Biotech Firms: The Undead of Capitalism?

The Wall Street Journal today did not describe biotech companies as zombies but it might as well have.

That, despite an increasingly brighter financial picture for the biotech business.

All this was contained in a piece by Brett Arends. He said the good news – the brighter picture – is the bad news. He wrote that the biotech industry, which includes stem cells, is “incredibly popular with many private investors,” but is a “risky area with very mixed results.”

Arends said,

“It's hard enough to value a profitable company that makes widgets or coffee. How do you value a speculative science project that may not come to fruition for years, if ever? ...(A)nalysts in the sector sometimes talk about 'the probability-adjusted net present value of peak sales,' essentially guessing how much a company might make off a drug at peak sales, lowering that value to reflect how long it will take to get there, and then calculating the probability that a drug will make it through clinical trials and win approval.”

He continued,

“And then there's the dormancy risk—few biotech companies go bankrupt....Many of them just go nowhere.”

Sort of like zombie enterprises, the undead of capitalism.

Arends quoted Don Collins of Ironwood Capital Management as saying,

"They don't have any debt, so there is no one to force them out of business. So as the cash dwindles, the companies just shrink and shrink and shrink, until they have three guys working there and a business development manager going out looking for money.. They can stay like that for a long time.'

“Old biotechs, in other words, never die.”

The WSJ article pointed out that the average retiurn on a biotech IPO since 2001 has been minus 18 percent. Between 1995 and 2000, it was a meager 8.44 percent. You could have earned more investing in plain old bonds or cash.

Arends concluded,

“Capitalism famously depends on 'creative destruction,' in which bad or weak companies get weeded out. The strong survive. The best industries in which to invest are often those which have been starved of capital for a generation—think gold and oil. The worst, in turn, are often those like biotech, where it's all too easy to get capital without showing results.”

Something for the California stem cell agency to think about as it kicks off its unprecedented, $500 million biotech loan program, which optimistically projects “profits” of $100 million despite default rates of up 50 percent.

(The WSJ may have restricted the Arends article to subscribers. If you cannot access it, send an email to djensen@californiastemcellreport.com, and we will send the article to you.)