Only mergers can work miracles for biotechnology share prices

Back when biotechnology stocks were what everybody wanted, Oxford Glycosciences (OGS) was one of Britain's most desirable companies. Within a few short weeks of January 2000, the shares leapt from 500p to a staggering 3,245p as investors slavered over the prospect of block-busting miracle drugs unlocked by the mapping of the human genome.

Exactly three years later and OGS's shares are a much sorrier sight, languishing below the 200p mark and supported only by the recent news that the company has become an acquisition target for its old rival Cambridge Antibody Technologies (CAT).

For long-term investors in OGS, the structure of the deal is even more galling. CAT's all-share offer, announced on 23 January, struck at a time when OGS's market value was lower than the amount of money it had in the bank. Several analysts suggested that, despite all the talk of complementary technology, the deal was little more than a disguised rights issue for CAT that would give it £130m in cash.

Share prices across the sector show the market has run out of patience waiting for biotech to come up with its promised miracles. But even if the City has lost interest in the likes of OGS, the industry itself has not. As ING analyst Sally Bennett says: "OGS has filed patents on around 4,000 proteins in its history and has undertaken considerable work to sort and validate these as potential drugs targets. While their true potential remains unclear, I find it unbelievable to expect that in the medium to long term nothing of interest will emerge."

Last week it did emerge that Celltech – the biotech group that recently slid out of the FTSE 100 – is also eyeing a possible counter-offer for OGS, and could be prepared to use cash to buy it. There was also speculation that other companies, including the UK's Xenova and Switzerland's Actelion, might be interested in a bid. Suddenly, say the analysts, the biotech sector should be viewed in a new light.

The main revelation in this potential new bidding war is that the proposed CAT/OGS tie-up is critical from a scientific point of view. Biotech share prices are in trouble because the business models, with their high cash-burn and longer-than-expected conversion of theory to practice, now appear flawed. CAT or Celltech may be about to prove that what the industry needs is a round of mergers. These, so the argument goes, would mop up the small players that each hold one piece of the puzzle, and leave Britain and Europe with a handful of biotech powerhouses with all the science in one place.

As Salomon Smith Barney biotech analyst Jeremy Green says: "The announcement of a merger between CAT and OGS could turn out to be a major event for the European biotechnology industry. A union of two of the stronger companies could create a tem- plate for some of the weaker businesses that are set to run out of cash in the near future."

This is a process that has suddenly lurched into life across the Atlantic. Following the CAT/OGS announcement, an unprecedented flood of six biotech deals were struck in the US over the space of one week. These comprised a big pharma company tie-up with a listed biotech, two public-to-public mergers, two public-to-private mergers and one private-to-private deal.

In the case of CAT and OGS, the technology match is also a compelling feature of the deal. Put simply, one company finds the problem, while the other works out which antibody might provide a cure.

Because, as Morgan Stanley analyst Daniel Mahony suggests, the deal does little for CAT's goal of achieving profitability within five years. He joins other analysts in fully expecting the company to announce further deals over the next 12 months.

The phrase now being applied to speculation over the biotechnology sector is "critical mass". Biotech companies do not have huge workforces that can be slashed after a merger, so a consolidation spree would have to be based on something more fundamental. In the wake of the announcement in January, Emma Palmer of WestLB Panmure wrote: "The planned merger of CAT and OGS kick-starts the consolidation and drive towards critical mass that we have long said the sector needs."

The concept of critical mass would answer a question that the industry has been trying to solve for nearly a dec- ade. Selling technology licen- ces to big pharmaceutical companies is not bringing in enough revenues, and biotech players are struggling to persuade anyone that, on their own, they can really be thought of as independent research engines for the overall drugs industry.

The possibility of a battle for OGS is proof, for the analysts at least, that the biotech industry is still young enough that its managers have not yet arrived at the perfect formula for organising the science. Like many other industries before it, biotech may shortly reach the conclusion that bigger is better.

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