Improving health

Many biotech firms have been delivering record revenues over the last year, but that's not the only reason why the healthcare and life science sectors are catching the eyes of investors. In addition, there have been a number of important trends emerging.

In the healthcare sector, for instance, the last 12 months have seen some major transactions by the industry's largest players. UnitedHealth's $8.1 billion (€6.4 billion) acquisition of PacifiCare in December 2005 was a notable deal in terms of the consolidation of the healthcare industry. Meanwhile, the acquisition of disease management company LifeMasters Supported Selfcare by diabetes treatment manager Healthway in May this year highlighted the increasing importance of managed care, given the need to develop preventative methods that reduce costs for government.

Jonathan Korngold, who manages healthcare investments for global private equity firm General Atlantic, says that the combination of an aging baby boomer population and the long-term unsustainability of healthcare systems around the world means that governments are desperate to work with companies that can cut healthcare costs.

“The sector is poised for more growth today than it ever has been in the past,” he says. “People in the US today spend more money on healthcare than they do on food. Soon there will be a huge flood of baby boomers who are starting to reach an elder age, and two-thirds of people over 65 have one or more chronic conditions. That's going to require a significant increased need for the healthcare system.”

Korngold adds that, with 30 percent of healthcare costs being borne in an average patient's last six months of life, there will be increased activity as more people move into that later stage. Korngold points to two of his firm's recent transactions as examples of this concept: Arizona-based Schaller Anderson, a provider of consulting services to governments and private healthcare organizations worldwide, which General Atlantic backed in 2002; and MultiPlan, the largest independent PPO (preferred provider organization) network in the US, which was sold earlier this year to Washington DC-based private equity firm The Carlyle Group for an undisclosed sum.

Continues Korngold: “Twenty percent of US GDP is focused on healthcare. Every investor is going to be looking at that area. It's the same thing with strategic players, they're increasingly looking to round out the scope of services that they're providing, and that's led to a huge increase in the level of M&A activity in the last few years.”

This increased level of opportunity is being accompanied by seismic changes in the dynamics of the industry. “The current model is just not sustainable,” says Jonathan Heppel, an investment director with BioScience Managers, a UK-based venture firm that makes healthcare and life sciences investments on a transatlantic basis. “As large players consolidate, that will shift a lot of power in their direction, which will affect any change in healthcare legislation.”

The past year's sweeping changes to the Medicare prescription drug benefit plan in the US is just one example of how intimate the relationship is between the healthcare sector and government. In the US, the government pays more than one-third of healthcare expenses, and with an aging demographic, the role of government will only increase. In Europe and Asia too, the government is the dominant player in the market.

“If people can't get comfortable with having government as their biggest customer, they should stay out of healthcare and life sciences,” cautions Heppel.

However, while in the US government involvement in healthcare is increasing, the opposite is true in Europe. “You're seeing a huge opportunity in Europe as states are increasingly looking to the private sector to supplement what's government provided,” says Korngold.

As a result, deals are occurring regularly in the European healthcare sector. Last year saw the €320 million acquisition of French private hospital group Medi-Partenaires by French private equity firm Cobalt Capital and the UK's Barclays Private Equity, as well as 3i's purchase of Nordic healthcare services company Carema for an undisclosed sum.

Investors in life sciences, meanwhile, have had to learn some hard lessons. In 2000, the success of the human genome project generated a flurry of interest in life sciences, and in that year the US biotech industry raised a record $4.9 billion through IPOs. But when investors realized that the sector was unlikely to generate short-term returns, there was a broad retreat. After the bubble burst, venture capitalists became more risk averse and increasingly came to focus on laterstage, product-focused biotech companies.

Today there are indications that this could be changing, and some investors are starting to again look to earlystage companies. Some biotech companies say that the late-stage investment appetite of the past few years has left young biotech companies hung out to dry. But those companies that were able to survive the last few years may now be seeing a payoff.

2005 was a record year for biotechnology. For the first time in the sector's 30-year history, the revenues of publicly traded biotech companies surpassed $60 billion, an 18 percent increase over 2005, according to a study by Ernst & Young. While revenues increased, the industry's net losses decreased by 30 percent to $4.3 billion.

As a result, investors have been exhibiting increased interest in the sector. In 2005 the global biotech industry raised $19.7 billion, down slightly from the $21.2 billion raised in 2004 but still the second-highest total since the bubble of 2000, according to Ernst & Young. The industry secured 32 new product approvals in the US in 2005, including 17 first-time approvals.

Despite the generally increased interest from investors, they have shows a hesitancy to invest in very early-stage companies since 2000. Start-up companies with little clinical success to point to have struggled for funding, and those that have gone public have had disappointing valuations.

“In the life sciences sector, timelines are so long and costs to get the product to market are so high, and there is a high failure rate,” says Carter Neild, a managing director at New York-based Orbimed Advisors, which has just closed a $500 million fund focusing on late-stage life sciences investment. “We would rather wait until a company has at least some human clinical data, and then we can make an informed decision about the likelihood of that product getting to market.”

It's no wonder that many venture capitalists are wary of investing too early in life sciences companies. It can take as long as two decades to take a drug candidate from early-stage discovery to product launch. With the life of a typical venture fund being ten years, this is well beyond the timeframe most venture capitalists like to see. But in order for the sector to be healthy, it needs to have investment in all stages.

Stephen Bunting is managing director of London-based venture firm Abingworth, which invests in early-stage biotech companies on a transatlantic basis. He says that for a GP to invest in an early-stage company it needs to see a viable exit route in the future. But even with the most careful planning, some earlystage investments are bound to fail.

“The drug development business is a risky one,” he says. “You need to make sure you have enough projects and programs so you can manage both success and failure. That means you have to be very effective with how you use your capital.”


Revenues ($m) 63,156 47,790 9,781 2,584 3,002
R&D Expense ($m) 20,415 15,979 3,272 852 312
Net Income (loss) ($m) -4,388 -2,128 -1,943 -324 7
Number of biotech companies
Public companies 671 329 122 81 139
Private companies 3,532 1,086 1,491 378 577
2005 2004 % change
Type US Europe Canada US Europe Canada US Europe Canada
IPO ($m) 626 691 160 1,618 359 85 -61% 92% 89%
Follow-on and 10,740 1577 608 11,810 1,596 435 -9% -1% 40%
other offerings ($m)
Venture financing ($m) 3,328 1,738 242 3,661 1,447 271 -6% 20% -11%
Total 14,694 4,006 1,010 16,979 3,402 791 -13% 18% 28%

Although life science companies haven't had much joy with IPOs in the US, in Europe companies listing on the London Stock Exchange and elsewhere have fared much better. The number of IPOs in Europe and aggregate capital raised increased significantly in 2005. In addition, US IPOs have often been priced below their IPO ranges and fallen further on subsequent trading, while European IPOs have often done the opposite. For the first time, 2005 saw more European biotech IPOs than in the US.

Bunting says London's AIM market is changing the way VCs think about IPOs and the prospects of raising capital in Europe. “Europe has been an easier place to take companies public of late, and I think that will be significant for the industry over here,” he says. “It shows Europe as being a very considerable source of capital.”

For this reason, Abingworth recently took a US life sciences company public on AIM rather than Nasdaq. Entelos, a California-based company that develops predictive computer models of human disease, went public on AIM in April.

“It was too small a company to go public in the States, plus the US has the Sarbanes Oxley burden,” Bunting says. “The US market is looking for something more like a valuation of at least $200 million, and for companies that fall under that valuation it's not easy to go public. A lot of companies are in territory where they can't justify their existence on the Nasdaq, and this is not the case on AIM, which has a large number of companies with lower market caps and is very flexible.”

However, Jonathan Heppel says that though European IPOs are now meeting more success, life sciences companies still see the US as the more developed market by far.

“Where you see a big difference between the European and US biotechnology sector is, in the US you have the ability to raise significant funds once a company is public, whereas in Europe that is still quite restricted.” he says. “That's partly the reason why many investors in Europe look to redomicile a company in the US, so it can tap into the US market.”

In terms of depth of management expertise and availability of capital, the US life sciences sector is still far beyond its counterparts in the rest of the world. The industry in the US delivered strong product approvals and solid financial results in 2005, the third consecutive year it has done so. According to Ernst & Young, revenues in the US grew by about 16 percent in 2005. In a sector long characterized by instability, this consistent growth is being taken as a welcome sign by investors.

At the same time, European hotbeds of biotech activity like Cambridge and Oxford in the UK and Basel in Switzerland delivered strong results as well, as the sector in Europe emerges from a period of restructuring. Public biotech company revenues increased by 17 percent in 2005, compared with a 5 percent decrease in 2004, according to Ernst & Young. And while there were just 8 biotech IPOs in Europe in 2004, in 2005 there were 23.

“There are still many inefficiencies in the European market, but we're starting to get to a position where you're seeing more maturity in the management,” says Heppel. “The changes that are going on in the pharmaceutical industry have continued to supply people and opportunities, and I think that the relationship with pharma, both from the biotech companies and the investors, is becoming closer. I think it's being recognized that biotech has a key role to play in being the research and development provider to large pharma.”

While activity has increased in the US and Europe, growth in life sciences in the Asia-Pacific region has been even faster. In East Asia, the combination of an increasing focus on the biotech space by Asian governments and increased interest by foreign companies in getting into the fastest growing drug markets has created a boom in activity. Asian life science company top-line revenues last year increased by an estimated 46 percent compared to 2004, according to Ernst & Young. This has partly been due to clarifications in the regulatory framework in Asian nations and stronger intellectual property protection. Japan especially has seen consolidation pick up as a result of regulatory reform and growing foreign competition.

“The Far East is getting more interesting as far as acquiring assets is concerned,” says Quester's Wilcock. “It's not obvious yet how to unlock that potential, but figuring it out is time well spent.

Vaccines has been a particular area of focus in Asian biotech as fears about avian flu, SARS and other possible pandemics prompt governments and private enterprise to undertake more research and development in these areas. With several popular drugs expected to lose their patent soon, generics has also been a rapidly growing segment of the Asian biotech sector.

With all of the increased activity in healthcare and life sciences around the world, private equity players should proceed positively, but with caution. These sectors may provide exciting new opportunities, but may not be the best medicine for anyone looking for a quick or clear exit.