How will biotech survive the GFC?

The news from around the biotech world is grim.

The global financial crisis has sent private capital tumbling into a nuclear bunker, safely hunkered down until the storm is over.

The well that is the venture capital market has run dry, listing as a public company at the moment is tantamount to lunacy, and the deep pockets of government are being raided by all and sundry.

This is the state facing the biotechnology industry the world over, and everyone is feeling it. In the US, a third of listed biotech companies have less than six months of cash, according to current estimates.

It is exactly the same in Australia: industry association AusBiotech estimates that one in four public biotechs do not have enough cash to make it past June. Others suggest it is closer to one in three. One in two could fall within a year.

The situation is dire, but rather than behaving like the stereotypical decapitated poultry, is there anything biotech, government or even the public sector can do?

For Craig Lawn, a life sciences specialist with PricewaterhouseCoopers (PwC), it is pretty straightforward: the directors of biotech companies who are not confident they are using their shareholders’ funds wisely, and who will struggle to come out of the crisis in a strong fashion, should make the call to shut down sooner rather than later.

“They need to do something now, and if they don’t, it is inevitable that companies will fail,” Lawn says. “The fundamentals clearly show that half the companies need to do something and they should do it now while they’ve got cash and they have something to negotiate.”

Lawn says good companies are currently doing this – preserving cash, mothballing some projects and divesting non-core assets while still maintaining a market presence and relationships – but for poorly performing companies, there is a bit of a problem.

“There is still a lot of ego out there – people taking salary and not meeting their fiduciary obligations, to be blunt.”

For industry associations like AusBiotech and BioMelbourne Network, one area of hope is the government.

In December last year, when the full ramifications of the economic downturn were becoming clearer, the CEOs of both associations, Dr Anna Lavelle and Michelle Gallaher, along with others from Research Australia, Medicines Australia and the Federation of Australian Scientific and Technological Societies, wrote a letter to the Australian Treasurer, Wayne Swan, emphasising the importance of some sort of assistance in the 2009-10 budget, to be tabled in May.

They are still asking for it, and have gained a little ground. The Minister for Innovation, Industry, Science and Research, Senator Kim Carr, recently announced the freeing up of $83 million in follow-on funding for innovative industries like biotech, IT and cleantech.

“The Innovation Investment Follow-on Fund will provide urgent support to capital-starved start-up companies,” Carr told ALS. “We also expect it to boost confidence and shake loose additional private sector capital.”

However, he warns that the May budget will be tight and the government’s capacity to make new spending commitments will be limited.

“Our priority right now is to restore private credit flows,” he says. “This will require global action to deal with toxic assets and strengthen financial regulation. Australia is pursing these objectives through the G20 and other forums.”

---PB--- What biotech wants

The biotech industry in Australia is asking for a couple of things, but a bail-out isn’t one of them, Dr Deborah Rathjen, chair of AusBiotech and CEO of Adelaide biotech Bionomics, says.

“What we are really looking for here is not a bail-out but an invigoration of investment and enthusiasm by the government for investments in innovation and the growth of new industries in Australia,” Rathjen says.

“It’s not just about the GFC, but about the longer term future for new graduates who come out of our universities [and] new businesses that are struggling in the current climate, but if they make it through will be stronger and more effective. It’s not a bail-out; it’s renewed investment.”

AusBiotech has come up with a three-point plan that it has put to the government to help save the local biotech industry.

The first request is what the government has just delivered, the freeing up of $80 million from the Innovation Investment Fund into a follow-on fund, financed by money returned to the IIF when firms it supported were floated or sold.

This is a good start but it is also just a drop in the ocean, Rathjen says.

For BioMelbourne Network’s Michelle Gallaher, while the $83 million is a good first start, the problem is that biotechs will be competing for funds with ICT and clean tech companies, which she says are traditionally more attractive prospects for a venture capital funding model.

"I'm concerned that the valuable Victorian biotech sector may not see much of this money and if so, it's likely to only be a few companies that are already of interest to the venture capital community,” she says.

The other two prongs of the AusBiotech strategy are a 50 per cent refundable tax credit for companies with a turnover of less than $50 million, which the organisation says will return cash to company coffers.

“If they bring in things like tax credits, that’s great, but it really won’t start to impact until 2010,” Anna Lavelle says. “It won’t have an immediate impact but will still be well received.”

The main thrust is a program of direct and matched grants. AusBiotech has put forward a plan for both proof-of-concept and existing projects.

It is asking for a small amount of money to be set aside for proof-of-concept studies, with grants of up to $1 million for early-stage projects that may or may not withstand the market test and be spun out into a legitimate company.

The other is for a larger grant, which would have to be matched by private capital, of between $3 million and $10 million for companies that are moving products into the clinic.

This sounds a lot like the Commercial Ready program, which was axed by the new government last year and has caused a great deal of angst in the biotech industry. It has led to repeated calls over the last year for the program to be resurrected.

Carr, however, is very firm on this. “There will be no resumption of Commercial Ready,” he says. “Many companies and organisations have made representations to me about the program, and I appreciate their concerns. However, our focus must now be on the future.

“Commercial Ready was replaced in part by other programs, such as Climate Ready, which has been a huge success. The government has responded to the global recession with new initiatives for industry, including a $3.8 billion business tax break and the $83 million Innovation Investment Follow-on Fund. These initiatives will directly benefit the biotechnology sector.”

---PB--- What else can biotech do?

In the absence of much further assistance from the government, and with private capital powder-keg dry, are there alternatives that biotechs can investigate to ride out the storm?

Craig Lawn has a few ideas. Mergers and acquisitions are obvious avenues, as is agreeing to early partnering and licensing with Big Pharma.

One idea is the creation of a “loss look-through rule”, such as that used in the mining industry, which allows investors in companies that are doing exploratory work but creating losses to have access to those losses while they are investing.

Another idea is to consider the basic research sector for a helping hand in the tough times.

“What part of the industry, and what stakeholders, are relatively well off? The universities,” he says.

“A number of the major universities have been recognised by the government and have some reasonably secure funding.

“There are some good technologies and they spin these out and take the money, but perhaps there’s an opportunity here to go back into a joint venture with universities, go back onto university premises, to reduce spend through joint ventures and utilise the resources of universities and think creatively.

“From the universities’ perspective there have been some good benefits flowing back, and in a pipeline sense, the universities want to have a vibrant industry and to keep some good companies going.”

This could tie in well with the R&D tax cash rebate scheme, which returns up to $375,000 straight to companies with a turnover of less that $5 million whose R&D spend drops below $1 million for the first time in several years.

“For some of the smaller companies, all of a sudden that might become more relevant as they start to mothball some of their projects,” Lawn says.

“All of a sudden they get their losses paid out in cash – it is automatic, it’s not discretionary and you don’t have to apply for a grant – just submit a tax return and typically within six weeks this wonderful cash arrives.

“It just means getting more creative about how we’re organising ourselves and who does the spend and how.”

---PB--- Economic Darwinism

In an article published by the US magazine The Scientist recently, US management consultant Stephanie Marrus mentioned a constant criticism of the biotech industry worldwide – that many companies are just ‘science projects’ rather than real businesses, and that what the industry may need is a dose of good old-fashioned rationalisation.

This is a constant theme in Australia too: that companies are spun-out too early, that too many small companies list on the stock exchange too quickly and too often, and that the egos of CEOs and scientists are as large as the US national debt.

It is an age-old debate, Lawn says. “Too many small companies are listing, and the answer typically from the CEOs is that this is the only alternative funding they’ve got, and that it provides access to what has proved to date a pretty ready source of secondary capital.

“That has justified a lot of companies continuing to go to the market, but that ability to tap the market through secondary funding has absolutely dried up, so even existing investors won’t support existing investments. That’s been a big change.”

AusBiotech’s Lavelle agrees, saying the Australian model encourages small companies to go out to early, too often.

“The system in Australia is that universities are funded to do R&D,” she says. “They are not funded to spin out companies or to commercialise their discovery or their raw science. And that’s precisely where it breaks down. It is way too early for an investor to come in because it is unproven at that point.”

That is why she is asking for the proof-of-concept grant system, which would weed out poor or unviable ideas very early. “Fail early, fail cheap,” is the mantra, she says.

Michelle Gallaher, CEO of the BioMelbourne Network, warns against taking this idea of ‘economic Darwinism’ too far. This is a term she is noticing being used with increasing frequency in the media, particularly about biotech, she says.

“I’ve been hearing people say, ‘oh, well, at the end of this we’ll be tougher and sharper and more focused’ and maybe this is a good thing,” she says.

“That’s not right. Biotechs are tough – we’ve never had easy access to capital, we’ve always had to demonstrate milestones, we’ve always had to answer because of the funding models that are available.

“The mindset too, which is accurate, is that it takes a long time to get a result and it is high-spec stock. There is a dose of reality in that but I don’t think we should just shrug our shoulders and say ‘tough’.

“The thing that worries me is the loss of intellectual capital from this sector – that people will give up on biotech and go back to medicine or finance or the law. You can say we will be sharper at the other end but there will also be a loss, and we have to accept that now.

“We also have to accept that if we don’t fund this sector, if we don’t create a stimulus package for the biotech sector, then we need to accept that these new medical discoveries will not reach the market for a lot longer, if at all.”

---PB--- Glimmer of hope

There is absolutely no doubt that while many are struggling, there are also many who are strong, are quietly chugging away and delivering the goods.

“Quality shines through and companies can still raise capital,” Lawn says. “Companies are still doing deals. There are investors still, there is cash out there, but investors are cautious.”

For instance, adult stem cell company Mesoblast recently raised $10 million and microbicide developer Starpharma has raised over $4 million.

Kim Carr certainly has confidence in the industry, he says. “There is no question that the global slowdown is weighing heavily on the sector. It is placing tremendous pressure on individual firms.

“Nevertheless, Australia has fundamental advantages in biotechnology that I believe will enable the sector to get through these dark times and grow strongly in the future.

“When the recovery comes – as is must – biotechnology will be instrumental in driving the creation of new industries and opening up new pathways to prosperity.”

But will it all be too late? Lavelle doesn’t want to be a panic merchant, but she does ask the question: if something is not done now, will it be too late in a couple of years?

“It can’t be switched on an off like that, because a lot of the people involved in it will have gone off-shore, they will be working elsewhere, the companies will have been rolled up or part of a merger and acquisition, and the technology will be gone.

“We will be back to investing like we were 10 years ago, of starting up and revving up the engine again.”

This is something that concerns Gallaher as well. She is noticing some significant shrinkage in the industry, with companies either shelving projects or reducing headcounts.

“If we lose those people from the biotech sector, that is going to have implications in the next five or 10 years,” she says. “If we mothball some of the research we can always pull it out and dust it off, but you can’t do that with people.”

Lavelle says many of her members are just hanging on, waiting to see what the government does in the May budget. This is also when a response to the Review of the National Innovation System, conducted last year by Dr Terry Cutler, should be ready.

Carr says a detailed response is being developed as part of the budget process, and that a white paper will be delivered later this year.

That’s all he can do at the moment, he says. It might not be enough, but Gallaher says she has noticed a great deal of optimism as well as the expected frustration in the small Australian biotech community.

“People in this industry do it because they care – they are not doing it for the money. This is what staggers me, the degree of how people in the industry care about the industry. No other industry is like ours in this respect.

“It is unique, the passion you find in the biotech industry, and it shouldn’t be underestimated.”