Biotechnology’s Long Wait

Say the word biotechnology, and investors scramble to get in line for the IPO. The word is irresistible with its promises of biblical longevity and abundance. Consequently, we see an ever-expanding number of companies sidling up to the public trough with promises to cure the most deadly of diseases and produce the most nutritious of tomatoes.

Often overlooked, however, is this subtle point: The appropriate description of the industry is not Biotechnology but Biotechnology R&D. The R&D stands for "Research & Development." And what this really means is that it’s a company without a product, without manufacturing experience, without distribution, without marketing, without money, probably without even a clear understanding of how to proceed legally in the arcane world of drug development. This industry with all its dazzle says something important about success—it requires more than smart people who have a gleam in their eye.

Like pharmaceuticals, biotech companies typically must endure 3 phases of clinical trials, each one a time-consuming, expensive process, wrapped in bureaucracy, and progressively more demanding. At the end of this winding road, they face FDA approval, which itself imposes a tangled web of requirements on the applicant. In 1981 a company could expect to spend 12 years and lay out $65 million in hard, cold cash to get a pharmaceutical drug to market. The FDA has streamlined its review of new drugs, but it still takes 8 to 10 years and even more money, which biotech companies ask the public to pay for.

It requires the investor to wait years. In the meantime the company will be busy with numerous private and secondary offerings to feed the effort’s voracious appetite for money. Unless it can keep its story scintillating the new shares of stock drifting into play will impose a downward pressure on the price. Without a product, however, it has few ways to sustain enthusiasm. If it’s lucky, one way is to announce alliances with pharmaceutical companies. Technologies of true potential will attract interest and investment from the large manufacturers, which should give the biotech company a boost.

The other way is to show promising results at the end of a clinical trial. Good results from Phase II should generate more enthusiasm than good results from Phase I. And of course, Phase III is the best. A company IPOing with prospective drugs in Phase III clinical trials should be of greatest interest to the investor. It will mean the company’s prospects have received a measure of scientific validation with an increased likelihood of getting to market. If indeed this should happen, it also means a good percentage of the costs and time are behind them.

Since the company is not in the business of selling a product during its R&D stage, it expects to lose and indeed does lose money to the tune of millions every year, which it calls an "accumulated deficit."

Figure 1 snapshots the industry for 100 companies with revenues under $100 million, which is where the vast majority lie. The trend line shown in the plot confirms one’s expectations that increased revenues return increased net income generally. However, the increase is not particularly substantial.

Half the companies generated under $12.8 million in revenue, which is surprising, since typically they have nothing to sell. Frequently the revenue comes from licensing fees for future products. A fourth of the companies sampled, over 30 in number, made less than $3.3 million.

Fully half in the sampling of 123 companies lost at least $6 million last year. Among those 63 companies, half again lost $13.4 million or more.

Half the 123 companies show stock prices at or below $9.63. Of the 63 companies in this range, half of those show stocks below $4.25. Figure 2 gives the data for 101 companies below $100 million in revenue. Again, increased revenue is correlated with increased stock price, but the variation in price is only $10 as a trend.

Companies with stock prices under $20 generally show a loss by as much as $10 million (Fig. 3). However, there’s not a strong correlation between income and stock price. That is to say, many companies with net income also can be found in the range of price up to $20.

We can conclude that most biotech companies, which IPO in the $9 range, which only now are entering Phase I clinical trials, and which show few affiliations with strong companies, will find it difficult to sustain their opening price.