All those companies racing to find the cure for cancer and join the Fortune 500 . . . maybe they'll find the cure for cancer.
THE NEWS TEAMS DIDN'T SHOW UP at Cetus Corp., a biotechnology company near Oakland, Calif., until Friday, December 6. But when they came, they came in force. "I think we had eight television crews and something in the neighborhood of 80 press calls to deal with," says Katharine Russell, who as Cetus's communications director found herself at the center of the storm. "No one here had quite predicted how the media and the general public would react."
Behind this flurry of activity was a dramatic report in the December 5, 1985, issue of the New England Journal of Medicine. A team led by Dr. Steven A. Rosenberg, the National Cancer Institute surgeon who took part in President Reagan's colon-cancer operation, had conducted an experimental treatment regimen on 25 critically ill cancer patients. Rosenberg and his colleagues reported that 11 members of the group responded to the treatment, with 10 experiencing at least a 50% reduction in tumor size. One patient's cancer had gone into remission entirely.
The key ingredient in the program was a substance known as interleukin-2, or IL-2. Minute quantities of IL-2 occur naturally in the body's immune system. But genetic engineers at Cetus and elsewhere had learned to synthesize the substance biologically, and medical researchers had immediately begun testing its effects as a pharmaceutical. Now, several years later, the results of the tests were beginning to come in. Rosenberg's report, the most promising so far, suggested that Cetus had an effective anti-cancer agent on its hands. And that, as the company quickly discovered, was news.
Biotechnology has been in the news a lot lately. This year alone, a California biotechnology company got in trouble for conducting unauthorized tests on a new virus, and a Nebraska animal-health concern found itself in the midst of a furor over its genetically engineered swine vaccine. But if such episodes stir the public's fears, its hopes for biotech have seemed to fasten on the dozen or so companies focusing on new pharmaceuticals. Like IL-2, most of the drugs under development are aimed at cancer, heart disease, or other hitherto intractable illnesses. Nearly all are still in the testing stages. But whenever a test result is announced, people stop, look, and listen.
Especially people on Wall Street. Boosted by Rosenberg's announcement, Cetus's stock rose from around 20 in late November to nearly 30 on December 6, and in late spring was trading close to 40. Other biotech stocks have done even better in recent months, propelled upward by a sense that some of the industry's research and development is finally bearing fruit. "The transformation of the industry is occurring," says J. Misha Petkevich, an analyst with Hambrecht & Quist's New York City office. "There's going to be a flood of data in the medical literature about biotech's products, and that's going to keep [all the companies] in the public eye."
The pharmaceutical branch of the biotech business, in short, has regained the luster it had a few years ago: it's once again a sort of entrepreneurial Land of Opportunity, complete with Wall Street glamour and dazzling new products in the works. This time there's even a sense of ambition emanating froml the industry itself. In their early days, biotech companies were typically no more than glorified R&D labs, many of them founded and run by the scientists who developed the breakthrough technologies. As new products began to work their way through the six-to-eight-year testing pipeline, though, most of the companies quietly brought in seasoned top management -- chief executives, often, with years of experience in the pharmaceutical industry.With them came a new vision. "Cetus's objective is to become a large, fully integrated pharmaceutical company," says Robert A. Fildes, the company's jovial, cigar-smoking chairman and CEO, and his words are echoed by the CEOs of Cetus's competitors. New technologies spawn big new companies, so the thinking runs -- and like Apple Computer Inc., the biotech companies should grow up to take their rightful places alongside their Fortune 500 predecessors.
The events of recent months have lent credibility to such ambitions, with reporters and investors alike both buying and peddling the companies' stories. But before the bandwagon gets too crowded, it's worth remembering that businesses -- even high-tech, big-money businesses -- aren't all the same. In biotech, the odds in favor of successful, long-term company building have been poor from the beginning. Despite all the recent developments, despite all the excitement, they aren't much better today.
In a sense, a biotech CEO's troubles begin with that six-to-eight-year pipeline. Companies in other industries develop a product and make plans to have it on the market in a few months or a year. Biotech companies develop a new drug and ask the government's Food and Drug Administration when they can begin testing it. The tests alone are likely to take five years, and the agency may then take at least another year to make its decision. Unlike conventional drug manufacturers, biotech companies can't depend on a backlog of existing products to keep them thriving while new ones run the testing gauntlet.
They depend instead on immense quantities of capital. It takes from $25 million to $50 million to bring one pharmaceutical from lab bench to marketplace. Since an ambitious company can't risk putting its eggs in a single basket, all the major players have several products in the works. Typically, they must come up with something between $75 million and $300 million before they can expect significant revenues from sales.
In their younger days, biotech companies were content to take that capital in whatever form they could find it, without much thought for the future. Most cut licensing deals with the pharmaceutical giants, giving up manufacturing or marketing rights to their earliest drugs in return for equity investments or fat research contracts. Several assembled hefty R&D limited partnerships, raising tens of millions of tax-advantaged dollars against the chance of down-the-road payoffs. And all but one or two went public as soon as they could.
That was fine as far as it went. But they still need money today, because they still have a ways to go. "If you carry out [biotech companies'] current resources and spending lines," says Luther Smithson, director of the biotechnology program at SRI International, a research firm, "the cross-over point is somewhere between 1989 and 1990. Most of the products won't be on the market until after that." And if they're really shooting for the Fortune 500, they can't keep trading away future revenues. Partnerships and licensing deals were "a stage in the evolution of companies," explains M. Kathleen Behrens, an analyst with Robertson, Colman & Stephens; "one way or another you had to bring the capital in the front door. But very few companies have been successful by being [just] licensing or R&D companies."
The only source of capital left, in short, is the public markets. Companies haven't been shy about going back to this well: in the first four months of 1986, for example, nine already-public biotech concerns issued secondary offerings totaling some $292 million. And Wall Street, in its present expansive mood, has been snapping them up. No stock buyer, least of all an institutional money manager, wants to be accused of having missed the company that found a cure for cancer.
But no one wants to be accused of hanging on to a once-glamorous dog, either, and it's on that score that biotech companies' reliance on equity markets makes them vulnerable. Right now, the typical biotech company doesn't have any earnings; the "profits" that show up in some annual reports are there only because accounting rules let funds received from R&D partnerships be treated as ordinary income. So Wall Street is relying purely on hopes and dreams. As Behrens puts it, "investors are buying futures in these companies."
Any futures market, however, is notoriously sensitive to bad news, or even to news that is not as good as expected. A few setbacks, a product that doesn't live up to its advance billing -- suddenly the stock price plummets and the well dries up. This has already happened once. Battered by disappointments over interferon, the industry's stocks declined throughout much of 1983 and all of 1984, with Kidder, Peabody & Co.'s biotech index hitting a low of 60 in January 1985 (compared with its recent 240). "Investors weren't interested," remembers Behrens, "and the pool of capital available to biotech actually shrank."
From a shareholder's perspective, the chance of a collapse may not matter in the long run. Either your stock recovers on the next round of good news, or the company winds up in trouble. Troubled biotech companies don't die, they get bought out. And because the buyer's interest is mainly in the company's scientific talent, it may offer shareholders -- a group that includes the scientists -- a sweeter deal than would otherwise be merited.
Biotech CEOs, by contrast, are relying on Wall Street for the money they need to build their companies. From that perspective the Street's fickle nature is potentially fatal. Biotech has done as well as it has because of the enormous hopes it has generated. Unless companies can somehow maintain those hopes, they won't have access to the ever-larger quantities of capital they need to stay independent.
Every fledgling industry, to be sure, has had its doubters and doomsayers, and it might fairly be pointed out that biotech is too new to be judged a bad risk by conventional standards. "As a technology, biotech is transforming the traditional pharmaceutical industry dramatically," argues Hambrecht & Quist's Petkevich. "It's discovery machine, which allows you to identify novel and more efficient ways of treating patients."
All right: they scoffed at microelectronics too. So suspend disbelief on the money question for a moment, and assume that biotech's labs crank out more and more as-yet-unimagined pharmaceuticals whose medical potential keeps the capital flowing. That would be good for company building, so long as product development proceeded according to the usual rules of business. Rules such as, "A company that develops a product can do so without its competitors knowing what it's about," and, "Once you patent an invention, you get to own the resulting products."
In biotech, the rules are still being written -- but already they look different. It's a science-based industry, for one thing, and scientists make their mark professionally by sharing their discoveries with colleagues and publishing their results in scientific journals. Managers concerned with protecting their companies' trade secrets might want to curtail such tendencies, but it's hard: when products take several years to develop, and when they must be tested on hundreds of patients at dozens of different sites, anyone's ability to control the flow of information is limited. Besides, a manager has to keep the company's scientists happy for the many years it takes to bring products to market. "We take the position that our scientists should publish because we want to be viewed as a first-rate technical place," explains the president of Centocor Inc., a company based in suburban Philadelphia. He may be making a virtue of necessity -- but no one in the business doubts the necessity.
As a result, the state of the art in biotech is very much in the public domain, and most of the new pharmaceuticals are being developed by more than one company. IL-2? Cetus, Immunex, Amgen, Biogen. Tumor necrosis factor, another anticancer agent? Genentech, Biogen, Cetus, Chiron. Because the development process takes so long, moreover, there's no guarantee that whoever made the original breakthrough will continue to lead. In biotech, as in life, there's many a slip twixt cup and lip.
The publicity and competition wouldn't matter if new products could be patented before they were announced to the public, as drug companies have traditionally done. But the patent situation in biotech is murky. Like IL-2, most of the industry's products are substances that occur naturally in the body. To be patentable, they must be produced in a unique composition, through a unique process, or with a unique application.
Companies have filed many applications for patents along these lines. Few have been granted, though, and no one knows how well any that are issued will eventually stand up. "There are a lot of ways around them," argues SRI's Smithson. "There will be a lot of products with the same clinical position sold by a lot of manufacturers." If patents don't stand up, he adds, any number of the industry's products could suddenly turn out to be generic drugs -- commodities, in effect.
Businesses in every industry have competition, of course, and most have to rely on manufacturing or marketing skill, not patent protection, to beat back competitors. But biotech companies exist in an unusually hazardous universe. Like the fast-growing microcomputer companies of the early 1980s, they have their hands on a hot new technology. Unlike those companies, they have climbed into bed with their biggest and strongest potential competitors. Imagine where Apple Computer would be at the moment if, say, it had signed a manufacturing-and-marketing agreement allowing IBM to make and sell the Apple II.
That, with only a little exaggeration, is the situation a lot of biotech companies are in today. Take Genetics Institute Inc., which despite its name is a profit-seeking company considered a strong contender in the business. G.I. was scheduled to go public in early June -- it was the last major player to do so -- and it listed four major pharmaceuticals in the "products under development" section of the offering prospectus. All of these were completely licensed out to pharmaceutical giants, which had acquired worldwide manufacturing and marketing rights.
G.I.'s aggressive licensing has enabled it to operate close to break-even, without money from R&D partnerships. And it may be able to use the royalties from its licenses to develop proprietary products, as CEO Gabriel Schmergel plans. But the strategy is risky. By farming out manufacturing and marketing, G.I. and other licensers are letting the Sandozes and Baxter Travenols of the world learn their business. How long will it be until the drug companies know enough to enter the field on their own? If patents can't be relied upon -- or if they are superseded by second-generation products -- biotech companies will find themselves up against some of the biggest, most experienced manufacturers and marketers in the world.
All these troublesome uncertainties are reflected in the story of Genentech Inc., the South San Francisco company whose stock has been shooting up in recent months.
If biotech were a senior class, Genentech would be voted most likely to succeed. It already has two genetically engineered products on the market, the first ones approved for sale in the United States. Its scientists are the envy of all: "There's Nobel Prize -- level work coming out of there," a physician who works for a competitor says admiringly. It also has plenty of money, including what's left of $122 million raised through R&D partnerships.
What sets Genentech apart from the competition, though, is the fact that it has a potential blockbuster awaiting FDA approval. "This product," says an industry insider, "is going to be a real watershed for biotech."
The product is tissue plasminogen activator, or tPA, a substance that occurs in minute quantities in the blood. As a pharmaceutical, it has been called a heart patient's Drano: it dissolves the blood clots that cause heart attacks and other cardiovascular disorders. Getting rid of the clots, in turn, dramatically improves a patient's prognosis. Genentech scientists began working on synthesizing the substance biologically six years ago, and this spring submitted an application to the FDA for permission to manufacture and sell it. No one knew how long the agency would take to make its decision, but some analysts are betting that tPA will be on the market sometime in 1987.
The company hopes tPA will become the standard therapy for heart attack victims. If it does, it could be used on almost a million patients a year in the United States alone. Some analysts estimate the eventual market size in the $500-million-to-$700-million range. Genentech, moreover, has retained U.S. manufacturing and marketing rights, licensing out marketing rights only to Europe and Japan. According to James Gower, vice-president of marketing, the company is primed for immediate full-scale launch of the product: it is already manufacturing tPA at "the same scale we'll need to satisfy full market needs," and it has begun to build a 60-person, hospital-based sales force.
Such developments led Business Week magazine last April to write glowingly of Genentech as "the next IBM" -- a view that evidently has been shared by investors, who pushed the company's market valuation up to nearly $3 billion as of early May. But biotech's twin question marks, money and product rights, apply to Genentech as much as they do to everyone else.
Consider the details -- and the unknowns. Development of tPA was partially funded by one of the company's R&D partnerships, which has a portion of the claim on the drug's revenues. To buy out the partnership right now would cost the company roughly $110 million worth of stock. That might not be much if the market is really as big as $500 million. But who knows? There are two drugs already on the market -- streptokinase and urokinase -- that do roughly the same thing as tPA. Together, points out Jim McCamant, a biotech specialist who edits Medical Technology Stock Letter, they have a developed market of only $15 million in the United States. TPA does appear significantly more effective. But, McCamant adds, there will be many heart patients who can't take it for one reason or another, and it's likely to face competition from other bioengineered drugs that are in the clinical-trial stage.
The patent situation of tPA is equally doubtful. Genentech has filed a product patent on tPA and a process patent for manufacturing tPA. At least two competitors, however -- Genetics Institute and Biogen -- have developed tPAs of their own, and have licensed them to large pharmaceutical companies. When Genentech was issued a patent in the United Kingdom last spring, it immediately filed suit against Wellcome Biotechnology Ltd., G.I.'s licensee. But neither Wellcome nor SmithKline, Biogen's licensee, seems fazed by Genentech's rattling of its patient sabers. Wellcome filed suit in Britain to have the patent overturned. SmithKline refused to comment on the situation, but confirms that it is proceeding as planned with the development and testing of tPA.
What has happened with tPA -- what happens in biotech generally -- is that hopes and dreams get confused with realities. There is little doubt that tPA is a remarkable new drug, that it will save many lives and enjoy a large market. There's also little doubt that Genentech enjoys a substantial lead over its competitors. But the company's future turns not on such indisputable truths but on a series of unknowns. How large is the market? How large will Genentech's share be? Will the company maintain proprietary rights to the product? Genentech's astronomical stock price ($83.50, compared with a split-adjusted IPO level of 11.67) is based on favorable answers to all these questions. Should one turn out less than promising, the price will drop and Genentech will encounter a chillier reception at the capital windows.
At that point, even Genentech would be vulnerable to the specter that haunts every other ambitious biotech company: acquisition by an offer too good to be refused. So far, explains Kathleen Behrens, two factors have kept the big drug companies from making a move for Genentech: its sizable valuation, and the fact that the two drugs it already has on the market are partly or wholly licensed out. Suppose tPA makes it to market, turning out to be a significant income producer, but doesn't live up to the enormous expectations it has generated. Genentech's valuation falls -- yet its income, paradoxically, rises. It's then a plum ripe to be picked. And if Genentech is acquired, will its competitors be far behind?
If biotech companies do end up as grist for the acquisition mill, most people probably won't care. The big drug companies, whatever their failings in coming up with new products, have proved themselves effective at manufacturing and distributing pharmaceuticals that work. And the biotech companies, whatever their chanciness as business propositions, already have so many new drugs in the pipeline that some -- tPA, maybe IL-2 -- will almost certainly prove beneficial. So patients stand to gain, and investors who bought in at the right time will profit.
What's sacrificed isn't the results, it's the dreams of Cetus's Robert Fildes and the other CEOs who hoped to create the next generation of pharmaceutical companies on the back of a promising new technology. No one can fault these would-be company builders for trying. But no one should be too surprised if they don't succeed.