Investment: The drugs don't work

Investors with shares in Protherics, the UK biotech group that specialises in cancer and critical care treatments, have struck gold.

The group announced last week that it has had approaches from several potential suitors, sending the stock up by more than 100 per cent since the news. The smart money is on the UK's second biggest pharmaceutical firm, AstraZeneca eventually gaining control.

For those that back UK biotech groups, this is the ultimate endgame. After years of supporting companies through failed drug trials and other setbacks, the best a dwindling number of biotech investors can hope for is that one of the big boys comes in to swallow up the likes of Protherics. Incidentally, the group's shares are still well below the peaks of 2006 when they reached highs of 84p, up on yesterday's close of 58.25p.

The good news is that there are several examples in recent months of this happening: the British vaccine maker Acambis is being bought by Sanofi-Aventis of France, while the US group Genentech is being swallowed up by Roche, of Switzerland.

There are those, however, who are worried about the future of the industry in the UK. Biotech has always struggled to raise funds from institutional investors, who worry that returns on their money, while never guaranteed, are at best many years away from an initial punt. The industry is a graveyard of good ideas, and though there are few who will say it is reaching its nadir there is nonetheless a sense that the present downturn is the most severe for many years.

"Biotech is a long-term game and it is rarely smooth," says Mick Cooper, an analyst at Blue Oar Securities. "The savvy investor knows that it takes a long time and that, if they back 10 companies, it would only take two to work in order for him to be in the money."

The problem, Dr Cooper concedes, is that traditional institutional investors are shying away from the sector with fund managers increasingly called to account for the performance of their books each quarter. Exposure to biotech groups, whose shares typically move about on news of trial data, rather than on the ebb and flow of financial performance, can stick out horribly.

"There are a number of venture capital backers that do come in and support biotech groups in the initial stages, but there is a gap in the middle of a company's development," he says. Some, such as the neuroscience company Proximagen, have been around for many years but are only now entering clinical trials, such is the difficulty in raising funds, he adds.

One such venture capital backer, Merlin, is run by Sir Christopher Evans, the founder of one of the more successful UK biotech groups, Chiroscience, which went on to be taken out by Celltech. The fund has more than €450m (£357m) of capital to invest in the biotech industry.

Despite the tales of woe, some in the industry say that tales of its death are exaggerated. Investors have not entirely given up, says Glyn Edwards, the chief executive of Antisoma, an oncology group that suffered a final phase failure of its ovarian cancer treatment in 2005, which led to a big drop in the shares. He draws the distinction between those companies that have cash, and does not believe that investors' move away from biotech is permanent.

"Things look pretty grim for those companies that need to raise money in the next 12 months," he says. "Because of the current economic climate, it is very difficult to attract funds at the moment, but, while this is a deep point in the cycle, investors will return when the market improves."

Mr Edwards does concede that there is not one example of a UK biotech group getting its drugs to market, without assistance through a buyout or partnership agreement.

By signing a partnership agreement, bigger pharmaceutical groups take on much of the cost of getting a treatment to market, but in return expect a chunk of eventual sales. Antisoma, with Novartis, is in the final stage of testing its 404 treatment – a drug that attacks the supply of blood to tumours. Novartis brought in $100m (£53m), says Mr Edwards, which, while diluting shareholders' eventual benefit, has provided the group with more cash to bring other treatments to market.

Even though the industry is undoubtedly struggling, some argue that it is just a function of a cyclical market, and in fact the present downturn is no worse than others. Ibraheem Mahmood, an analyst at Investec argues that "a back-of-the-envelope calculation back in 2002/03 suggested that several key biotech groups were trading on an enterprise value basis of close to nothing, meaning that the technology was worth pretty much zero".

The difference this time, he says, is that investors are not prepared to come in and rescue those groups that are struggling. He contrasts firms like Antisoma, which held a deeply discounted rights issue when its ovarian cancer treatment failed, with a company like the speciality care group Phoqus, which went into administration last month.

However, Dr Mahmood points out that the quality of these groups has not diminished, arguing that the groundswell of takeover rumours is due to the value of biotech groups falling to a level that the likes of AstraZeneca find attractive. "Rather than avoid the sector, investors should go bottom-fishing and invest in 10 biotech stocks and then forget about them for a few years. You can almost guarantee that one or two will be terrific successes," he says.

However, he does concede that the definition of success is for firms to be bought out and that the prospect of a biotech group succeeding without the help of big pharma is very low.

While there are many chief executives of struggling biotech companies ready to blame overly nervous investors for the industry's lack of success stories, others suggest those running biotech groups are also at fault. Dr Cooper at Blue Oar argues some groups have pushed through drugs too quickly without initially raising sufficient cash to ensure drugs pass through trials successfully, forcing the group to then go back to the market to ask for more from irritated backers.

One such group, he says, is Oxford Biomedica, which last month said that its renal cancer treatment, Trovax, would fail its third phase trial. The company, which has seen its shares fall 72 per cent in the past 12 months, is trying to fend off a takeover bid from Genethera, which presumably is doing its own bottom-fishing.

Unlike in the UK, there are examples of US biotech groups succeeding without the need for licensing or being sold. True, US investors have deeper pockets, but the UK's own industry body, the Bioindustry Association (BIA), which last month ran what it describes as a "war game" to show UK groups have a tougher time than their US counterparts, also pointed to failings in the way UK biotech is run. As part of the analysis of the event, the BIA concluded: "The limited ambition of UK biotech management was compounded by UK investors' much lower risk appetite. This contrasted with US management who were focused on higher investment returns and building a more sustainable business."

While Dr Mahmood says that biotech is no more risky than speculative mining or exploration companies, the perception among investors is biotech is about as treacherous a place to park money as is possible. The safety catch is that much of the science works and, as the value of biotech groups falls, some will inevitably catch the eye of big pharma, which is starting to circle the market and, in the case of Protherics, beginning to swoop. There may be a lot of blood about to be spilled, but there will be winners among the carnage.

Tough times for the UK biotech industry

The winners...

BTG

The life sciences group has had a bumper year, with its shares soaring 160 per cent on the back of licensing agreements with big-pharma. Early this month it announced it would receive $7.5m (£4m) from Tolerx for starting a third-phase trial of the diabetes treatment, otelixizumab.

Acambis

Shares jumped by nearly a third in a day in July when the French drugs giant Sanofi-Aventis said it was buying the group for £276m. The deal makes it more likely that the group's treatments for Japanese encephalitis, West Nile virus and Dengue fever will see the light of day.

Cambridge Antibody Technology

The jewel in the crown of UK biotech. The group was sold to AstraZeneca for £702m in 2006. The company, which developed drugs looking into gene sequences, had been stalked by the UK's number two pharmaceutical group for two years before the buyout.

...and the losers

PPL Therapeutics

The Scottish group's most-famous exploit was Dolly the Sheep, but sadly it has gone pretty much the same way as its now deceased four-legged friend. The group collapsed in 2004.

Ardana

Went into administration in June. The reproductive medicine group has only listed in spring 2005, but failed to encourage enough investors to support it after burning £43m of venture capital funding.

Phoqus

A month after Ardana called in the administrators, so did Phoqus, which "develops products for use in indications where patients are underserved". Those patients will continue to be underserved, unless someone can salvage something from the wreckage.