Burgeoning Biotech Sector Demands Investor Attention

Apr 20 2007 | 11:13am ET

Investment in biotechnology is growing rapidly, with capital raised by global biotechnology companies soaring by 42% last year, to $27.9 billion, according to a recent report from Ernst & Young. Chicago-based Kilkenny Capital Management, which manages $200 million in long/short biotech funds, has been investing in this growing marketplace for 12 years, and, according to firm founder, Michael Walsh, now is the time to jump onboard the biotech bandwagon.

Michael WalshMichael Walsh“Seven years ago there was the sequencing of the human genome, which has allowed scientists to understand disease at the molecular level,” Walsh says. “It seems like seven years is a long time, but it takes five to 15 years to bring products to market, so right now we’re just entering that period when the advances from five to 10 years ago will come to fruition.”

The Ernst & Young report, “Beyond Borders: Global Biotechnology Report 2007,” reveals that deal values in the biotech sector skyrocketed last year, with alliances involving U.S. companies totaling $23 billion—an all-time record—while high premiums drove the value of mergers and acquisitions to the second-highest level in the industry’s history. It also shows that global public biotech company revenues grew by double-digit rates and crossed the $70 billion threshold, also a first.

Walsh is attracted to the biotech space because companies’ product margins are very high and it doesn’t cost very much to make these products once they’re on the market. “It is mostly intellectual capital that has gone into the development,” says Walsh.

According to Walsh, the total combined market capitalization of a subset of the largest medical technology companies is $1.6 trillion, which equals the combined market cap of the largest tech companies.

“A lot of people don’t realize that there is as much value in the biomedical world as there is in all of the hi-tech world, but you would never know it by looking at stock trading volumes because tech companies are trading 10 times as high as biomedical companies,” he says.

“The largest 10 to 15 companies out there have enough cash on their balance sheets and enough free cash flow from operations to acquire every single public company with a market cap of less than $10 million with only nine months of free cash flow. So that shows you the potential for M&A activity going forward is still extremely high.”

Invest With Care

While Walsh, who was a sell-side biotechnology research analyst with Robertson Stephens and Co. before founding Kilkenny in 1995, is bullish on biotech, he warns that investors need to take care, as the failure rate for new products in this sector is staggering: Eighty percent of products that go to clinical trial never make it to store shelves because of the regulatory hurdles, Walsh says.

“You can imagine that Microsoft and IBM have no such requirements because we’ve all suffered through many computer and software problems where the products are neither safe nor effective.”

Also, over the last 10 years, research and development has steadily outpaced products coming to market. 

“The understanding of human biology, while getting better, is still somewhat rudimentary, and as a result a number of new products coming to market in the last 10 years has remained about flat even though R&D spending has gone up two-to-threefold,” he says.

But despite these figures, Walsh’s firm is going forward with plans to expand its product offerings in the biotech space. Kilkenny is currently working on a less liquid private investment in public equity strategy, as well as a “super-liquid” market neutral strategy that would appeal to institutional investors.

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