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Investment Opportunities Abound in Life Science Tools Sector Despite Sour Economy

NEW YORK (GenomeWeb News) – Despite the fact that US biotechnology venture investment is at its lowest point since 2002, the outlook for the life science research tools sector remains positive due to a marked increase in innovation at universities and research institutions, according to industry insiders.

However, the venture capitalists also generally agreed that they are being much more cautious with their early-stage investments, primarily because of recently reduced chances of a profitable exit due to higher risk aversion among potential acquirers, the lack of an IPO market, and pending public policy that might adversely affect the tax situation surrounding long-term investments.

According to the most recent PriceWaterhouseCoopers/National Venture Capital Association MoneyTree Report, US venture investments through the third quarter of 2009 totaled about $12.2 billion and were on a full-year pace of $16.3 billion, which would be the lowest annual total since 1997's $14.2 billion.

In addition, 1,910 venture investments were made through Q3 2009. This extrapolates to 2,546 deals for the entire year, which would be the lowest number of deals made since 1995's figure of 1,837, according to the report.

Although the biotechnology sector still garners more bets and has weathered the storm much better than other market sectors, it has not been immune to the financial downturn.

Indeed, VCs are on pace to invest a total of about $3.3 billion in biotechnology companies in 2009, which would be the lowest total since $3.2 billion in 2002. Meantime, investors are on a pace to log 379 biotechnology deals this year, which would be the lowest total since 346 deals in 2003.

Nevertheless, the life science tools market – which traditionally has not been as overtly appealing to investors as have markets such as therapeutics and medical devices – is an area that healthcare-oriented investors may consider targeting more frequently based on recent results.

"The life science tools space has not been one that the broad VC community has gone after," Sue Siegel, a partner with Menlo Park, Calif.-based Mohr Davidow Ventures, told GenomeWeb Daily News last week. "There are not a huge number of deals that come out of this space, but lots of value has been created."

Siegel cited Illumina, Applied Biosystems (now part of Life Technologies), Sequenom (prior to this year's misfortunes), and Siegel's former company Affymetrix – though it wasn't technically VC-backed – as examples of companies that built strong market valuation based on enabling life science research tools, sometimes just with one key technology.

"There is a real opportunity here, and there is true scarcity value within this space," Siegel said. "MDV has taken a fairly active investment stance around that." MDV's current investment portfolio includes cancer diagnostics startup On-Q-ity; personalized medicine company Navigenics; sequencing upstart Pacific Biosciences; and nanofluidics specialist RainDance Technologies.

According to Juan Enriquez and Steve Gullans, both managing partners with Boston's Excel Venture Management, innovation in the life science research tools sector may be at an all-time high. "We've never seen a stronger data flow," Enriquez told GWDN, and the academic sector is the major source of this innovation.

"Two things are happening – one is that there are fewer VCs in business with money or in business at all," Enriquez said. "And there's been this massive investment in innovation and research in the last 20 years in life sciences. All of a sudden, those innovations are beginning to play out across the whole of the economy. You're seeing them relevant to clean tech, climate change, energy, pharma, biotech, chemicals, agriculture, et cetera."

And that innovation should continue following the bolus of federal stimulus funding provided over the last year by the NIH for cutting-edge biomedical research, according to Gullans.

"I think the stimulus money moving into the academic centers has been a driver that's been slow to materialize, but nevertheless will be a big driver in the tools space," Gullans said. "One of the things about the research community having more money to play with is they tend to be more enamored of the latest, hottest toys."

Optimism for investing in life science research tools is guarded, however, as no part of the economy has been untouched by the recent global financial meltdown.

Josh Phillips, a general partner with Boston-based Catalyst Health Ventures, said that his firm sees "an awful lot of innovation" taking place in this space, but that there are also some inherent problems that make life difficult for VCs playing in the sector.

"The first problem is that it tends to be very capital intensive," Phillips told GWDN. "It tends to take a lot of money to get a company out of academia or from an initial technology proof-of-concept stage to a commercial entity."

The primary reason for that is a dwindling universe of potential acquirers, according to Phillips. "There are large companies like Life Technologies, but there aren't very many of them," he said. "And they tend to want to buy commercial companies as opposed to early-stage technologies, at least at this point in time."

Phillips spoke from his experience with Catalyst portfolio company and recent Life Tech acquisition BioTrove, "which raised a lot of money," Phillips said – at least $35 million since it was founded in 2001.

"And particularly, in this marketplace, it's difficult to fund and build commercial organizations that can make a successful commercial entity that then drives an exit," Phillips added. "It's not easy to do, especially without an IPO market."

Again, Phillips' comments were underscored by his experience with BioTrove which, prior to its acquisition by Life Tech, filed for a $75 million IPO in the spring of 2008 and subsequently withdrew the offering in December of last year.

Phillips also compared the medical device market, in which Catalyst plays, to the life science research tools market to illustrate his point.

"It's very different," he said. "There are a number of large acquirers in the medical device space, and they are willing to buy companies that are not a commercial success yet, that are based on technology. There is much more competition among those companies than there is within the tools space."

Phillips said that companies such as Illumina, Affymetrix, and Life Technologies "tend to be competing with their own proprietary platforms against each other. The life science tools companies tend to want things that fit into their technology bucket. That's not always the case, but if you look at BioTrove, it was a natural fit with Life Tech's portfolio. It's not such a natural fit with others. That natural structure tends to give you fewer choices for an exit in that space."

Excel's Gullans and Enriquez, who also invested in BioTrove, said that certain public policy issues are also threatening the early-stage investment community – namely a bill, HR 4213, which was recently passed by the House and which aims to provide some $31 billion in immediate tax relief for individuals and businesses by extending through 2010 more than forty provisions that are scheduled to expire at the end of this year.

Unfortunately, according to Enriquez, one of those provisions changes the tax status of venture capital carried interest from capital gains to ordinary income, essentially doubling taxes on venture capitalists that make early-stage investments with the intent of building long-term value.

"The single biggest driver of innovation I think is this bridge between academia and industry that's created by venture capital, and I think the single thing that's going to determine whether these tools and technologies get built is the current bill in Congress," Enriquez said.

"It creates a huge incentive for you to invest really short term," he added. "Right now, if you invest and cash out in less than one year, then you're going to be taxed at double the rate than if you are investing for the long term. But if the tax rates become the same, then in essence you double your long-term tax rate, and the incentive to go out and invest in something that's going to take three or five years to develop is reduced to about zero."

That would have a huge impact on investments in life science technologies, which generally take at least that much time to develop. If the current House bill passes into law, "a whole lot of people will stop investing for the long term," Enriquez said.

In part two of this article, which will be published tomorrow, VCs share their thoughts on how they are coping with the economic downturn and what life science research tool and molecular diagnostic technologies have recently piqued their interest.