Ernst & Young finds Canadian biotech private companies are sustaining, while public companies are struggling

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Ernst & Young report

It was a case of some good news mixed with a lot of bad for Canada’s biotechnology sector in 2007, according to the findings of Ernst & Young’s 2008 Beyond Borders Report.

In terms of the good news, the Canadian biotechnology industry had a very strong year on the financing front attracting more than US$1billion in capital while generating revenues of almost US$2.7 billion. This was driven by a 72% increase in venture funding.

Additionally more Canadian public companies continued to mature, with at least seven companies moving therapeutics into pivotal Phase III clinical trials.

However the lack of activity on the IPO market by Canadian biotech companies in 2007 continues to be a disturbing trend, stated Ernst & Young. In all, there was just one Canadian IPO in 2007, and while the number of public companies held fast at 82, the need to raise capital is now a concern for many of these companies the report contends.

In May, Ernst & Young’s Canadian biotech industry leader Rod Budd confirmed that Canada’s biotech industry is facing a real funding crisis not just because of the lack of IPO’s but also in terms of how this correlates with an overall trend in the marketplace.

“In Canada, the industry market cap dropped 26% in 2007, funding to public companies dropped by almost US$900 million and the number of companies shrunk by 14%,” said Budd, adding that ‘curbing this trend’ has to become a priority for the industry.

Further net losses for public companies jumped to $722 million, up from $594 million the year before. The report indicates that the declining market cap is one of the more significant trends in this area along with depressed share values for most of the companies making the sector unattractive to investors.

While the maturation of Canadian biotech companies pipelines, is generally considered a good thing for the industry it does come with its setbacks. These trials that are in Phase II and III will require significant financing to complete. This is one of the reasons for the 12% increase in research and development expenditures in 2007 and further increases are expected in 2008. This raises a further concern in that the higher costs associated with these late stage trials may force Canadian companies to partner their drugs prematurely and for less than optimal values.

Total financing by public companies only slightly exceeds the industry’s net loss in 2007. More than half the companies have less than two years of cash, and 30% have less than one year. At the same time, a number of companies are finding it difficult to maintain the listing requirements for the Toronto Stock Exchange (TSX).

Among the other challenges listed by Ernst & Young, is that many companies with low trading volumes dominate the sector.

Without a continuing stream of positive news, company stocks have suffered on the TSX, which has adverse effect on investors leaving them wary from jumping into the sector.

“The Canadian industry has to make commercial success a top priority,” stated Budd “In Canada, there is a pipeline of late-stage products that should make the public market for biotech stocks as attractive as ever but the sector itself needs more support from those that make up industry as well as the public sector.”

One option in terms of the support needed that is offered up E&Y is flow through shares. This is based on the way they have helped the natural resource sector. Budd also believes that cash advances or loans related to nonrefundable scientific research and experimental development tax credits by public companies and more loan programs for companies on the verge of commercialization should be considered.

On the private sector side the news is generally not much better. In 2006 Ernst & Young reported that there were 383 active private companies in the sector, but in 2007 that number dropped to 322 active companies, despite seeing higher investment figures.

While the private sector thrived from this influx of cash, the attention has had some negative trickle down effects on the sector as a whole. Specifically, the E&Y report cited that although venture financing in the private sector shot up 72% in 2007, rebounding from US$205 million in 2006 to US$353 million in 2007, many of these companies have already remained private for far too long. Moreover because these companies have not gone public, they have had to secure significant rounds of venture capital funding to support more mature corporations and advanced clinical trials.

Ernst & Young explains that the average deal size of venture capital investment has increased from US$4.9 million to US$7.5 million, while the number of actual venture financings has decreased over the last six years to fewer than 50 from over 100. This indicates investment is up, but the money is going towards supporting more mature private companies to fund expensive advanced clinical trials.

Related to this, the report states that the large capital requirements of these more mature private companies are draining funds viable for the creation of more startup companies.

Ernst & Young believes that we are in fact already seeing this trend with the number of startup corporations significantly diminishing in 2007.

A further trend noted in the report indicates that in Canada, larger pharmaceutical companies are forming public-private alliances with universities and researchers further diminishing the number of private companies in the sector. In the past these same university researchers would usually establish independent biotech companies through small seed funding.

Other highlights of the report were the two major deals of 2007, the first being Aspreva’s acquisition by Galenica for a little over US$900 million and the other, Axcan’s acquisition by the private equity firm Texas Pacific Group for roughly US1.3 billion.

The report also noted that many Canadian biotech companies, assisted by the stronger Canadian dollar, have been in licensing technologies from other parts of the world.

The report is hopeful that these deals will increase revenues for Canadian companies and in turn increase their value in the eyes of investors. At the same time, Canadian companies have also been involved in a number of notable out licensing agreements.

With the continuing financial difficulties being felt by companies in the Canadian market, such alliances or collaborations should provide a significant source of funding moving forward.