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A flurry of acquisitions and the possible opening of an initial public-offering window are giving health-care VCs reason for optimism about exiting prospects in 2010.
With the economy improving, acquirers are striking while valuations remain reasonable. Recently, Johnson & Johnson agreed to buy Acclarent Inc., Cubist Pharmaceuticals Inc. bought Calixa Therapeutics Inc., and Celgene Corp. said it would acquire Gloucester Pharmaceuticals Inc., for example.
Rising stock prices are also stoking public-investor interest in new offerings, some observers contend. Expecting an IPO window next year, a few companies have filed to go public recently, including AVEO Pharmaceuticals Inc., Ironwood Pharmaceuticals Inc. and Aldagen Inc.
Yet investors continue to see M&A as their primary exit option, even for companies that do go public. And many suspect that the recent spate of merger deals will continue into 2010.
One reason is that corporations have plenty of cash, and they are finally willing to spend it. With more than $500 million on its balance sheet, for example, Cubist Pharmaceuticals could well afford the $92.5 million it spent upfront for Calixa Therapeutics. While companies will steer some of their stash to internal research and share buybacks, they'll also use it to stock their pipelines through acquisitions, several investors said.
The activity contrasts with the caution seen early this year. "I can think of big companies that wouldn't let people get on a plane to go to a conference or visit a small company that [could] be acquired," said John Steuart, managing director of Claremont Creek Ventures.
But in 2010, corporations "will look increasingly to small companies as an off balance-sheet source of R&D," he said. "They're going to go on a shopping spree."
Some see a spree happening now. "We have three exits in process right now," said Lisa M. Suennen, managing member of Psilos Group. Each deal, if completed, will return three or more times the firm's money, she said. "For us, it's going to be a great year."
It won't be great for everyone, of course. Suennen sees 2010 as a year of big winners and losers, with the best receiving big buyout bids, and flagging companies staging fire sales. Those in the middle will soldier on and build more value. That may not be the best thing for their backers' IRR, but it could lead to better cash-on-cash returns. "My guess is that everything in the middle will not get done," she said. "If they have the capital, they'd rather wait it out."
Many acquirers making deals over the past year have capitalized on their leverage by structuring agreements with significant earnouts. Cubist's Calixa takeover could rise in value to $402.5 million as the company's drug reaches various milestones, for instance.
As conditions improve, however, some leverage will swing to small companies. While structured acquisitions with earnouts will continue to outnumber other deals, Johnson & Johnson's $785 million cash takeover of Acclarent shows that there is opportunity these days to get a significant sum up front, said Chip Linehan, general partner of Acclarent backer New Enterprise Associates.
Competition from the public markets could spur buyers to make better offers, and some observers see reason to hope that an IPO window will crack open in 2010. The ability of public companies such as Human Genome Sciences Inc. to raise hundreds of millions through new offerings signals that there's strong interest in health care. And with the run-up in share prices, fewer public companies now appear undervalued. As a result, investors are starting to look for value in private companies that they see as comparable to listed ones, said Carl L. Gordon, general partner of OrbiMed Advisors.
But judging from the performance of Omeros Corp., which listed on Nasdaq in October, public investors won't make it easy for early entrants. Omeros, a clinical-stage biotech company with no marketed products, went out at $10 but now trades at $7.50.
Even so, Omeros, now valued at $160 million, got a better valuation by going public than it would have in a venture round, said Andrew Fink, managing director of Omeros backer Trevi Health Ventures. "No one was thrilled to see the stock trade down, but [it's] a pretty big achievement to get this company out, it's a liquid stock," he said.
Biotech prospects these days must do more to pass muster with IPO buyers than they historically have. With Congress striving to revamp the health system to expand health-insurance coverage, companies with products serving unmet needs enjoy a big advantage over those pushing remedies that only improve upon existing treatments, said Tony Gibney, managing director of the health-care investment bank Leerink Swann LLC.
"Very highly priced products are going to start to be more scrutinized," Gibney said. "Products that are not meaningfully differentiated, those are the ones that would narrow the audience of [IPO] participants."
With the capital markets largely closed the past two years, many venture-backed companies have been maturing as private entities and have emerged as good candidates to go public. Yet VCs won't take them all out just because they can. Since the technology bubble burst, most IPOs have been financings only, not liquidity events. That means firms must decide if the step up in valuation is enough to justify the costs a company incurs, and the restrictions shareholders submit to, once a public offering is complete.
Nowadays, the benefits often do not outweigh the drawbacks, some say. "My overall sense of taking companies public is, it really has not been an attractive prospect since 2000," said David Collier, managing director of CMEA Capital. "There's a lot of negatives to weigh in thinking about whether you want to take a company public."
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