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How are CFOs in Europe's biotechnology sector overcoming the "investor gap" compared with U.S. competitors?
Eila Rana, CFO Europe Magazine
October 1, 2007
Dave Lemus, CFO of German biotechnology company Morphosys, has a vivid memory of when the company launched its IPO in 1998. After a very technical presentation to a group of investment analysts from Morphosys' banking consortium, there was complete silence. "I was pretty sure nobody really had any clue about what was going on," says Lemus. "That was confirmed when one of the analysts had the courage, about two minutes into the silence, to ask: 'Is your technology a gas, a liquid or a solid?'"
Getting the message across to prospective investors is a challenge for all CFOs, but it's a particularly difficult problem for those in the biotech sector, mainly because the science can be so complex. If analysts don't understand the prospects for a biotechnology to become an approved and profitable treatment, how are they going to persuade investors to back it?
On top of that, European biotech companies face other disadvantages compared with their U.S. competitors when it comes to attracting investors — in Europe, the approval process of new drugs and the pricing regime are far more arduous than in the United States. While the European Medicines Agency can give Europe-wide approval for a drug in about the same 12-to-18 month time frame as the U.S. Food and Drug Administration, each decision in Europe will be scrutinised at the national level, where there is a right of rejection. What's more, prices in Europe are also set on a country-by-country basis and must be negotiated separately.
Not only does the heavier bureaucracy add to the sector's complexity, but it also frustrates European biotechs' efforts to raise funds, says William Powlett Smith, head of Ernst & Young's UK biotech practice. The upshot: the more streamlined US process gives firms there a headstart. (See "Poor Cousins" at the end of this article.)
The U.S. biotech sector, perhaps as a consequence, has matured more quickly — analysts reckon it's around ten years ahead of Europe's — and has a greater number of specialist investors who understand the risks and are willing to invest long term. That maturity also means there are a greater number of listed biotechs in the United Staes, which allows investors to spread their risk more widely. And it's success stories, such as California-based biotechs Amgen and Genentech, that provide examples for investors of what the sector is capable of delivering, according to Tony Weir, chairman of the finance and tax committee at the UK's BioIndustry Association. These companies, each with some 25 years of experience behind them, now have very substantial sales and profits — sales of $13.9 billion (€10 billion) for Amgen and $7.6 billion for Genentech in 2006, with net income of $2.9 billion and $2.1 billion, respectively.
The big fear now in this competitive, talent-driven industry is whether the European sector is heading into a vicious downward spiral, not helped by a knowledge drain to more successful companies in other parts of the world. Last month Schering-Plough, the U.S.-based pharmaceutical company bought Organon Biosciences, the biotech arm of Akzo Nobel, a Dutch pharma, for €11 billion.
So, how are CFOs of European biotech companies facing up to these challenges, and what lessons can they offer other industries facing similar difficulties? The answer so far lies in a more flexible attitude — in terms of how to communicate with investors, in terms of which investors to target, and even in terms of the business model used.
Dumb It Down
For his part Lemus, who doesn't have a science background, says he took a multi-layered approach to communication. For example, he "dumbed down" the Morphosys presentation that he and his colleagues had been giving. "That was particularly important because I felt that Morphosys' future lay with growth-oriented investors, rather than biotech specialists who had been investing in us in the last couple of years," he says. "We have several versions of this presentation, from one for guys who are completely up to speed [with the technology] all the way down to someone who's never heard of an antibody." Lemus adds two more solutions to the communication problem: work closely with analysts to help them make the company's story more tangible to investors and try to speak the language of finance, rather than science, wherever possible.
Over the course of its short history, Morphosys has had to make profound changes to its original plans. When the company was set up in 1992, the German venture capital industry was almost non-existent so the Bavarian company was forced to look to UK-based Korda Seed Capital Fund for start-up cash. "That initial capital was scarce and that had an influence, ultimately, on what type of business model Morphosys was forced to go with early on," Lemus says.
The model needed to generate revenue and have the prospect of making profit in the "near future." One way to guarantee income was to use the company's fully human antibody technology to help big pharmaceutical companies create their own drugs. So today, every time Morphosys reaches a milestone in a drug development process, it receives payments from its big pharma partners, as well as royalties for the use of its compounds.
By the time of the IPO in 1998, Lemus was able to tell potential investors that Morphosys would be profitable within two years. And as the first biotech to float on the Neuer Markt Stock Exchange, he and his team created enough interest and demand to end up with an IPO that was six times oversubscribed and raised €25m. By 2000, however, Lemus had spied an opportunity to deliver a greater return to shareholders by setting up Morphosys' own drug development business, which had the potential to generate far more revenue than any partnership with a big pharma. It was the height of the dotcom boom and Lemus was convinced that venture finance would be easy to find.
"In that vein we started to look at building up our own proprietary development, which is cash-burning and capital intensive," he remembers. "With hindsight, we could have avoided developing our own drugs." As the markets crashed, "that business model was not financeable." Two years later, Morphosys had lost €20m, its share price had hit an all-time low of around €4 (from €25 at IPO) and there was just €10m in the bank. That low point included a patent dispute with Cambridge Antibody Technology, which was costing Morphosys more than €6m a year.
How to get back on track? First, the patent dispute was settled. Lemus also drastically cut back on development work and reduced staff by a third to 40 people. The company also launched a money-making catalogue business, selling antibodies as research tools.
Morphosys was cash positive again by 2004 but the company's ultimate goal seemed further out of reach. "It was extremely difficult for us because we felt that, long term, there is very serious value in creating your own proprietary drugs," says Lemus. The problem was that investors were happier with the short-term returns of the initial business plan and bailed out quickly when the markets turned. "I feel that in Germany, and more broadly in Europe, there is a risk aversity among investors compared to the US," Lemus concludes.
But he hasn't given up on the dream of Morphosys developing its own drugs. Now that the company is making money again, he has revived this part of the business, albeit on a smaller scale. It's working on two products that may go into phase one of clinical trials next year. "We're going in that direction increasingly because we think there's a further upside," says Lemus. "Will it drive us back to the loss-making business model we had in 2000? Probably not, because we're using cash from the businesses that are cash generative and funding it that way rather than through the capital markets." Investors also appear to be more comfortable — the share price had climbed to nearly €40 by September.
Going It Alone
A company that has had more luck in proprietary drug development is BioAlliance Pharma, a Paris-based specialty pharma focusing on developing products that fight resistance to treatment for cancer, HIV and infections such as herpes. Although it still hasn't found the traction it wants with a broad investor base, it has successfully ploughed its own furrow.
Last month, it launched Loramyc, a treatment for oral fungal infections, in France and recruited ten salespeople to target 1,800 hospital doctors across the country. An in-house sales team is unusual for European biotechs but CFO Nicolas Fellmann says this "strategic turn" was taken last year after it became apparent that Loramyc would receive approval. Fellmann says the drug has the potential to bring in €150m from the French market alone, while two joint ventures to market the drug outside France will generate further revenue — one deal with US company PAR Pharmaceutical will bring in $65m; the other, with European company SpePharm, will generate €30m.
Despite the Loramyc success and two other hot prospects in late stage development, BioAlliance's shares are below the IPO price of €13.30 and their performance has been flat. The problem, says Fellmann, is that the buzzwords investors are used to hearing are not part of BioAlliance's business model. Rather than working with a "big pharma" on a "blockbuster" drug for the "GP market," BioAlliance has been developing its own niche drugs for specialised markets. "There are some words that people do not understand — specialty pharma is one of them. When you don't say 'blockbusters,' 'GP market,' etc, people look at you as a small player unable to generate significant numbers," he claims. "The challenge is to explain as clearly as possible our strategy and business model and show that despite the fact that we do not yet have agreements with big pharma, we can still generate significant profits either through the agreements we can make or through our own sales."
Fellmann certainly knows that the best way to build investor confidence is by delivering on promises. It's off to a good start — the €4 per day price it obtained for Loramyc in France was in the upper range of analysts' predictions and the value of its two joint ventures for the drug also exceeded expectations.
But the bigger challenge is to diversify BioAlliance's investor base as a way to improve the performance of its share price, currently hovering at just above €11. Fellmann wants to attract more long-term investors and expand its shareholder profile beyond France to the UK, which has the largest biotech market in Europe. He's after investors who better understand BioAlliance's business model and will provide stable, long-term financing, but he thinks the company's market cap may be an initial obstacle.
"Ours at the moment is around €140m to €150m and I think some UK investors tend to look above €200m, so maybe that's the reason why there haven't been so many UK investors in our capital so far," he says. "We have organised a roadshow for our secondary public offering and we have seen a number of UK investors. I hope that some of them will be interested in buying the shares."
Profiling Your Investors
The benefits of having the right investor profile is something that Tim Dyer understands well. The finance chief and co-founder of Swiss-based Addex Pharmaceuticals raised $128m in May 2007 by floating on the Swiss Exchange — the biggest biotech IPO in Europe and the United States in the past three years. Dyer says it was a textbook IPO thanks to the groundwork that had been done over the previous five years, which was mainly aimed at redefining the company for its prospective investors.
Addex launched in 2002 as a specialty pharma, treating addictions with "allsoteric modulation" — or what Dyer describes as "dimmer switch technology." An early breakthrough persuaded him to switch the company from being a specialty pharma focused on addiction to focus on its technology, which could be used to treat a range of illnesses, including central nervous system disorders, schizophrenia and migraines.
From 2004 to 2007, Addex went through a round of funding from venture investors and another that brought in Johnson & Johnson, GlaxoSmithKline and Roche. "This gave a message to the investment community that we didn't just have a strong set of VCs who knew their business, we also had three big pharmas which would have done their due diligence before putting their money in. So this gave a very good backdrop to go and address the public markets." In the end, it was relatively easy to sell the IPO, which was five times oversubscribed.
Unfortunately, "the price performance post-IPO has been very bad. So, from the public investor point of view it's been unsatisfying," Dyer admits. Having seen a very high churn rate on its first day of trading, Addex shares had a swirling ride over the summer and were about 25% below their debut price, at about €56 in September.
Dyer thinks the post-IPO dip was mainly due to too many generalist investors who were in it for a quick profit. "It's difficult to know who put their order in based on a sound analysis for the long term and who put their order in because they heard a lot on the street about this great IPO that was oversubscribed," he says. "If you go public and your stock loses 5% on day one, investors who put an order in without doing a sound analysis sell. They question their entire investment decision."
Is it possible to persuade generalist investors to stay the course? Dyer reckons it is, as long as conversations with them are based on trust and openness. On a practical level, that means being accessible for analysts — Addex has detailed formal guidelines on how to talk to the media, release information and control information inside the company. Dyer is also doing things that "give people a warm feeling about how things are managed here." That includes closing the company's half-year results and announcing them a month ahead of peers, as well as holding an R&D day to tell investors more about the science behind the company.
Are strategies employed by CFOs such as Dyer, Fellmann and Lemus strong enough to not only keep their own investors on board, but also generate a wider confidence in biotech stock? Funds generated from IPOs are increasing but biotechs are not necessarily getting the best price for their product, says Ernst & Young's Powlett Smith. "In Europe there are so many opportunities for relatively faster payback or safer investment that institutions are averse to risky biotechs," he says. "It means that the values which are attributed by independent institutions to biotechs are relatively low compared with the values that are attributed to them by big pharma." That explains deals such as AstraZeneca's recent €852m takeover of CAT. (See "There's a Catch" at the end of this article.) With big pharmas under pressure to renew their pipelines as their patent protections draw near to expiry, and biotech drugs emerging as more effective than traditional ones, biotechs seem like a good bet.
Do biotech CFOs welcome this? Dyer says he would have been disappointed if Addex had ended up as a trade sale. "We believe we're sitting on a pharma business which is just at its beginning now," he says. "We've had five years and it takes on average 12 years to build a pharma product. I think it would have been too soon to have sold out to a pharma company." That said, he accepts that Addex's shareholders expect a return, even if that means being acquired. "But from the management's point of view, if you're motivated to build a stand-alone business, to have your legs chopped off is a bit annoying."
Eila Rana is a senior editor at CFO Europe.