Executive egos get in the way of consolidation among UK biotechs

Firms need more cash, more science, more horsepower – and the will
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The Independent Online

The UK biotech sector needs to consolidate. This has been accepted wisdom throughout the industry for years. Companies listed in London are too small and too financially weak, and are working on too few exciting new drugs to compete effectively against the giants in the United States. And yet, again and again, informal talks within the close-knit community of biotech directors have failed to make first base. Could that be about to change?

The UK biotech sector needs to consolidate. This has been accepted wisdom throughout the industry for years. Companies listed in London are too small and too financially weak, and are working on too few exciting new drugs to compete effectively against the giants in the United States. And yet, again and again, informal talks within the close-knit community of biotech directors have failed to make first base. Could that be about to change?

As ever, there is no shortage of investors, company directors, analysts and bankers willing to argue the case for a bout of merger and acquisition activity – at least for a few breaths, before the "buts" creep in.

Elliot Goldstein, the Canadian chief executive of British Biotech, said: "All our companies are too small, there are problems with cash and most companies' portfolios are not broad enough. We need more science, more money, more horsepower."

Biotech share prices have been on a steep downward slope since the end of 2000 as investors lost interest in what remains one of the riskiest sectors in which to place money. Only one in 10 drugs which are trialled on humans actually make it on to the market, and thousands more have failed in the lab before then. The companies are burning through money in the search for new products, but with risk-averse investors on indefinite strike, the prospects of raising cash in the market are close to nil.

Shares in Vernalis, a migraine and cancer specialist, slumped almost 40 per cent on Friday after an investment magazine alerted private investors to its funding gap and the possibility it could have to resort to a deeply discounted rights issue. Glyn Edwards, chief executive of Antisoma, suffered a similar problem last year as he struggled to arrange a refinancing. "Antisoma raised money earlier this year, but it was quite painful, and I think it is very much harder now," Mr Edwards said.

Unless the markets improve, the whole sector is heading for a cash crunch that might only be avoided through M&A activity. Invesco Perpetual, part of Amvescap, has built up substantial stakes in a swathe of the smallest companies this year and is widely believed to want to push consolidation to the top of the agenda.

One banker said: "Fund managers say there is already plenty of money in the sector. The problem is that they have just put it in the wrong place. They say it is our job to find ways of getting it to the right place. That seems to be a new mood among fund managers."

The arguments for and against consolidation are well rehearsed. A combined company would have a much sturdier pipeline of products, reducing the risk of a stomach-churning dip in shareholder value when one fails. Size also counts in the sector, since as companies move up through the £50m, £100m or £250m barriers in market capitalisation, they tend to attract support from ever more cash-rich investors.

On the other hand, genuine synergies are hard to achieve from the science laboratories. Merged companies could cut back on research programmes, but then they could do that alone, and investors are perfectly able to buy a portfolio of biotech shares to diversify their own risk. The combination of two tiny companies heading for a cash crisis would arguably look less, not more, attractive to investors.

Add to that the UK's notoriously difficult-to-shift biotech executives and the prospects for deal making look daunting.

Sally Bennett, analyst at ING Financial Markets, said: "Apparently they all think they are going to lead consolidation. Our experience is that it is very difficult to get two companies to agree to merger terms. An even bigger tie-up sounds like the sensible option, and people have talked about it for a while, but I would be amazed if it happened."

Mr Edwards thinks the latest bout of speculation about a combination of companies' cancer interests has as much to do with bankers trying to generate business, and bonuses, in the face of miserable markets as it does with the financial state of the sector. He said: "We do talk quite regularly with our compatriots with a view to asking if we could do a deal that would make a better business and create better value for shareholders."

However, talks always seem to founder, and it is not always just because of a clash of egos at the top. "We all deny that – it is always the other guy standing in the way. But there are other difficulties. You need a strong team of people to work in a biotech company and make progress and it would be like merging two soccer teams."

But Charles Spicer, corporate financier at Nomura, said deals are increasingly possible. One of the issues to have stalled merger plans in the past has been the difficulty of valuing executive share-options packages, which would have to be bought out in the event of a top-level departure. That has disappeared as an issue in the bear market: they are all worthless.

Speculation need not be confined to UK Biotech plc, Mr Spicer said: "There are a number of US companies interested in gaining a European toe-hold, and a number of Japanese firms, too, and in time I think they will do some M&A work."

British Biotech, the fallen star of the UK industry, whose flotation in 1992 marked the emergence of biotech as a stock market sector, is already trawling the US for a transformative deal, since it has a dwindling number of attractive drugs in trials but a relatively robust financial position. Mr Goldstein said: "There is nothing UK-centric about this business, and synergies can be just as well offered by companies in continental Europe or North America, where there are more potential combinations. That is not to deny that some possibilities may be in the UK, but to confine ourselves to that would be like playing at one end of the pitch."

Other companies, including KS Biomedix, are understood to be looking across the Atlantic.

And there are homegrown possibilities outside the public markets. The failed flotation in May of Ark Therapeutics, a cancer specialist backed by the biotech entrepreneur Sir Christopher Evans, highlighted venture capitalists' eagerness to cash in their investments, although it also shows how they may not be willing to do so at just any price.

Oxford Glycosciences has emerged as the pivotal player. If it declines the opportunity to snap up its favourites in the UK – and its £160m cash pile would enable it to devour a hearty portion of the sector – and chooses to pursue product-by-product deals instead, the chance of a wave of consolidation could be lost again.

The company has one niche drug – Zavesca, a treatment for Gaucher disease – close to launch but nothing else likely to hit the shelves for years. David Ebsworth, installed as chief executive in May, has made no secret of his desire to use the cash pile to stock up on new products, and those who favour consolidation in the sector were yesterday encouraging it to start out on an acquisition spree.

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