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Bay Area on Track to Lead All US Regions in 2007 Biotech VC Funding, E&Y Analyst Says

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SOUTH SAN FRANCISCO, CALIF. – The Bay Area’s life science companies are on pace to amass this year the largest sum of venture capital in the nation since the 2000 collapse of the technology market, an Ernst & Young biotech observer told an industry conference here last week.
 
During the first half of 2007, the four sub-regions comprising the San Francisco Bay Area collected $708.3 million in VC funding, up from $494.7 million raised during last year’s first six months, according to E&Y. The Boston-Cambridge, Mass., region collected $351.3 million, up from $318.5 million a year earlier. And the San Diego region racked up $464.1 million between January and June of this year, compared with $240.9 million in the first half of 2006.
 
Scott Morrison, E&Y’s US life sciences leader, noted that the Bay Area is the only one of the nation’s top three biopharma clusters to already raise more money in the first half of this year than in all of 2006, when it raised $494.67 million. San Diego finished last year with $694.5 million and Boston-Cambridge, $553.4 million.
 
Morrison said the growth reflected in the first-half numbers should keep the region atop the nation’s life sciences clusters into the foreseeable future. During that time, New England and San Diego will round out the list of top-three US biopharma clusters, he added.
 
“I think the race in the US is over, and it [the biopharma industry] is going to be concentrated in these three geographic areas,” Morrison told attendees during the morning plenary session at GeneAcres 15, a day-long biotech conference hosted Sept. 25 by the Bay Area life sciences industry group BayBio at the South San Francisco Conference Center.
 
“I’m having to travel less and less East than I had in the past. I think the critical mass in those three areas will continue to accelerate. I think it’s going to be very tough for new geographic areas to get into this in a big way.”
 
Rather than measure themselves against companies in other US regions, Morrison said that Bay Area companies should position themselves more to compete with companies from two Asian potential growth spots for biotech.
 
“I think that global competition in India and China is more of a concern, and I think the Bay Area [can be] a real beachhead for that activity — where there’s a lot of interaction, where companies based in the Bay Area have operations in India and China, especially as patent laws and intellectual property laws continue to mature in those areas.”
 
In an interview after his address, Morrison said he based his assessment on a belief that the Bay Area’s critical mass of academic researchers, venture capital firms, businesses, and institutions would remain larger than that of the New England and San Diego clusters.
 
“The Sand Hill Road types are really the ones that are financing this industry globally from an emergent company basis, and most of that talent is here,” Morrison said, referring to the Silicon Valley thoroughfare famed for its concentration of VCs.
 
Morrison offered his audience an updated version of “Beyond Borders,” E&Y’s annual report on the biotech industry, released May 7 at the annual Biotechnology Industry Organization convention in Boston.
 
“The big picture for 2006 and 2007 is really absolute continued maturity of the industry and product success,” Morrison said.
 
Yet the industry will also face challenges to growth and profitability, he said, including a growing number of attempts to enact public policies unpopular with biotechs — such as allowing the production of generic biologics.
 
The head of a growing Bay Area biotech business not at the conference agreed with Morrison that the region has the elements to ensure continued success in the life sciences industry.
 
Gail Maderis, president and CEO of Five Prime Therapeutics in San Francisco, told BioRegion News those factors go beyond numbers of companies and capital invested, to less tangible factors such as brainpower and the availability of seasoned biotech management talent.
 
Maderis cited the executive chairman and founder of Five Prime, Lewis (Rusty) Williams, who launched the company in 2002 after serving as head of R&D at Chiron, and after co-founding Cor Therapeutics, acquired in 2001 by Cambridge-based Millennium Pharmaceuticals.
 
“There is a tremendous group of people that, once they built companies, have spent a lot of time mentoring and helping grow future leaders in biotech. That was important because we never have had a huge pharmaceutical contingent,” Maderis said in an interview. “The talent pool here is truly remarkable, both on the management and business leaders’ side and also on the science side.”
 
Entry-Level Shortage
 
Despite its wealth of talent and critical mass of activity, Maderis said, the Bay Area faces a shortage of entry-level workers, since they are most likely to be priced out of the region due to its sky-high housing costs. While the number of homes sold in the San Francisco suburbs of San Mateo County fell 5.9 percent in August, to 611, the median price of those houses as of Aug. 31 still rose 7.9 percent, to $809,250, according to real estate information provider DataQuick. That figure reflects medians of $541,000 for condominiums and $900,000 for existing or “resale” single-family houses.
 
“The reason we have trouble at the lower end is because the cost of living is very high,” Maderis said. “We have to continue to work on workforce development. We have a need for more people in lower-skill positions. We need technicians. We need clinical research associates for trials.
 
“A company needs only one CEO, one chief scientific officer, but it needs hundreds of research associates and manufacturing workers,” Maderis added.
 
Maderis’ concern was echoed at the conference by a trio of business leaders during a discussion of the Bay Area’s strengths and challenges for businesses.
 
“I don’t know what to tell someone who makes $80,000 a year who wants to live a half-hour off our site, which is downtown San Francisco, that they’re facing a $600,000 mortgage. There’s not much a company like Merck can do to help a person like that,” said Alan Sachs, vice president of RNA therapeutics for Merck.
 
Merck expanded into the Bay Area last year after it closed on a $1.1 billion acquisition of Sirna Therapeutics. The deal made Merck the largest tenant at 1700 Owens St. with 70,000 square feet of the 153,000 square-foot building, completed earlier this year by developer Alexandria Real Estate Equities at the Mission Bay biotech campus in San Francisco.
 
Sachs was one of three business leaders who turned the conference’s lunch plenary session from a scheduled talk on the real estate needs of biotech companies to a discussion on a broader set of Bay Area quality-of-life concerns.
 
Agreeing with Sachs was another panelist, Shehnaaz Suliman, director of corporate development at Gilead Sciences.
 
“The cost of living in the Bay Area is a disadvantage to some candidates who have to relocate. It’s a key factor for many individuals. It’s one of the reasons why in choosing to diversify our R&D sites, we’re hoping to ramp up our R&D spending to attract people to Foster City. While we want our R&D site to grow, there are economic factors that are unalterable. It has been a little more difficult and challenging,” Suliman said.
 
Yet expense won’t stop Gilead from expanding in the Bay Area given the region’s concentration of talented professionals, Suliman added: “It’s easier to get people to a major center.”
 

“I think the race in the US is over, and it [the biopharma industry] is going to be concentrated in these three geographic areas.”

Morrison of E&Y said the Bay Area, like other US biotech clusters, cannot depend long-term on manufacturing for job and business growth. While companies may be willing to ramp up production short-term during their clinical testing phases, drawing on proximity to researchers, they will ultimately face the same pressure to cut costs that other industries have addressed by shifting their manufacturing to China or India, he argued.
 
BayBio President Matthew Gardner agreed with Morrison that manufacturing will only provide a short-term boost to US biotechs.
 
“Manufacturing of those products, at least for the next five to 10 years, is a limited opportunity in the United States. After that the window will probably move as those products get commoditized,” Gardner said.
 
Near-Record Financing
 
Through mid-September, Morrison said, US biotech and pharma companies raised about $26 billion in capital — up 27 percent from a year earlier and just under the combined $28 billion raised all of last year, which was a 42 percent increase over 2005.
 
“We’re on target for about a $35 billion fundraising year,” he predicted.
 
But it’s not a year that would surpass 2000, when at the peak of the technology market biopharma companies raised an all-time high of $39 billion: “That was clearly a year that’s going to be hard to repeat,” he said.
 
The total financing includes $3.8 billion raised in venture capital in the first half of 2007 by 194 biotech and pharma companies, up more than $1 billion and 70 companies from the year-ago period. These companies are on pace to raise a combined $6.5 billion this year, up from $5.4 billion in 2006. The increases have come, Morrison said, because a rise in Series A financing rounds has more than made up for a dearth of smaller angel funding needed by startups.
 
Morrison said the increased financing reflects a healthy biopharma industry, citing several numerical measures from the end of 2006:
  • Revenue growth: Up 14 percent, to $55.5 billion. The figure does not include biotechs acquired by pharmaceutical companies, such as MedImmune, for which AstraZeneca paid $15.6 billion in June. “The revenue growth in the industry is really closer to 20 percent, pretty astounding growth across the industry,” Morrison said.
  • R&D spending: Up 38 percent, to $22.9 billion, driven by increasing R&D budgets as well as acquired-in-process R&D charges from acquisitions.
  • Employee growth: Up 9.7 percent, to 130,600 employees — not including contract research organizations, contract manufacturing organizations and outsource operations. “The growth of the extended enterprise is even higher,” Morrison said.
  • Net losses: Up 151 percent, to $3.5 billion — but Morrison insisted the figure was skewed by the fact that public biotech and pharma companies have been forced since last year to begin listing as expenses the stock options held by their CEOs, as well as a jump in one-time charges related to mergers and acquisitions given the industry’s consolidation wave.
Mergers and acquisitions last year produced a record-high $23 billion in deals. Without offering a prediction by dollar amount for 2007, Morrison said the industry can expect 20 to 25 public biotech companies merging per year.
 
“Some are going to be biotech to biotech. Some are going to be acquired by pharma. That is a good trend. Consolidation is good. Seven hundred global biotech public companies and 6,000 global biotech companies is simply too much. The industry has to and will continue to consolidate as it matures,” Morrison said.
 
Yet while companies consolidate, BayBio’s Gardner said, many more small businesses are being formed, auguring well for the industry. Sixty percent of biotechs, he said, consist of fewer than 50 employees.
 
“What we still see here is this volume of customers that are built small and require small, flexible space. That tells us that the adaptive uses that are talked about for Mission Bay are important. That also tells us that the needs of Genentech are not the needs of the many,” Gardner said. “This is a signal of a bunch of things coming. It tells us the industry as a whole is about to become a general employer. They’re going to need regulatory affairs professionals to get those products through the pipeline. They’re going to need finance professionals to finance that pipeline. And they’re ultimately going to need marketing professionals, and the kind of administrative jobs that go with a retail-level employer.”
 
Morrison said that even with consolidation and stock optioning, the US biotech industry is on track to meet a previous E&Y prediction that the industry as a whole will finish in the black in three years.
 
“The industry is at profitability now, and by 2010 is going to be wildly profitable, which is going to draw more attention and more scrutiny, but stabilize the financial markets even more and provide more growth and more growth opportunities as we move forward,” Morrison said.
 
“And the Bay Area is going to be a primary beneficiary because as the industry consolidates, the more mature markets are going to be the winners, not the losers.”

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