rachel Leheny recently wrote a research report naming 14 companies that have fallen to the value of their cash on hand -- or lower. This means that the acquired company could essentially pay for itself out of its cash reserves. Take Aclara Biosciences (ACLA ). At a price of $5 per share, Aclara "could logically prove attractive to corporate acquirers," Leheny wrote. Like many other genomics companies, which specialize in making sense of the human genome's vast quantity of data, Aclara recently took defensive measures to stall a takeover.


  The number of genomics companies could shrink significantly. One potential buyer is Human Genome Sciences (HGSI ), which has $530 million in cash and a relatively strong stock (around $50). It could buy other companies with promising drugs under development. Millennium Pharmaceutical (MLNM ) is already on an acquisition spree. It promised investors that it would have 12 drug candidates in human testing by the end of 2001, and now has only six. But it also has more than $1.4 billion in the bank, so it's in a good position to buy whatever it needs to meet its target.

Biotech bellwether Chiron (CHIR ) made a big move last September when it paid more than $700 million for PathoGenesis -- and it may be eyeing others. Joyce Lonergan, vice-president for corporate development and investor relations, notes: "Certainly, there are a lot of things that have come closer to the right intersection between price and value." In buying PathoGenesis, for example, Chiron gained an inhaled antibiotic product that added to its revenues immediately. It also got a slew of infectious-disease drugs that are still being tested.

Will Big Pharma also get into the act? Knight notes that some major players may be in the market for genomics expertise that they have not yet developed internally. The big companies may also want to add to their drug-development pipelines on the cheap. Johnson & Johnson (JNJ ), for one, recently agreed to buy Alza for more than $10 billion in stock -- an apparent steal, considering Alza stock was much higher just a few weeks before the deal. Such buyouts of bigger biotech outfits make sense, says Kevin Caliendo, a convertible-securities analyst specializing in health care at First Union Forum Capital. The problem, he says, is that "there are not that many Alza-sized companies with compelling pipelines."


  One exception is Vertex Pharmaceutical (VRTX ), which could have as much to offer as Alza. (See BW Online, 3/15/01, "The Vertex Vortex: Drug Development at Hyperspeed?") With eight projects in clinical testing and a biotech-based drug-discovery platform, Vertex could be a smart acquisition for a big company in need of a stronger pipeline, some analysts contend. Banc of America Securities analyst Eric Ende calls it "an awesome science company." Vertex, for its part, had $700 million in the bank at the end of 2000, putting it in a strong position to stand alone or make small acquisitions of its own.

Still, a period of sustained and massive consolidation is unlikely. For one thing, big drug companies are fearful of high-risk acquisitions that could dilute their earnings. Plus, founders of small biotechs tend to prize their independence, a streak that makes them tough to negotiate with. Ende predicts that most deals will be between small companies -- "the guys who have a lot of cash but not a lot of liquidity, and the guys who may not have lots of cash but need better liquidity." The barbarians aren't at the gate yet. But for the biotech sector, it's yet another sign that, for now, the boom is over.

Tsao covers biotechnology issues for BusinessWeek Online. Follow The Biotech Beat every week, only on BW Online

Edited by Thane Peterson