Healthcare: Healthcare: heading for the next dotcom-style frenzy?

Pharma-linked biotech stocks are already creating a buzz, although that buzz has not bought stability in stock prices to the sector. Stock prices were on the rise across all exchanges – in part fuelled by the excitement created by the imminent completion of the human genome mapping. As Shahzad Malik at Advent Venture Partners points out: “Biotech is a trillion-dollar industry, people are always going to get sick and there were a lot of maturing biotech companies in the US that had single-figure multiples on earnings. So the educated investors moved some of their money back into biotech, and this smart money was followed by momentum money.” And so biotech stock prices continued to climb.

That status continued until US President Bill Clinton, joined by UK Prime Minister Tony Blair, hit out at biotechnology firms claiming the right to patent human genes. These outbursts followed the completion of the mapping of the Drosophila melanogaster – or fruit fly – genome by Celera Genomics, a tracking-stock business unit of PE Biosystems Group that is part of the New York Stock Exchange-listed PE Corporation. Celera released details of the mapping free of charge to researchers via Celera and GenBank, the public database in March this year, and has a patent application pending approval.

Celera Genomics reacted to the US and UK premiers comments saying: “Since the announcement of Celera’s formation we have made a clear commitment that upon our completion of the consensus human genome we would publish it in a peer-reviewed scientific journal and make it available to researchers for free.” What it didn’t say and what many industry observers are saying – including attendees of Bio2000 in Boston last month attended by over 10,000 people – is that it is unfair to ban biotechnology companies from receiving patents.

This is because a patent enables a company to grant licenses to companies that make saleable products on the back of knowledge gained from patented information. This, believe industry observers, is the quid-pro-quo for the high cost of mapping the human genome. After all, other than gaining kudos, this mapping is not going to make money or cure diseases, but give biotechnology and pharmaceutical companies the tools with which they can conduct R&D projects that they hope will produce profitable drugs. Furthermore, the patent-to-licence-and-royalty route is deemed acceptable for a plethora of other industries and some believe that this issue will die down, Celera will be granted a license and that, once again, knee-jerk politics were at work. No doubt the fact that a private company – (see box opposite) – is looking set to pip years of publicly-funded research to the post added fuel to the fire. Observers note Celera Genomics’ research methods, though much faster, do not have the same levels of accuracy as the publicly funded methodology so the validity of the latter is not eroded.

This hiccup aside, biotech is seen by many as the next big buzz area when the dot.com frenzy subsides – the existence of real cash flows and profit margins being one incitement! Others include the fact that the completion of the human genome mapping will change the pharma landscape and real leaps in medical science are believed by many to be around the corner. Genomics is a hot topic for venture capitalists too. Commerz Beteiligungsgesellschaft has this year invested in Artemis, a gene targeting business that is conducting research on the human genome and how it is structured, and Cellcenix Technologie Transfer which is a biotech company founded in 1994 as a spin-off from the University Medical Centre in Freiburg in Germany. It develops, produces and markets GMP grade cell and protein products for the treatment of cancer and orthopaedic patients. Advent Venture Partners has invested in Oxagen a company established in 1997 as a spin-out from the Wellcome Trust Centre for Human Genetics in Oxford.

Oxagen is involved in the study of complex disease genetics. In August 1999 Oxagen, PE Biosystems (which runs the Celera Genomics business mentioned earlier), and Geomica Corporation agreed to develop advanced software for high-throughput genotyping. This leverages Oxagens expetise in high-throughput genotyping and functional analysis with Geonica’s analytical software tools an PE Biosytems instrumntation systems and unified software for drug discovery.

Most biotech investors point to the need for portfolio diversity and invest across the life science spectrum – or in the words of Shahzad Malik: “We look at everything from DNA through to clinical waste”. e-health is another area that is attracting a lot of buzz from the venture capital community – the success of Medscape.com in the US being an obvious and oft-cited magnet. A number of similar ventures appear to be springing up across Europe thanks to venture capital backing and consequently this is another area of the biotech/healthcare space that eventually may become ripe for consolidation.

The trade sale of a biotech company doesn’t appear to face the same issues surrounding, for example, the IT industry. In the case of a trade sale where one IT company is bought by another, the information technology is the asset and the buyer will have an army of its own programmers and developers that are able to get involved in the project immediately and eventually take it over. However, in the case of a biotech company sale, the brains of the scientists are as much part of the package as the intellectual property already incumbent in the company. This equates to greater security and leverage for the acquired company and its management. While a trade sale, usually to a pharma company, has been the most obvious route for developing biotech companies and exiting venture capital investors in the past, a greater understanding and acceptance of biotech stocks on the listed exchanges means an IPO is a viable option once again. This is so because stock market confidence, despite recent shake-ups, remains high and, as a result ,investors will support an IPO of a loss making company with a strong growth story.

To go back to the IT analogy, this might throw up interesting scenarios. Michael Barrett at Forrester Research in Cambridge, Massachusetts, notes the increasing importance of IT in the future of biotechnology and pharmaceuticals research. In particular he notes companies like Affymetrix Inc, which develops and commercialises gene chip DNA probe technology for automated gene sequencing and management of complex genetic information. Affymetric will put thousands and thousands of genetic samples on a computer chip which can be swept by running thousands of minute variations to see which part of the gene/enzyme/protein is mutated. Some have taken the logic of these developments to their conclusion and are talking about a time when the testing of drugs is carried out within the context of a software programme rather than by animal testing and human trials. More sober commentators point out that this is more likely to be decades rather than years away.

Biotechnology, life science and healthcare venture capital investors thankfully remain one of the few truly niche breeds of investors in the industry. The more established groupings, which tend by and large to have venture capitalists working alongside people with biotech industry experience, are sceptical of the biotech industry newcomers with toe-dipping venture capital experience and their ability to go the distance. One who has done quite a bit more than toe dipping is Jrg Muschiol at Capman Management in Munich. He has a medical background (and as MBA) and has acted as a business angel for a number of successful biotech projects. Medicineonline.de where he acted as a consultant plans to float on the Neuer Markt in the next couple of months.

Capman is a start up run by people with an industry background. Capman is in the middle of raising its first fund which will operate as two parallel investment funds thanks to a E25 million commitment from a first time venture capital investor from the Emirates. The second fund, for which commitments were still being collected at the time of writing, also aims to meet E25 million. Proving your pedigree can be a difficult game at the outset but Jrg Muschiol , who has positions at names such as Zyma and Schering-Plough on his CV points to Capman’s choice of board members. The board members include Richard Roy the managing director of Microsoft Deutschland and Peter Wutenberger the managing director of Yahoo! Deutschland. In addition, and a boon for sourcing deals, Capman’s board includes Dr Heinrich Kuhn and Dr Zxel Polack who are on the licensing boards of the Max-Planck Institute and HGF, respectively.

While biotech venture capitalists are wary some newcomers they are keen to build co-investment arrangements with domestic and international partners. Life Science Ventures, for example, has co-invested in Sequenom a 1998 TVM Techno Venture Management biotech start up looking to develop molecule enzyme drugs for infectious diseases. TVM Techno Venture Management, like Life Science Ventures, is located in Munich. On an international level, Life Science Ventures has a three-year partnership with the US venture capital fund of fund investor Oxford Bioscience Partners and has and is in the process of cultivating partnership arrangements with other players.

Coinvestment appears to be something that biotech venture capitalists, perhaps lacking the arrogance of those outside the sector, actively look for. Dr Wolfgang Hanrieder at SVM Start Ventures in Munich says:

“We are always interested in a good syndicate – we prefer to syndicate than deal on our own even though the downside is that you don’t always maximise your position. But you must have the right partners – we have two or three very close friends in Germany and four or five in the US.” Until the beginning of 1999 when the venture capital market in Germany really began to heat up, SVM Star Ventures concentrated on investee companies located in the US and Israel. The focus now is more on a three way split.)

There is still a perception the market that biotech/pharma-linked investments are volatile as indeed they can be. However, investors are not shying away and new entrants and venture capital firms that can be considered old hands in this field are not reporting any difficulties in fund raising – in fact quite the reverse. As with any hyped area where new faces keep springing, up there is an element of wariness that a few poor fund performances could spoil it for the rest – not irrational given the dramatic plunge across all biotech stocks following the Clinton/Blair outbursts. To give them their due, however, venture capital firms throughout the sector will almost certainly be credited with having bought commercialism and ultimately financial success to concepts that might otherwise have lounged or been buried in

institute laboratories.