AFG Venture Group Dispatches

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Will The IPO Market Open For Australian Biotechs in 2011?

David R Blake
Co-Editor, Bioshares

For some ASX listed biotech the last 12 months have been positive beyond belief. Stem cell company Mesoblast saw its capitalisation rocket from $286 million at the end of the March quarter 2010 to a little over $2 billion as at March 31, 2010. Its closing share price on that day was $7.25, up 255% for the 12 months. Mesoblast’s great leap forward came courtesy of a deal signed with US speciality pharma, Cephalon, which licensed the rights for cardiovascular and CNS applications of Mesoblast’s stem cell technology in December 2010. Cephalon invested $223 million to take a 20% equity position and paid US$130 million up-front. Total deal value based on passing development milestones was US$1.7 billion. What should be remembered about this deal is that, firstly, Mesoblast was de-risked from a funding perspective holding $280 million in cash to fund other projects, and secondly, retained manufacturing rights, which can be a source of both leverage and value in the future. Mesoblast’s deal now ranks as one of the all time ever best deals across the globe in terms of total bio-dollars (which are potential, not actual dollars).

Mesoblast’s valuation shift is unparalleled in the history of Australian start-up biotechs, with the closest comparison possibly being Biota’s run in 1999 to a market cap of $670 million, only to be followed by 50% fall when its flu drug Relenza (partnered with GlaxoSmithKline) failed to achieve FDA advisory panel support at its first attempt. For Mesoblast, sustaining such a valuation requires numerous events to take place in the right order and at the right time and for a first class hit rate in the clinic and a sterling approach to execution. There is no margin for error in its $2 billion valuation as ascribed by the market.

The stock perhaps as equally talked about as Mesoblast has been Acrux. Both Mesoblast and Acrux are based in Melbourne, although Mesoblast’s technology originates from the Hanson Centre for Cancer Research in Adelaide. The foundation patents for both companies date from the late 1990’s, illustrating (once again) the long gestational period required for developing medical products.

Acrux not only succeeded in licensing its Axiron product for the treatment of testosterone deficiency in males to Eli Lilly in March 2010, but it sailed through the regulatory process with FDA with remarkable ease (said only in hindsight!) in November 2010. Deal terms included an upfront payment of US$50 million, followed by an US$87 million payment on FDA approval, and a further $197 million contingent of market progress. Although never revealed, we estimate that Acrux stands to receive royalty payments at or near 20% of net sales. However, why Acrux, which was capitalised at March 31, 2010 at $500 million has hit it off with investors is that it will deposit $100 million of that cash received from the Lilly deal, in the hands of shareholders in the form of a special untaxed dividend. It is probably the single biggest sum of money to ever return to shareholders of a start-up biotech, which traces its origins to the Victorian College of Pharmacy and the famous ‘Parkvillle Strip’.

It seems some companies get almost all the cash in biotech. In our weekly investment report, Bioshares, we monitor capital inflows on a quarterly basis. In calendar 2010, $554 million was raised by ASX-listed biotechs. The gourmet dinners were enjoyed by just five companies who accounted for $307 million of capital sourced from placements and convertible notes. For the crumb gatherers, 19 companies shared $30 million of placement related funding, and 20 companies collectively raised $63 million from rights issues. In average terms, that’s $1.9 million and $3.3 million per company. That’s the kind of money that keeps the lights on, maintains patents and pays the salaries of core staff. However, it is not sufficient to fund proper clinical programs and advanced development programs.

Two IPOs were completed 2010, one by Brisbane-based CBio, which raised $7 million, the other by US-based Reva Biomedical, which raised $85 million. CBio is developing the Xtoll immune-therapy for treating auto-immune diseases and Reva is developing a bio-resorbable coronary stent. Since then Canadian drug developer, vet products and food-safety company Bioniche listed, raising $12.5 million, although it also conducted a C$15 million raise on its home exchange in Canada. Bioniche undertook a listing because of a longstanding Australian shareholder base, mostly drawn from the veterinarian community.

The sentiment towards IPO offerings appears to be weak. Continued global X-factor or Black Swan events, such as turmoil in Libya and the earthquake initiated catastrophe in Japan have not helped. Unpredictable decisions and actions by medical product regulators have also not helped. However, just possibly, some of the money flowing back into the sector courtesy of income and capital gains from out-performers like Acrux and Mesoblast might move the needle towards an ‘IPO friendly market’ setting on the dial.

The challenge for companies raising any type of capital, not least IPO capital, is having the right story. Better structured companies stand a better chance of getting underwritten by sponsoring brokers. The question is – what sells in today’s biotech capital market?

There is some evidence to suggest that platform companies do better than single product opportunity companies. Carving out product opportunities where there is a poorly served market continues to make sense. Companies that offer improvements and patent life extensions to existing drugs, diagnostics or devices have appeal. Companies that maintain a lock on manufacturing can also set themselves up for a stronger future, as can companies that are seeking to introduce manufacturing efficiencies into the pharmaceutical or devices industry.

One of the great, big fat advantages going for investors as they confront the next wave of biotech IPOs that is surely bound to come, is that there is a greatly expanded pool of experienced executives that technology/company structuring agents can call on giving private companies their best shot in a public markets world. Nowadays, there is no shortage of deal-makers, trial managers, contract managers, patent attorneys, QC, QA and manufacturing specialists to put rigor and credibility into a growing start-up.  More importantly, there are now teams of execs ready to do it all again.

The ASX-listed biotech sector has gone through a period of tremendous transformation in the last two years as a dozen or more companies have matured into successful companies, generating revenues or verging on having products registered. At the same time upwards of 30 have had to close their doors or significantly change their business. There is no success without failure. However, with that key barometer of investor sentiment towards biotech, the Nasdaq Biotech Index, having recently breached the 1000 point barrier several times, for the first time since 2001, and showing a very strong uptrend, perhaps biotech, not just in the US, but in Australia and elsewhere is about to be very popular with investors again.

About the Author

David R Blake is the Co-editor of Bioshares, a weekly biotech, pharma and healthcare stock report published in Melbourne, now in its 12th year of publication. The 7th Bioshares Biotech Summit will be held in Queenstown, New Zealand, over July 22-23, 2011. blake@bioshares.com.au +61 3 9326 5382