High Hopes and Altered Genes

Biotech has long been a high-risk, high-reward industry. It is an industry in which numerous firms, including many small-caps and start-ups, intensively research possible new products that could lead to high profits and rapid growth, but which also carry significant chances of never reaching any customers or generating any revenues.

Biotech also has a history of being buffeted by the vicissitudes of politics. The industry has been a political lightning rod, with criticisms coming from diverse parts of the ideological spectrum; genetically modified foods have generated much opposition on the left, for example, while embryonic stem cells have met much resistance on the right.

Health care reform efforts have repeatedly shown a capacity to roil biotech stocks. During the Clinton administration’s reform push in the early 1990s, biotech stocks underperformed not only the broader market but also traditional pharmaceutical stocks on concerns that price controls would strip away profits from breakthrough drugs. The Obamacare debate also has fueled an up-and-down ride for biotech, albeit mitigated by expectations that health insurers, rather than biotech or drug firms, faced the greater vulnerabilities in the legislative maneuvering. Indeed, biotech got a boost from its summer victory in lobbying for extended patent protection for biological drugs.

Nevertheless, a decade into the 21st century, this most futuristic of industries faces major financial challenges as well as political uncertainties. In May, merchant bank Burrill and Co. estimated that 135 out of 342 publicly traded biotech firms were operating with less than a year of cash, and that 42 percent of these were down to less than six months of cash.

Unlike Big Pharma, which can fund much R&D from existing product sales, biotech firms typically depend heavily on equity financing. Yet biotech IPOs have become notably rare amid market volatility. Consequently, capital for the biotech sector has depended to a growing degree on acquisitions — with pharmaceutical companies buying large and small biotech firms, and large biotech firms absorbing smaller ones.

Such transactions have included Roche’s $47 billion takeover earlier this year of the remaining 44 percent of Genentech (in which it had long held a majority interest), Eli Lilly’s acquisition of ImClone Systems in 2008, Gilead Science’s purchase of CV Therapeutics earlier this year and Bristol-Myers Squibb’s recent acquisition of Medarex.

The industry’s future profile thus may be different from its historical one, with more big players and fewer small ones. Still, any resulting moderation in the volatility of biotech stocks will likely be limited by the inherently uncertain nature of biotech research and by recurrent political clashes over the costs and uses of biotech products. Provided that political pressures do not actually cripple its capacity for innovation, biotech can be expected to remain an industry with high risks punctuated by occasional large payoffs.

Biotech’s Rise

The roots of biotech can be traced back over centuries, involving such precursors as the fermentation of yeast in beer production. The modern biotech industry, though, began on April 7, 1976, when biochemist Herbert Boyer and venture capitalist Robert Swanson founded Genentech to develop drugs based on the technology of recombinant DNA, in which genes from multiple sources are combined into a single molecule. Boyer and geneticist Stanley Cohen had pioneered such gene splicing earlier in the decade.

Genentech went public on Oct. 14, 1980, with 1 million shares offered at $35 each. Investors bid the price up to $89 in a matter of minutes, and the stock closed for the day at $70. The company, by the way, at this point still had no actual products, though it had achieved some important laboratory milestones, such as cloning human insulin.

This vivid demonstration of investor appetite for biotech opened the way for waves of new issues. Early entrants included Cetus (later part of Chiron, which in turn was bought by Novartis), which tapped the market for $107 million in March 1981. The pace of IPOs quickened in 1983, with Amgen and Biogen among the firms going public. A further surge of offerings in 1986 conveyed Genzyme and ImClone, among others.

Increasingly, the biotech industry’s products reached market as well. In 1982, Genentech’s Humulin, a diabetes treatment using human insulin produced by genetically engineered bacteria, became the first biotech drug to get FDA approval. By the late 1980s, biotech drugs had been approved for illnesses ranging from cancer to heart disease to kidney transplant rejections.

Industry revenues reached $8 billion in 1992. New biotech drugs in the early 1990s included Amgen’s Neupogen, to boost low white blood cells during chemotherapy, and Chiron’s Betaseron, to treat multiple sclerosis. Biotech firms pushed into agriculture as well. Calgene’s Flavr Savr tomato, with an added gene to resist rotting, was the first commercially available genetically modified food, arriving on supermarket shelves in 1994.

The Clinton Effect

The clash over the Clinton administration’s health care reform effort demonstrated the vulnerability of biotech stocks to political pressures. The prospect of price controls on pharmaceuticals was particularly damaging, as it threatened to undercut the rationale for the huge up-front expenditures that biotech firms were making to develop new products.

According to a 2007 National Bureau of Economic Research working paper by University of Connecticut finance professors Joseph H. Golec and John A. Vernon, biotech stocks dropped by 51 percent during a period in 1992-1993 when the Clinton proposal was developed and debated. Traditional pharmaceuticals were also hit but less hard, losing 32 percent, while broad market indicators gained by more than 10 percent.

Biotech stocks began edging upward after the Clinton health care plan was defeated in the summer of 1994, and by the following year the industry was in a full-fledged rally. The Nasdaq Biotechnology Index rose 88.5 percent in 1995, compared to 37.6 percent for the S&P 500. Biotech then leveled off for a couple of years, with Nasdaq’s sector index generating slight losses while the broad market continued to soar.