Elan: One Sick Celtic Tiger

Accounting woes and disappointing drugs have the biotech in deep trouble

In the high-flying markets of the 1990s, Elan Corp. was Ireland's fiercest Celtic Tiger. The Athlone-based company achieved what most biotechs only dream of, transforming itself from a small research operation into a full-fledged pharmaceutical company. Revenues mushroomed from $322 million to $1.9 billion between 1995 and 2001 as the company acquired more than a dozen small biotechs. At its peak in 2001, Elan (ELN) was Ireland's biggest business, with a market value of $22 billion. It wasn't just a local phenomenon: A huge part of Elan's shareholder base is American.

Now the tiger may be endangered. Last year, Elan scrapped a highly anticipated Alzheimer's vaccine. The launch of the company's most promising new drug, a therapy for Crohn's disease and multiple sclerosis, has been pushed back to 2006 after disappointing clinical-trial results. The company is the subject of two separate probes by the U.S. Securities & Exchange Commission to see if it inflated earnings and improperly accounted for two off-balance-sheet entities. Investors have filed a flurry of class actions making the same charges. Since a June rally, Elan's share price has slid almost 50%, to $4 and change; in 2001, it traded at a high of $65.

Most of all, investors have been wondering what was holding up an audit of Elan by KPMG International. As part of its obligation to bondholders, Elan was required to file its 2002 accounts by June 30. The company has managed to get six filing extensions and finally announced on Sept. 4 that it would file on Sept. 5. Good thing: A failure to present clean books by Sept. 16 would trigger a potentially crippling default on $2.2 billion in debt owed to the company's bondholders. ``The process has taken longer than either we or KPMG anticipated,'' says CEO G. Kelly Martin, a former Merrill Lynch & Co. exec who took over the troubled company in February.

The company had been asked to consolidate its controversial off-balance sheet vehicles under U.S. GAAP as required by the SEC. Elan expects the restatement of its 2002 financials will result in a further $46.1 million reduction in the company's net worth. The reduction is bigger than the company previously anticipated. But it also weren't as disasterous as investors had feared. The company's stock price soared 26% just hours after the announcement. "The conclusion of the 2002 audit and the filing of our 2002 annual report is an important and necessary step in our recovery effort," says Elan CEO G. Kelly Martin.

As for KPMG, policies protecting client confidentiality keep it from talking. But the auditor's reputation is at stake, too: KPMG gave its blessing when Elan's former management created the off-balance-sheet joint ventures that the SEC is currently scrutinizing.

Once the report is filed, a black cloud should lift from Elan. But even a clean bill of accounting health will leave Martin with the monumental task of cleaning up Elan's balance sheet while keeping the drug pipeline full.

Voracious dealmaking sowed the seeds of Elan's rise -- and fall. Elan negotiated complex joint-venture agreements with more than 50 companies. Typically, it would pay up to $20 million for convertible preferred shares in a biotech company and form a joint venture, in which Elan would hold a 19.9% stake. By keeping a position below 20%, Elan kept the joint venture's poor results off its own income statement and avoided expensing research & development costs. But the company still earned revenue from the joint venture in the form of a $15 million licensing fee paid to Elan by the biotech partner.

It is these joint ventures that have attracted the SEC's attention. While the agency's Enforcement Division is still looking into whether or not Elan artificially inflated its earnings and misled investors, a separate investigation -- focused on how Elan incorporated its off-balance-sheet vehicles into its accounts -- by the SEC's Corporate Finance Division is now complete. What the SEC concluded will be known only upon publication of Elan's annual report.

Since these operations came under study, Elan's room to maneuver has narrowed considerably. The outfit is expected to post 2003 operating losses of $140 million this year and remain in the red until 2005, according to Ian Hunter, analyst at Goodbody Stockbrokers in Dublin. Unless the debt is restructured, Elan's credit crunch is likely to resurface come 2004. Elan will be burning cash to fund the hefty investment in R&D -- $300 million in 2003 -- needed to push its products through clinical trials. Increased competition is expected to slow sales of Elan's five main drugs, from $800 million in revenues this year to $770 million by 2004. Still, Martin is confident that Elan will survive. ``We have $1 billion in cash and products on the market, something very few other biotechs can claim,'' he says.

Indeed, Martin has made substantial progress. By May, he had met his target of raising $1.5 billion through asset sales by the end of the year. He has narrowed Elan's focus to three therapeutic areas: autoimmune disease, pain, and neurology. The company says all but 18 of its 55 joint ventures have been terminated. ``Our goal is to get that down to 10 by yearend,'' Kelly says.

Fixing the finances is imperative, but keeping the drug pipeline full is just as important. Elan was forced to pull the plug on its promising Alzheimer's vaccine in early 2002, after it was found to cause brain inflammation in a handful of patients. The company now is betting on Antegren, a potential blockbuster therapy for Crohn's disease and multiple sclerosis. Recent results from the Crohn's trials proved disappointing, however, and are expected to delay the drug's launch until 2006 at the earliest. But Antegren still has promise as a treatment for MS.

Goodbody's Hunter estimates that Antegren, if successful, could generate revenues of more than $1 billion within two years of introduction. Elan also hopes to begin trials within the next 18 months to see if Antegren can be used to treat rheumatoid arthritis.

As Elan has retrenched and simplified, some of its partners have suffered along with it. San Diego-based Ligand Pharmaceuticals Inc. joined forces with Elan in 1998 to co-promote the medication Avinza, a 24-hour pain reliever Elan had developed. When Elan descended into scandal last year, it pulled Ligand's stock down, too. And when Elan sold its sales force to another company earlier this year, Ligand was forced to launch Avinza alone, with a small specialty sales staff. Half of the prescriptions for Avinza are written by primary-care doctors, and Ligand was counting on Elan to provide a primary-care sales force. Ligand eventually found a new partner, and Avinza is now one of its top sellers. Elan still gets a cut, but a much reduced one. ``We needed [a primary-care sales staff] to fulfill the promise of what Avinza could be,'' says Ligand spokesman Michael Watts. Unfulfilled promise seems to be the story at Elan these days.

By Kerry Capell in London, with Arlene Weintraub in Los Angeles and Faith Arner in Boston

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