We all heard reports that January was a great start to 2012 for the stock market, and even more so for Biotech. But how big was it, really?

The Amex Biotech Index (the “BTK“) had its biggest January on record, since 1992, with a +21% pop:

The companies behind the numbers?

The Nasdaq Biotech Index was up 11%, the best in a decade. The January 2000 jump of 15% is still a tough month to beat for this broader Biotech index.

The drug class of 2011 was larger than the past few graduating classes. We count over 30 new “innovative” drugs found among the list of FDA approvals last year. This is in contrast to the 20-something range of the past few years. On the list are some clear breakthrough treatments and a few glimpses of “the future of biotech”. The specific drugs are listed further below, but first a big picture view:

Ten of the approvals were for biologics, six of which came through CDER. Of these six, three were antibodies, two were recombinant fusions, and one was a PEG linked enzyme. The other four biologics came through CBER. The CBER approvals contain blood or serum derived therapies such as the first blood cord stem cell therapy (Hemacord), a mixture of horse derived antibody fab domains for scorpion venom (Anascorp), and an autologous cell therapy for wrinkles (LaViv). One recombinant blood protein was approved by CBER, rFactor XIII (Corifact).

A range of disease areas were addressed by the the approved therapies. Cancer, being the most prevalent with eight approvals. Two of the small molecule new molecular entities (NMEs) are kinase inhibitors for cancers that were approved along side companion diagnostics. We expect to see more of this in the future, as patient identification and responder selection gains more traction in the industry, and regulators welcome the concept. News this week from Biogen, regarding Tysabri, underscores the importance using diagnostics for patient stratification even for approved drugs. News that Roche has bid ~$6B for Illumina also illustrates the imperative for drug developers. Examples of companion diagnostic for negative/positive responder identification, as well as safety profiling, will likely become a major theme in biotech in coming years.

The drugs slated for fast review and decision accounted for over 50% of the approvals. Orphan designated drugs made up a fifth of these approvals, and over a third were priority approvals.

Counting approvals that are new and “innovative”, is not as straight forward as copying and pasting from fda.gov. First, we only include drugs that are being approved for the first time, for a first indication. Second, we do not include imaging agents in our list, like the FDA did in their fiscal year list back in November (note we use a calendar year here). Third, unlike lists published elsewhere online that only count CDER BLA approvals, we include certain BLAs approved via CBER. Fourth, we exclude new formulations, and combinations. However, we do include chemically modified forms of exisiting drugs, such as this year’s addition of PEG to arginase in Erwinase (chemically like what Amgen did for Neulasta or Celltech did for Cimzia). As another example, two drugs with Gabapentin were approved in 2011, but only one was chemically unique (the prodrug Horizant) and made it on our list. The other, Gralise is a once daily reformulation.

Below is the 2011 list of new drugs. The colors denote biologics: Antibody (green), fusion or native protein (blue), blood fraction or cell therapy (orange).

The National Venture Capital Association (NVCA) has released their 4Q 2011 numbers for biotech venture financing in the US. The report echoes the global numbers already out from BioCentury and BioWorld – a boost in investment for 2011.

The take away, however, is not the total amount, but 1) the drop in the total number of biotech deals, and 2) the drop in start-up, early-stage deals from 2010. The total number of deals near 447 was down 8% from 2010, and the number of start-ups receiving funding dipped 19% from 2010. Biotech 1st round deals fell below 100 for the 3rd time in a decade (see table below). The NVCA defined “Life Sciences” group had the lowest deal number in FIFTEEN years. (They add device companies to biotech to get their “Life Sciences” number, which essentially means things are worse off in the device space.) As is often the case in our sector, the devil is in the details.  So, take the 20% jump in VC $ funding with a grain of salt.*

Here are the 1st round VC financings from NVCA since 1995:

Below is the US biotech venture investment from NVCA, 2005-2011. The second chart shows TOTAL US venture investment and total deals. Note that the second chart shows the total number of deals for all sectors going up, yet biotech (in the first chart) goes down for 2011:

What this implies is that although we did see more investment, the funding is becoming more concentrated. We see fewer deals, but more money invested. There are two possible reasons for why this could be happening. First, VCs are very conscious of capital constraints in a volatile macro environment and want portfolio companies to weather the next storm if need be. Second, later stage assets in biotech require more funding. With LPs demanding closer time horizons for an exit, these companies may have a better chance receiving additional rounds vs. discovery start-ups (without an asset) seeking a first round.

*A point that has been brought up since the NVCA release, see Bruce Booth and Rick Soltero, is the over reaction to the magnitude of the drop in the 1st round deals. Bruce argues that 100 is still a decent turn out, and Rick argues that they get more than they used to, with quality the focus on the VC front. Both are valid points and do not disrupt the thesis that more late-stage rounds deals are occurrring vs. early stage. When we plot the number of biotech deals that are 1st round vs. later round, the divergence is pretty clear (see below). However, when we plot the amount of money going into 1st rounds as a percent of total biotech investment, it is far more consistent (15-20% of all invested biotech VC money). Thus, taken together, this would mean the following:

1. There is no growth in the number of start-ups per year, potentially at a baseline near 100 (the 98 companies in 2011 is off peak levels of 140, by 30%, and below the 15 year average of 105)
2. The VC allocation discipline to early stage is about the same, but off peak allocation of 20% of invested money (typically 15-20% range since 1995)
3. Because there is more VC money invested in 2011, and start-up numbers stagnate, the investment per start-up is increasing (see last chart)

How did the Nasdaq Biotechnology Index (NBI) perform in 2011 relative to other sectors?

Second place. Not so bad considering 2011 was the year of defense in the stock market. Like a page out of a textbook on defensive market plays, utilities edged out ahead with a +15% gain, followed by consumer staples with 11%. The NBI squeezed in between at 12%, just above the overall healthcare sector.

Overall, the S&P500 was flat for the year, so the NBI took home double digit alpha for 2011. However, it was not an easy ride for either as this next chart shows. That big drop in August (the AAA crash) meant a -22% drawdown for the NBI (in red below)  and -16% for the S&P500 (in black). The big pop in the spring was in part due to data coming out of Biogen Idec, Pharmasset, and Regeneron, and approval hopes for Vertex. The December pop was a Christmas gift from GILD.

It is also useful to compare the NBI vs the Russell 2000 Small Cap index, given that most biotechs are small caps. The movement of Russell 2000 will give you a better idea of what your typical biotech may have experienced in 2011. (The NBI really shows you the movement of large and mid cap companies, which account for 78% of the market value of the index. It can be hard to imagine this given that 75% of the companies in the NBI are actually small caps. It is just that they comprise such a small weighting.) Below is a month by month breakdown of performance for the Russell 2000. Note the big swing the Russell 2000 took from September to October. The NBI held up (relatively speaking) and avoided ending up in the red for the year. The “R2″ left 2011 down -6%.

Next time we will look at the Amex Biotech Index (BTK) performance in 2011. The BTK was actually down -16%, but why?…

2011 ended quietly for the US biotech IPO market. It has now been almost two months without a biotech IPO. The last few IPOs back in November continued the theme that was in place at the beginning of the year – you can get out, but with a -30% haircut. In fact, only two of the 12 IPOs in 2011 raised more than they filed for. This is shown in chart 1 below.

The two companies evading the haircut are not your typical emerging biotech drug companies. One is Sagent, which actually sells 22 marketed generic drugs, a specialty pharma company. It makes it into our coverage here due to its small size, biotech commercial overlap, and 46 ANDAs in the pipeline. The other is Solazyme, a bio industrial company focused on converting plant sugar into oil. This is the 4th bio industrial IPO for the recent IPO window, coming in after Codexis and Amyris in 2010, and Gevo in 2011.

Since the 2009 Cumberland IPO, no pure-play drug biotech has made a debut without a discount to the offering price.

Chart 1: Amount Raised vs Filed for Biotech IPOs 2009-2011.

Looking at IPO performance in chart 2, only four of the 12 IPOs in 2011 were up by year end (33%). The mean and median performance for the class of 2011 is on par with the class of 2009-2010: -26 % and -33%, respectively. (IPOs from 2009 and 2010 dropped -27% and -37% for their collective mean and median performance.)

Chart 2: Performance of IPOs 2009-2010.

So far, the IPO picture is still generally negative for biotech fundraising. However, in terms of the number of companies that are exiting from the private to the public realm, biotechs are actually on track with the last US IPO window of 2003-2007. The total number of US IPOs since 2009′s Cumberland IPO is 31, compared to 30 at this time back in 2005. That averages out to a rate of one IPO per month for both time periods. With 22 companies “on deck” for a public offering, biotech IPOs could easily match this trend in 2012.

Chart 3. Comparing IPO Window of 2003-2007 with 2009-2013.

With only two weeks to go in 2011 it is looking like a five year low for deals. The chart below shows therapeutic deals dropping every year since 2007.

We use the Windhover/Elsevier Strategic Transaction Database as our starting point for deal analytics. We analyze each deal to determine if the deal is for a drug asset, removing generic/OTC deals, manufacturing/service deals, device/diagnostics/tools deals, and tech transfer deals. What remains are deals for biotech company pipeline drugs, from discovery through regulatory filing, and approved, branded drugs. These deals reflect the collaborative funding and corporate partnering for biotech’s in the drug space.

Table 1. Drug deals are down.

This data is in stark contrast to the number of meetings we see at our partnering events, and the discussions we hear from pharma executives. One on one meetings at the large BIO International Convention and BIO Europe conferences are still increasing at double digit growth rates year over year. Talk from pharmaceutical executives, as referenced in this WSJ story, continue to describe a widening of the deal net. So what is behind the divergence? Although there are fewer companies today vs. back in 2007, and more consolidation of “buy-side” licensees, can this really explain the magnitude of the drop? Perhaps we can dig into this a little deeper during the business roundtables at the upcoming BIO CEO Conference, February 13-14th in NYC.

Seeing the markets open down 2% or more on a Monday morning feels like “business as usual” on Wall Street these days. What is not, is seeing the Nasdaq Biotech Index (NBI) shoot up 4.5% on the same day the markets are cratering. It is very rare these days to find any sector not correlating with the volatile downturns set off by debt laden countries around the globe.

So what is behind the inverse correlation today? Look no further than Pharmasset (VRUS), a company that comprised 7% of the Biotech Index last Friday and now accounts for almost twice that. News that Gilead (GILD) will buy the company for $11 Billion shot the stock up 85% this morning.

Just how big is $11 Billion? $11 Billion puts this acquisition in the top 5 of the last 5 years. And that holds when we look at pure biotech buyouts or traditional and specialty pharmaceutical acquisitions.  The first table below shows the top 10 biotech acquisitions since the start of 2007. The second table shows the Pharmasset deal with the traditional and specialty pharma acquisitions.

Table 1. Top 10 biotech acquisitions since the start of 2007

Table 2. Top 10 traditional and specialty pharma acquisitions since the start of 2007

The $11 Billion is even more impressive when you realize that all the other names above are of companies that sold FDA approved drugs. Pharmasset is still at the clinical trial stage.

Pharmasset’s primary focus is the development of oral therapeutics for the treatment of hepatitis C virus (HCV) infection. They currently have three clinical-stage product candidates advancing in trials in various populations. PSI-7977, an unpartnered uracil nucleotide analog, is currently being studied in an interferon-free, Phase 3 program (FISSION, POSITRON and NEUTRINO) and in five Phase 2b trials including subjects with all HCV genotypes. PSI-938, an unpartnered guanosine nucleotide analog, is in QUANTUM, a Phase 2b interferon-free trial of PSI-938 and PSI-7977 in subjects with all HCV genotypes. Mericitabine (RG7128) continues in three Phase 2b trials and one interferon-free trial being conducted through a strategic collaboration with Roche. (For more info visit http://investor.pharmasset.com)

Here at the 10^th Annual BIO Investor Forum, investors and CEOs are debating “all the options” for private companies. The first panel of the conference explored the backdoor entrance into public markets as chilly winds continue to blow through the latest IPO window. For the lunch plenary, panelists examined the option to go virtual and make capital efficiency a reality.

Reverse Mergers

It is no secret that the IPO market for biotechs has been tough. What is less known is that reverse mergers in biotech continue to gain momentum, with eight transactions in the last year alone, and 19 over the last few years. Alan Auerbach, President & CEO of Puma Biotechnology has been part of two of these transactions, the latest being Puma’s merger with Innovative Acquisitions. In his view, reverse mergers offer a cheap route to the public markets that can open a company up to investors seeking the increasingly popular PIPEs, or Private Investments in Public Equity. PIPEs have been rewarding for savvy, specialized investors over the last three years. When comparing reverse mergers to IPOs, Alan sees little difference after the first few weeks of going public as trading settles into a fundamental valuation range, accented by broader capital market forces. The real differences are found in the legal formalization of the shell on one side and gaining board consent and intent on the other. Jonathan MacQuitty, a Partner with Abingworth, notes that reverse mergers have a place in markets where most equity investors and underwriters are only willing to support high valuation, highly liquid companies.

Paul Hastings, CEO of the privately held OncoMed, adds that private companies need to have all options available so a move can be made when the time is right. For some companies, remaining private is the best option, for others it might be filing the S-1 or seeking the shell route. He added that for all options to be available we need to see regulatory certainty return to the sector. Only then will investors on both sides of the market widen their allocation to risk capital.

Marc Beer, CEO of the recent IPO company Aegerion (AEGR), argues that if venture investors and management view the IPO as a fundraising event, as opposed to a final exit point, more companies would be able to take advantage of the IPO option. Otherwise, companies risk taking the next financing round with just enough capital for the next milestone, and not the next three. The unpredictable nature of this business and the funding environment we are in, makes the step by step approach inefficient. Marc adds that public investment is out there if you have the right data. Fortunately for him, he has a late stage asset in a rare disease, essentially the hottest place to be in biotech these days.

One of the tough realities of the public market today is the myopic valuation models for development stage biotechs. Companies with a late stage asset are being valued on their lead program, with the rest of the pipeline valued at such a deep discount that it is essentially irrelevant. For a company with multiple early stage assets today, it makes the IPO or reverse merger prospect not as inviting as a deal from pharma that may offer a premium. The counter to that argument is all the CVR activity we are seeing today as the buyer’s market continues its trend.

The barriers to going public also include the stage of an asset and its perceived risk. We see this in the fact that most IPOs these days are late stage asset companies, as opposed to a decade ago when many IPOs were actually pre-IND. Those days are gone, but companies with earlier pipelines can knock down their risk by running careful designed studies addressing issues identified by regulators, investors, physicians and payers. Marc cited the example of Aegerion, where extensive communication with outside entities helped identify safety and regulatory hurdles. One by one they addressed these issues, cutting safety and regulatory risk through trial data such that investors were willing to accept the remaining risk in the program.

Virtual Companies

Start-up biotechs are also working on ways to appeal to investors in ways that bring costs well below traditional levels and bring exits years earler. Venture capitalists are turning to the capital efficient, virtual approach to drug development. In essence, the old biotech model of building a fully staffed company around IP and then seeking to bring a molecule through the clinic is morphing into building a molecule through the clinic first, then building the staff. With success rates so low in the industry, perhaps the industry had the cart before the horse when launching last decade’s start-ups.

The panel today exemplified this potential sea change for early stage biotech structures, with working examples illustrated in Versartis and Diartis Pharmaceuticals. Jeffrey Cleland, CEO of both companies, explains that each of these companies has just one drug, spun out from a parent innovator company. If the drug fails, the company fails, but there won’t be any layoffs. The reason is that the company is run by clinical and regulatory experts that oversee outsourced development. No human resource department, no cleaning crews, no bench scientists, no accounting department, no press team, no IR department, no bricks and mortar. Even the CEO, wearing many hats, will just rotate his focus to another portfolio company if one compound dies in the clinic.

The idea for most of these models is to advance the drug from IND to POC, then explore options for acquisition by larger pharma or biotech. David Collier, Managing Director at CMEA Capital explains that it is much harder to exit at POC today if the company burn rate is burdened by non-development expenditures. He believes the old model burn rates were 60-70% unrelated to a drug’s actual clinical development. The CEO’s salary and peripheral corporate staff salaries heavily weighed on this figure.  The new model is attractive to suitors as the excess fat has been trimmed and capital is laser-focused on execution. We are in a buyer’s market and the cost of clinical drug development is soaring, so anything that cut costs and adds value through data generation is where biotech start-ups need to be.

David Collier is also the CEO of Velocity Pharmaceutical Development. Velocity’s motto is “We build drugs, not companies.” The company seeks drugs that will make it to POC in ~3 years for just $15M, with no bias toward modality. The experience behind the three Chief Medical Officers that will oversee the external development is extensive and diverse, one of the essential ingredients to setting up such a virtual shop.

The panelists all agree that even a new model will not fix the industry’s productivity problems unless all attention is focused on the details of trial design and execution. The new model attempts to focus on the core clinical activity, much more so than traditional biotechs with many broad interests. Sanjay Shukla, CEO of RxMD knows this first hand, as his company has played “clinical trial quarterback” for many firms over the years. RxMD’s expertise is clinical trial design and execution for biotech clients. Their advantage is that not only are they deep in the trenches of running trials, they can also offer objective analysis of outcomes. This objectivity is key to killing drug programs after negative results. Without the objectivity, many management teams in biotech allow failing drugs to linger in development as they are wedded to the compounds they have discovered and fear how failure will affect their job stability.

Sanjay, Jeffrey, and David all agree that having trial design input from all constituents is critical to make the final package attractive to future acquiring entities. In addition to bringing regulators to the table at an early stage, key physicians and potential acquiring firms should be surveyed to establish all endpoints and comparator arms that might be needed to show ample evidence of efficacy, superiority, physician adoption, and reimbursement.

The biggest risk for start-ups today? Being successful with POC in man, yet finding no suitor. At this point a virtual company would have done all they set out to do, and faces closing down or switching gears to actually go beyond PII and into PIII, or even breaking the virtual model and actually creating a salesforce and fully integrated company. This would break from the original concept forcing management to spend a lot of their time seeking funding for the expensive inflection points and hiring staff.

Of the 300 publicly traded U.S. biotechs, 219 (73%) are developing drugs. The other 27% are working on molecular tools, diagnostics, biofuels, and other biotech endeavors. One question that is often asked with respect to drug-focused biotechs is: How big are they compared to traditional pharmaceutical companies? How many are valued as small start-ups vs large, or mid-size pharmas?

It turns out that more than half the sector trades with a market valuation of less than $200M, and a third trades for under $100M. So the sector today is predominantly composed of Small and Micro Cap stocks. In fact, even the Nasdaq Biotech Index, which excludes many Micro and Nano-cap stocks and biases weightings toward larger companies, trades in high correlation with the Russell 2000 Small Cap index. In Chart 1 below, we place the number of companies into buckets by market capitalization. Only five companies actually land in the “Large” bucket, as defined by $10B+ in market value (Amgen, Gilead, Celgene, Biogen Idec, Vertex). This compares with 142 of the 219 companies (65%) trading in the Micro Cap ($50-$300M) and Nano Cap (below $50M) range.

Chart 1. Most Biotechs are Tiny

In Chart 2, we sum the market caps of each of these five buckets and compare them with market caps of the three largest pharmaceutical companies (JNJ, Novartis, and Pfizer). It turns out that when we add all the large biotechs together, the total valuation does not even equal one of these “Big Pharma” companies. More interestingly, if you add up all the remaining 98% of biotechs (214 companies), they do not even equal one Pfizer in value. The combined market value of any two of these Big Pharmas (JNJ + Pfizer = $345B, for example) is larger than the total public biotech sector, which today stands at $258B for all 219 biotechs put together.

Chart 2. Added together, Biotech is almost a Big Pharma.

To put this in perspective, (mainly for M&A theorists), we examined the cash position at top large pharmaceutical companies, and asked the question: How much of the entire biotech universe could Big Pharma acquire with current cash positions? It turns out that the top 10 Pharma firms (by cash position) have enough cash to buy 98% of all publicly traded, drug-focused R&D biotech companies in the United States (Chart 3). By applying a more realistic 50% premium to current market values, these Big Pharmas could acquire 93% of the sector. A single company like JNJ, with more than $29B in cash, could acquire well over 50% of all biotech firms, at a 50% premium, and still have cash left over to finance operations (Chart 4). In fact, the bottom 50% (110 biotech companies) costs just $1.2B per year to run, based on summing the last twelve months of operating cash flow expenditures. This compares to JNJ’s $15B positive operating cash flow and $6.8B annual R&D expense.

Chart 3. What the top 10 Pharmas could buy.

Chart 4. What JNJ, Pfizer and others could buy. (Cash from 2Q11 is in parentheses)

The strong cash positions of Big Pharma vs. the relative size of biotechs has baffled M&A theorists predicting a major strategic wave of biotech takeovers is bound to come. That wave has yet to come, even with Pharma’s ability to issue debt at record low interest rates and continued pressure to refill and diversify pipelines. What has happened so far is a slow trickle of acquisitions, many in the private sector, and a couple of large deals in the public sector. Will 2012 be the big M&A year for Wall Street’s biotechs or will drug companies prefer to shell out higher dividends? Either way, I am sure the seers on our Closing Panel at the Investor Forum October 26th will tell us.

IPO plans for Quark Pharmaceuticals were officially put on hold last week as markets continue to drop and investors shy away from risk. This is the fifth IPO withdrawal since June. Ambit, Agendia and Clarus cited market reasons for their withdrawals, and Advanced BioHealing sought a higher valuation exit via acquisition. Only one biotech IPO, Horizon Pharma, has made it out in the last six months. Of the nine biotech IPOs so far in 2011, five are down more than 30% and only one was able to raise the original amount filed for.

All this points to an icy fall season for the IPO window, but is the window really shut? If conditions follow the last IPO window of 2004-2007 , the answer is “no”. In the chart below, we line up accumulated IPOs by month for the IPO window 2004-2007 and the current 2009-2011. What we see is almost a mirroring of what took place five years ago. After two years into both IPO windows, we have exactly 29 IPOs.

It will be interesting to watch the 19 U.S. biotechs with current S-1 filings. Will they bring about a surge in IPOs like the end of 2006? Maybe, but it will certainly be tougher this time around. Back then we were not following a “Credit Crunch”, nor were we in the midst of a “Debt Crisis” (back then the U.S. was still AAA rated and Greece could pay its bills). Global macro dynamics will  likely continue to define biotech stock and IPO performance over the coming months.

Cumulative IPOs for 2004-2007 vs. 2009-2011:

Biotech IPO Performance: (Median = -30%)