First off, if you missed Wednesday's column, hit the rewind button. Jeff Fischer firmly dispatched two investing bugaboos: Company management's wildly optimistic estimates of future growth and the practice of reporting pro-forma earnings numbers that exclude all sorts of so-called "one-time" charges. Bad companies! In this case, Cisco (Nasdaq: CSCO) and eBay (Nasdaq: EBAY).
Seizing the day for cash
Today's column is about company survival. It's addressed to all investors who own or want to own newer, unprofitable companies in exciting industries. If that's you, you absolutely must follow your companies' available cash, how long it will last, and what happens when it runs out.
Developing companies usually have only three sources of cash -- not counting the CEO's Aunt Harriet and her portfolio of big-city office towers. They are venture capitalists, initial public stock offerings (IPOs), and post-IPO financing, which includes secondary or follow-on offerings of stock, convertible debt, and devices such as private investments in public equities, or PIPEs. Because not all of these options are available all of the time, the best management seizes the day to fill coffers.
When the good times roll...
For example, when investors' enthusiasm for certain industries knows no bounds, unprofitable companies in those sectors can issue shares to the public and even sell more post-IPO shares. Think "Internet" boom, late 1990s. When that happens, venture capital is provided by shareholders, including individual investors like you and me. In those times, you are thinking like a venture capitalist, and accepting very, very high risk.
...and when the party's over
But when enthusiasm wanes, whether due to general economic conditions or short attention span, companies still private are stuck with existing financing or new venture capital based on sharply reduced valuations (these are often called down or toxic rounds). Unprofitable companies in a formerly hot sector are stuck living on their bank balances, scrounging for financing on unfavorable terms, having to merge, or, worse, going out of business.
Let's take a hot industry for whom the public financing window is currently shut or barely open -- biotech. I use this word to mean companies that are using advances in biotechnology to transform existing businesses (drug making, medical diagnostics) or create new ones (bioinformatics). The Rule Breaker port owns three biotech companies, Amgen (Nasdaq: AMGN), Human Genome Sciences (Nasdaq: HGSI), and Celera Genomics (NYSE: CRA), and we've been interested in others, including Millennium Pharmaceuticals (Nasdaq: MLNM).
Biotech financing booms and busts
In her book, From Alchemy to IPO, industry consultant and former Genentech (NYSE: DNA) researcher Cynthia Robbins-Roth identifies periods when the markets were so hot that shareholders became venture capitalists for biotech companies. She cites the mid-1980s, around 1990, 1991-1992, 1996 through May, spring 1998 (brief), and 1999-2000 (still continuing at the time of her book's publication, but now definitely over). Genentech was the first strictly biotech company to go public, raising $35 million in October 1980 and spawning further investor interest in biotech. (If you'd like to know more about the companies such as Genentech and Amgen that spearheaded biotech -- and learn which company stands out in that group today -- check out this month's hot-off-the-presses issue of The Motley Fool Select!)
The 1999-2000 boom dwarfed all others. Nature Biotechnology magazine puts the number of biotech IPOs in 2000 alone at 100, about 25% of the total number of public biotech companies at the start of the year. That's drives home what an historic period we just lived through. When else has there been that kind of activity?
But all that interest and -- let's be frank -- speculation obscures an interesting fact: Despite the 100-company increase, the total number of biotech companies declined from 1999 to 2000 from 389 to 361 (83 outside the U.S.). So even in a very favorable public financing period when the green river of cash gushed gonzo, not every company benefited. The lesson: Get it while you can.
Because it's very tough now, and many public biotechs will need cash infusions. Soon. Signals Magazine reports that 19% of public biotechs can only survive a year or less at current cash burn rates. And even for companies with a little more rope, such as Geron (Nasdaq: GERN), Orchid Biosciences (Nasdaq: ORCH) and Genomic Solutions (Nasdaq: GNSL), with 2.24, 1.02, and 2.6 years of cash respectively, time's getting shorter.
How Rule Breaking biotechs fared
Fortunately, our development-stage biotechs did not sleep through last year. Note that this category omits Amgen, a huge profitable cash machine that -- whatever you think of its current valuation -- generates massive cash flow to fund operations. But HGS, Celera and another company we've scrutinized, Millennium Pharmaceuticals, issued more shares and built massive cash reserves:
cash burn survival 3/31/01 rate* term** HGS $1.75 bil. $122 mil. 14 years Celera 1.03 59 mil 17 Millennium 1.45 140 mil. 10 *net cash used in operating activities + capital expenditures, for year 2000 or annualized from part-year **Cash divided by burn rate. At current cash burn, time until more capital is needed.
These are encouraging numbers. Because they issued new stock in 2000, these companies can fund their operations for years while they move to hoped-for profitability. All three companies are candidates to sign even more big money deals with large drug makers, though it's possible their current reserves give them independence and the ability to drive the hardest of bargains. We also know that it takes more than cash to make a great company, but a head start never hurt.
We know that anything can change, too. Human Genome Sciences plans to spend money to build up its manufacturing and testing capabilities for antibody and therapeutic protein drugs. That won't be cheap, so its burn rate will increase, and it won't have any income from drugs now in development until about 2003 in the best of circumstances. Millennium faces expensive testing for a pipeline of drugs ahead as well, though it's balanced by some expected revenues from its recently approved Campath. Its burn rate may well accelerate. And when Celera picks a clearer direction for its business, it will likely pick up its spending pace.
Good management manages cash well. Execs at unprofitable developing companies must take advantage of favorable financing periods to bolster company bank accounts for any leaner years ahead. Anyone today can look at the 1999-2000 biotech investing craze and observe, "what a favorable period for biotech financing," but only some biotech companies had management who made enough hay while the sun shone. This port owns two of them.
Tom Jacobs (TMF Tom9) thinks that biotech advances make this one of the most fascinating periods of investing ever. But watch the risks. At press time, he owned no shares in companies mentioned in this story. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy.
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