And How Would You Like to Pay for That, Mr. Lechleiter?

Check please?

When Carl Icahn (whom we probably owe an apology since we thought a $70/share bid was a pipe dream) first announced that Imclone had a mystery bidder willing to fork over $10/share more than Erbitux partner BMS, he suggested that bid was subject to due diligence, but not financing.

Well, Lilly must have left its moneyclip in its other pants, because here comes the credit card. And it's too late to play credit card roulette.

Just how easy it will be for Lilly--or anyone for that matter--to tap the credit markets for a few billion dollars here or there remains to be seen. The newly passed-into-law $700 gagillion bailout hasn't exactly greased the lending wheels just yet.

Our comprehensive coverage of the deal is at Pink Sheet DAILY, where Jessica Merrill notes that Lilly "intends to finance the acquisition with a combination of cash and debt. The firm expects the debt portion to amount to $2 billion to $3 billion. With today's tight credit markets, funding deals has become far from a sure thing, but Lilly said it remains 'confident' about its ability to finance the transaction."

Lilly shareholders? Maybe not so much. True it was a particularly bleak day for the markets yesterday (with the exceptions of Imclone, Dendreon, and, probably, Campbell's Soup), but Lilly shares were taken to the woodshed, down nearly 3% on the day. (In comparison, Bristol-Myers was only down 1%, its own fall cushioned by the $1 billion cash it stands to gain from its own 17% stake in Imclone.)

If pharma's rock is the credit crisis, its hard place is the fact that it will likely need to keep spending a ton of cash to access the medicines it has failed to develop on its own. So how will Big Pharmas like Lilly reconcile the two competing realities? Maybe Uncle Sam will help.

Remember the hilariously titled American Jobs Creation Act that allowed companies to repatriate vast sums of cash at much friendlier tax rates? (Ostensibly this was to lead to job creation but in reality the cash flowed mostly unimpeded to shareholders via dividends and share buybacks.)

Pharma has already succeeded in restarting its stalled R&D tax credit, which was tucked into the bailout bill (now known by the gentler acronym TARP), perhaps it is also hard at work lobbying for another AJCA so it can bring home more cash to pay for the alliances and acquisitions it so badly needs to bolster its own R&D.

Meanwhile the debate about whether Lilly paid too much for Imclone will continue. Lilly has clearly signaled its intentions to be part of the upper echelon of oncology companies--along with just about every other Big Pharma--and what you think of Lilly's $70/share Imclone offer will probably boil down to the faith you have in Imclone's pipeline (and Lilly's ability to hang on to the next-generation EGFR inhibitor 11F8).

image from flickr user lennonisgod used under a creative commons license.

The Longs And Shorts Of CVS Caremark

The Medicare Part D program is paying an interesting dividend for some the big pharmacy benefit management companies: they are now protected from short selling under new rules adopted by the Securties & Exchange Commission to combat the meltdown in the financial markets.

It turns out that CVS Caremark, Medco Health and Express Scripts qualify as “financial institutions” under those rules (at least as interpreted by the New York Stock Exchange) and so shorting the shares are prohibited until October 17, or longer if SEC extends the ban again.

Why? Because all three operate insurance divisions, primarily as part of the Medicare Part D stand-alone drug insurance offerings.

CVS, Medco and Express Scripts are not among the banks, big insurers and hedge funds initially protected by the SEC order. Oh yes, its true—one hedge fund was indeed protected from the short selling it practices…though it has since asked for those protections to be lifted.

But the SEC also set up a process for the stock exchanges to expand the list, and the big PBMs requested protection, citing their insurance divisions. So first Medco then CVS were added to the NYSE-protected list. (Express Scripts trades on NASDAQ and is protected via that exchange's procedures to implement the rule.)

Yep, that’s right. CVS turns out to be a fragile financial giant, right alongside Fannie Mae or the late lamented Lehman Brothers. As Reuters put it best, that notion certainly raised a lot of eyebrows among investors who are already critical of the notion that short-selling is somehow contributing to the financial crisis.

Nevertheless, the protection may give CVS a small added advantage in the context of a bidding war against Walgreen’s to purchase the West Coast retailer Longs Drugs. The deal, as we reported in “The Pink Sheet,” really focuses on the bricks-and-mortar pharmacy business in California. Walgreen’s is not on the protected list. (It does have a PBM division of its own, but it does not sponsor its own stand-alone insurance.)

Longs is also a relatively large Part D sponsor, through its Rx America division. The company, however, is also not on the protected list—though with a bidding war under way to acquire it, who would short it anyway?

So in the bidding for Longs, one party (CVS) has less to worry about when it comes to maintaining its own share price than the other (Walgreen’s). That’s not a decisive edge, certainly, but on the whole we’d rather be in CVS’ position. (In the unprecedentedly volatile market of the past week, it is simply impossible to determine whether the protections on CVS have made any difference versus Walgreens.)

In one sense it is only fair that CVS, Medco and Express Scripts are getting a little something back for jumping into Part D. As it happens, none of the big three PBMs was overly eager to dive into the new market—to them, it posed at least as much of a threat as an opportunity, since they have not historically been willing to be at-risk insurance companies, nor were they eager to see their lucrative retiree drug insurance products poached by new entrants in Part D. (You can read more about the mixed emotions of PBMs towards Part D here.)

On the other hand, the seeming absurdity of classifying CVS as a “financial” institution may further encourage a rethinking of the Part D model.

Both presidential candidates have big objections to the drug insurance program—albeit from radically different perspectives. But we’re betting that the current collapse of confidence on Wall Street—and in Wall Street—is going to give an even stronger hand to those who want Medicare managed more tightly by the federal government.

Venture Round: Looking for the Bright Side

What if this is the best thing that could have happened for venture capitalists and their companies?

By “this” we mean the complete and utter destruction of Wall Street, and by “best thing” we’re obviously thinking long, long-term impact here. Clearly, things will be rough for a long time coming.
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But venture capitalists have been squealing about how Sarbanes-Oxley has regulated them right out of the IPO business, saying the costs and oversight were too much for their little start-up companies to bear.

Then, the bulge bracket banks—the big guys with the bankers, analysts and cash—began turning their eyes to bigger, exciting and, yes, revenue-generating deals, leaving their little biopharma and device companies that could under-covered and forgotten in the eyes of many VCs.

Well, those days are clearly done. The question now remains, what will rise from the ashes? Will the banking and analyst staff that once populated the highest offices in Manhattan find their way to some of the boutique banks that have made themselves a nice little business putting together smaller deals, bringing the experience and resources to grow those institutions?

Furthermore, as one institutional investor tells us, venture capitalists could help themselves and this nascent boutique banking industry by steering some of the choice work toward smaller investment banks, eschewing the cache and hoopla associated with one of Wall Street’s blue chip names.

Uh, former blue chip names.

PE Hub had a similar conversation about small tech companies with Paul Deninger, vice chairman of the investment bank Jefferies & Co. We're not buying all that he's selling, but read it here, including the blistering comments. (BTW, we'd hardly consider IPC The Hospitalist Company, a tech company. It's a health care company thanks very much.)

So, is this the end of the world as we know it? Or has the past few weeks been a necessary—and admittedly painful—cutting of the larger trees that will allow some sunshine and rain wash over the growth underneath?

***

As we said the short-term is pretty bleak. Witness this week's announcement that the spin-out of Angiotech Pharmaceutical is in danger, which likely means no investment by Ares Capital or New Leaf investment.

Also, VentureWire Lifescience and others reported on the recent fund-raising by Kalobios, which didn't include previous investor Lehman Brothers.

"We were all set to close on Friday of last week, until Lehman filed for bankruptcy," said KaloBios Chief Executive David Pritchard. "They had several million committed to the round, and while we only lost one business day...we had to rush to make that up."

Lehman had led KaloBios' $20 million Series C round in July 2007 through its health-care venture capital group. That group invests directly off the firm's balance sheet, unlike Lehman's IT-oriented venture partners group, which closed a $365 million fifth fund in September 2007. Randy Whitestone, a Lehman spokesman, said the venture partners group is part of the firm currently being auctioned off, and he said the firm is not certain of the health-care group's fate.

Pritchard described embattled Lehman as "a great investor and very supportive of the company." Jeffrey Farrell, a senior vice president at the investment firm, was an observer on KaloBios' board.

Pritchard said many of the round's other investors stepped in over the weekend to fill the hole left by Lehman, contributing above-pro rata shares. New investors Genzyme Ventures and Mitsubishi UFJ Capital led the round, joined by existing investors Alloy Ventures, 5AM Ventures, GBS Ventures, Lotus Bioscience Ventures, MPM Capital, Singapore Bioinnovations and Sofinnova Ventures.

***

Fred Wilson, general partner at Union Square Ventures, has an interesting little post on his A VC blog about how the New York Times came to profile his firm. The serendipitous origin of the article must broil PR pros who would kill to get their clients such a profile, but more often than not this is how such profiles come together.

Anyway, the article relays how Union Square Ventures is willing to take small stakes in tiny start-ups, exclusively in tech. That's easier to do with a $165 million fund, but it got us thinking. We wrote extensively about how larger venture capital firms are maintaining their early-stage medical device flow by committing small bits of capital in ventures started by proven entrepreneurs who are affiliated with the fund. But are there any life sciences VCs who exclusively make similarly sized bets in untested start ups?

Burst Bubbles and Bailouts: Big Pharma and the Financial Mess

In Washington, there is a distinct undercurrent of gloating when it comes to the Panic of 2008.

No one is happy, exactly, about the incredible turmoil in the financial markets, nor can anyone be said to be thrilled that taxpayers will be putting up something like $700 billion to rescue Wall Street.

But in a town filled with people who work for the federal government, there is an undeniable sense of vindication. See, we are needed after all. Free markets don't take care of themselves. Sometimes you just have to turn to Uncle Sam to see you through.

Or, as Washington Post columnist Steve Perlstein puts it, "It will no longer be an easy applause line for a politician to declare that government is the problem and that markets always know better than regulators and politicians."

We've already pointed out that it may be naive of industry to think that the financial storm will spare it any damage, since the biotech industry is, in a sense, nothing more than an amazingly complex form of derivative finanicial instrument: a way for investors to tap indirectly into the immense profits of Big Pharma blockbusters.

We've also written about Big Pharma's own bubble problem: the fact that the industry is built to support an unprecedented--and apparently unsustainable--spike in approval of large, primary care brands in the mid-1990s, generating a need for infrastructure--and expectations for growth--that now present a terrifying cliff at the end of this decade. If Merrill Lynch can vanish, why can't Pfizer?

But it is not just loss of confidence in creative financing or in the stability of mega-cap companies that is a threat: there is also the renewed confidence in central government interventions in the economy to think about.

If the government must intervene to save Wall Street itself, then why can't it intervene elsewhere in the economy--like, for instance, in setting the price of life saving medicines?

As tough as it has been to be a Big Pharma company the last three years, it would have been even tougher without the Medicare Part D program, a massive new insurance program to subsidize the purchase of those previously mentioned blockbusters--and one that relies on the principle that free market competition is the ultimate path to efficient, economically effective health care.

This is the program that famously prohibits the federal government from "interfering" in the negotiation of prices between the private drug companies and the private drug insurance plans--and at the same time commits the public to pay whatever the price ends up being.

Its fair to say that the events of the past week will strengthen the hand of those who don't like the Part D model. After all, if the free markets don't work for mutual funds, will anyone believe that they work for Medicare?

Count both Presidential candidates among those with strong misgivings about the Part D program, albeit from very different perspectives. Democrat Barack Obama thinks it relies too much on private contractors, and favors given the government more power to act--especially when it comes to the price paid for medicines. Republican John McCain objects to the program for the opposite reason, saying that taxpayer funding shouldn't be commited to a new healthcare entitlement. But he too wants the government to get a better deal on any medicines it ends up paying for.

Obama has already begun hammering McCain for his free market approach to health care in general. Expect that to continue until election day.

But no matter who is victorious in November, the events of September will ripple into the pharmaceutical sector. After all, if Washington can set the price for AIG or Fannie Mae, surely it can decide how much Avastin is worth...

Hurricane Devastates Galveston; Heads for Biotech

At the end of this unprecedented week we are still too shell-shocked to have probed deeply into the implications of the Wall Street meltdown on our corner of the economy.

But we’ve done enough thinking to disagree with the majority of respondents to our IN VIVO Blog poll, 83% of whom think the effects on their companies will be merely mild to moderate. And disagree too with those still-in-denial private-equity investors our fellow blogger visits with here, who apparently think that our industry is a nice, safe place to put their money.

OK, that may be true for Big Pharma. After all, as in previous times of market turmoil, investors may vote Pharma because they see the companies as defensive plays, where demand for products is relatively independent of the economy. And indeed most drug firms have done, during this disastrous week, a bit better than the S&P 500 (though pretty much everyone is still down).

But Pharma looks a lot less defensive than it used to be. The generic cliff is way too steep and R&D way too unproductive. The traditional side-benefits of pharma investing, too, look kind of iffy. With cash flow likely to shrink, dividends are at risk – even more so the absurd stock repurchase programs into which, like some vast currency shredder, drug companies have continued to throw their money. And just a small issue: the dollar has been gaining value, and is likely to gain more. That means US companies won’t be able to simply rake in some incremental revenues. So maybe pharma is a better short-term bet than much of the S&P – but better ain’t great.

Far more worrisome, however, is biotech – which to some degree looks a lot like these incomprehensible derivatives. Like the buyers of subprime mortgage securities, buyers of biotech stocks have by and large invested on faith. Our bet is that few investors really understand the science they’re buying. Hell, we’ve met too many biotech CEOs who don’t understand their own science. How else, other than faith, do you explain why people continue to invest in an industry which over three decades has swallowed a lot more public money than it's returned?

And in a world in which investors will shun risk for a good long time, particularly risk they don’t understand, biotech is about as attractive as Galveston after Ike. Like other high-risk/high-return businesses, biotech attracts the extra cash investors have in their funds. And there’s going to be precious little excess cash for at least the next several months. And the fact that there are now three fewer banks to help biotechs with funding, stock coverage, and M&A advice isn’t particularly happy news, either. (Anybody want to bet how long Morgan Stanley is going to remain free-standing?) An IPO year which has started out as badly as any in recent memory – just two US biotechs managed to raise money, and paltry money at that -- will finish as the worst since the late 1980s.

Not that history is going to provide any answers, says Fred Frank, the vice-chairman of Lehman Brothers and soon to be a Barclay’s employee. This isn’t 1998 or 1988, he told us in a phone call today. “This is a whole new day for biotech. Don’t interpret by [historical] analogy; interpret with analysis.”

So here’s what we see. At the top end of the valuation pyramid, we’d bet PEs like Celgene’s – 51, at last viewing – are pretty vulnerable. Maybe those companies will recognize their currency is overvalued and will use it to buy some real cash-flow producing assets. (Not cash-starved early-stage biotechs, incidentally).

At the other end, what has been a relatively steady flow of start-up activity will slow to a trickle. Start-ups have been a tough investment argument in any event, given the dismal IPO market. But at least acquisitions have provided some fine returns over the last three years. The problem is that even before the Wall Street tornado hit, the M&A door had begun to close, (for our in-depth analysis of returns from acquisitions of private biotechs, see this Start-Up article). We suspect you’ll see health-care VC move towards devices and maybe services – avoiding new investments even into the kind of biologicals platforms Big Pharma has been snapping up over the last few years (for example, check out our write-up of the Bayer/Direvo deal here).

And in the middle: we have now come around to the notion that we’ll finally see a significant number of biotechs just close their doors. (Neose, for example, sold off its assets today.) Like everyone else, we’ve been amazed at the ability of many end-of-life biotechs manage to raise just a bit more money to keep the lights on and a program or two bubbling along. But we just don’t see that in the climate ahead. The investors won’t be there. Like the sensible Galvestonians, they’ve fled to higher ground.

Image from flickr user juliemwood used under a creative commons license.