Investment feature: public image Ltd

Much is made of Australia's scientific intellectual capital and the opportunities that it offers. But according to one of the world's largest accounting groups, it is a dangerous myth that states successful companies will automatically flow from the nation's renowned research achievements.

Ernst & Young tax partner Keith Hardy says that much more needs to be done to lift Australia's image, in the eyes of the outside world, as a hot spot - not just for science but also for science business. Hardy points to a range of issues that work against the perception of Australia as a place for biotech investment.

"I think we have got an immature venture capital market and a tax regime that doesn't work to attract overseas investment," he says. "The amount of money raised at IPO [makes it] questionable as to whether an IPO is the best way to get to market.

"There is also the issue of biotechs' inability to create attractive business models to attract investment."

Dr Lisa Springer, life sciences specialist with PricewaterhouseCoopers, agrees, saying that investors would not come to Australia simply on the strength of its technology. "Australian companies typically overestimate the technology they have and believe it to be more unique than it is," Springer says. "So their hopes and dreams diminish when they talk to investors in other countries who already know all about similar technology.

"It's about making sure they build a really globally competitive company." According to Ernst & Young's global report Beyond Borders, published in June, Australia's open market economy has left local biotechs exposed to the market volatility experienced by the United States and Europe. As a result, IPOs and follow-on funding have slowed significantly since September 11, 2001, with the majority of Australia's core biotech stocks suffering a 50 to 70 per cent blow during that period.

And while the nation is not alone in feeling the impact, Hardy says that the immaturity of our market makes things somewhat tougher on local biotechs.

"In Australia, the IPO market is dead but unless we get a robust venture capital market to fund the gap, there will be potentially difficult times ahead for biotechs," he says.

Beyond Borders highlights the fact that Australia does not have enough venture capitalists with early-stage technology expertise, are there are in the US. "The deficiency in early-stage private funding has led, in part, to early migration of investments to the US for companies to establish a presence in a more mature market and attract US venture funds, hence, the need for a government-based pre-seed funding stimulus in Australia," the report says.

Hardy says one way to approach the problem is to determine the needs of venture capital funds, rather than simply treating them as aggrieved. He says many biotechs expect investors to back risky single ideas rather than offer a portfolio approach, leading investors to lament the lack of viable and attractive business plans.

On the other hand, he says, marketplace maturity is needed to support Australia's growing biotech industry through an understanding of the long lead times before investment returns could be realized. In broad terms, Hardy says, the biotech industry needs "consultation with venture capital funds and government to promote Australia as a place to invest".

The government's role But aren't our governments already constantly extolling the virtues of biotech as Australia's next big thing?

Beyond Borders says the Australian government has flagged heightened support for the sector through amendments to pooled development fund arrangements, changes to capital gains tax provisions, amendments to double tax treaties with the US and cash for centres of excellence. But according to Hardy, much of this, particularly at the Federal level, is simply talk.

"At a state level I think they are very good, but Federally they just seem to be hamstrung a bit," he says.

"There doesn't seem to be the same level of activity and there is not as strong a national strategy as at state level, although there is only so much you can do at state level."

When it comes to attracting investment to biotech, a key priority in Hardy's mind, and indeed topping the list for many in the industry, is tax reform. He says Australia could not even boast a benign tax system, whereby an overseas investor cared not whether his money was invested here or elsewhere.

Instead, Australia presents significant disincentives for international funding of local biotechs. Among these disincentives are capital gains tax and a tax on advisor fees. In addition, Hardy says, general investment partners who choose not to take an equity stake in favour of a future "success fee" attract both capital gains and income tax.

"We need to get to the status quo with other countries and then think about ways of adding incentives to go beyond that status quo," he says.

Head of transaction services at KPMG, David Nott, agrees that capital gains tax poses a significant barrier to investment. "People come here because they are accessing technical skills and people that are without a doubt of some of the highest quality in the world," Nott says. "But a barrier would have to be the capital gains tax regime, which makes investment a high-risk situation for them."

He said a capital gains tax-free regime, or at least concessions to make investment more attractive, would improve the current situation. Nott concedes, however, that little is likely to be done unless there is tangible evidence to prove the existing regime turns investors away from Australia.

But according to Deloitte Touche Tohmatsu client director David Black, the tax issue is not as big a deal as the tyranny of distance. Black says investors and big companies based overseas tend to think that it is fairly difficult to control business based in Australia.

"I think Australia is battling the usual problem that we're a long way from Europe and the US where a lot of investment and money is, which obviously puts people off initially," Black says.

"We're starting to get across the message that it's a good place to do research and has a good education system and so on." He says overseas investors are currently more likely to keep a watching brief on the progress of the Australian biotech industry. Once a substantial critical mass developed, he says, investors will then come in seeking deals.

E&Y's Hardy says another thing for biotechs to consider in planning for growth is the opportunity for strategic alliances with groups in the international science and business community. Beyond Borders states that the challenge for Australia was to improve commercial exploitation of its public sector biotech R&D and to develop infrastructure and companies at home through local, multinational and overseas partnerships. "Otherwise the migration of intellectual property or products to the US, European and Asian markets will continue, due to the geographic isolation and size of the Australian market," it warns.

Singapore sling According to PWC's Springer, Australia still does not feature highly on international venture capital funds' lists of key places to invest. But ironically, it is Singapore's growing profile as a biotech investment location that is drawing the funds closer. Springer says discussions with VCs at this year's Bio 2002 event in Toronto had revealed about half of them acknowledged the opportunities available in Singapore and said that they would not be averse to giving the Australian scene the once-over when they were travelling in the region.

Nonetheless, she says, external funding for local biotech has grown in recent years. "By what percentage it is difficult to say, but from about five years ago, Australia certainly from a global perspective has a different face on it," Springer says.

"It is becoming a little more known to people and they believe things are being done to advance the biotechnology industry here in general."

Hardy says biotech, like the IT revolution before it, was born in the global marketplace and, as such, "if you have gold on offer, the picks and forks will come to you". As a general rule, he says that so long as a company is built on a portfolio of good, viable ideas, it will attract investment. "We are kicking into the wind a bit," he says, "but wind changes."