CANADA YEAR IN REVIEW

Mixed Reviews and Signs of Hope

nvestors following the biotech industry in Canada in 2005 would question the industrys ability to survive long term. One would certainly question whether the market for biotech could ever grow and ourish as it did at the beginning of the century if solely comparing its market performancewith urries of activity in the beginning of 2005 and at the very end of 2005with that of the enthusiasm generated in other sectors of the Canadian economy, which have propelled the Canadian stock markets to record levels. Industry observers, however, need to take a step back and look at the fundamentals. Industry funding in 2005, at over $1 billion, approached the levels of 2000 and 2001. Funding increased by 28 percent over the $791 million raised in 2004 and approached the $1.3 billion raised in the banner year of 2003. For the rst time since 2000, the industry raised over $100 million in initial public offerings (IPOs). Although only four companies completed IPOs, these totaled over $160 million, the most ever for the Canadian industry. Funding, however, was signicantly skewed to the rst quarter of 2005, when over $526 million was raised, including $150 million raised in three IPOs, over 50 percent of the Canadian total and the most ever raised in a quarter for the Canadian biotech industry. The second quarter was marginal, with $229 million raised. However, the third and fourth quarters were signicantly lower than they were in 2004 and certainly signicantly lower than the rst two quarters. Without a strong up-tick in nancings in December 2005, the fourth quarter would have been as poor as the third quarter. Major deals The most signicant single transaction in the Canadian industry in 2005 was the acquisition of ID Biomedical, the dominant Canadian player in the vaccines market, by GlaxoSmithKline (GSK) for $1.4 billion. At the time of the sale, ID Biomedical was one of the 10 largest market cap companies in Canada, with signicant growth over the past few years. PharmAthenes acquisition of Protexia from Nexia Biotechnologies for $18 million was the only other acquisition of

a Canadian public company in 2005. Nexia recently announced that they would monetize their tax losses through an oil and gas play. Public companies The Canadian biotech industrys market cap for the 81 public companies included in our index decreased by almost $500 million in 2005, from $13.7 billion to $13.2 billiona far cry from the $17.4 billion market cap reached at the end of 2000. These gures, reported in U.S. dollars, reect a signicant appreciation of the Canadian dollar against the U.S. dollar over the past two years. Expressed in Canadian dollars, the 2005 market cap would have decreased by almost a billion dollars. The market cap for the industry over the rst six years of the 21ST century has performed poorly when compared with other sectors in the Canadian economy, reinforcing the difculty that the industry is having in attracting investor interest. In Canada, most of the interest in the sector revolves around a few large players with signicant market caps. These companies are currently generating revenue and are either protable or are on the cusp of generating prots. Investors are interested in these companies for income growth as opposed to betting on a prayer and a promise. Many investment dollars in the Canadian economy have moved away from technology and life science companies, with some exceptions, to the nancial services and oil and gas industries, which continue to generate signicant returns for their shareholders. This shift by Canadian investors is likely to continue, limiting the ability of earlier-stage companies to attract investor interest and nancing. The 10 largest public Canadian biotech companies have a market cap of $10.8 billion, up from $9.1 billion in 2004. These 10 companies represent just 12 percent of the public biotech companies, but over 80 percent of the industrys market cap. There are 26 companies with an individual market cap of less than $20 million and another 29 companies with individual market caps of between $20 million and $100 million. Based on market capitalization and other relative size measures,

Canada: 2005 distribution of biotech companies by segment

Drug discovery technologies and services 3% Diagnostics 7% Industrial 8% Tissue engineering 8% Genomics, proteomics, and enabling technologies 8% AgBio 15% Source: Ernst & Young Drug delivery 3% Other 2% Therapeutics 46%

55 of the 81 public biotech companies, or 68, percent of the public companies in Canada, would not have gone public in the U.S. The Canadian biotech industry may be criticized as having too many small, earlystage companies. This is also true of the public companies, evidenced by the number of biotech companies with market caps less than $100 million. The Canadian industry and
Canadian biotechnology at a glance 2005 ($U.S.)
2005 Public company data Revenues ($m) R&D expense ($m) Net loss ($m) Market capitalization ($m) Number of employees 2004 % change

2,584 2,052 26% 852 794 7% 324 429 24% 13,211 13,685 3% 7,310 7,370 1%

Financings Public company financings ($m) 697 Number of IPOs 4 Private company financings ($m) 313 Number of companies Public companies Private companies Public and private companies

520 4 271

34% 0% 15%

81 378 459

82 390 472

1% 3% 3%

Source: Ernst & Young The 2005 data were converted to US$ using an exchange rate of 1.21 (Canadian per US$), except market capitalization, which was converted using an exchange rate of 1.16 The 2004 data were converted to US$ using an exchange rate of 1.30, except market capitalization, which was converted using an exchange rate of 1.20 When stated in Canadian dollars, revenues grew by 17%, R&D by 0%, and net loss fell by 30% 2004 numbers have been restated to reflect full-year results, since estimates in Beyond Borders 2005 included some estimation of fourth quarter results Numbers may appear inconsistent because of rounding

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CANADA YEAR IN REVIEW

Selected 2005 Canadian biotechnology public company financial highlights

(by geographic area, US$m, percent change over 2004)

Region Ontario Quebec British Columbia Other Total

Number of public companies

Number Market of capitalization employees 12.31.05 Revenue

R&D

Net loss (income)

Cash and short-term investments

Total assets

25 7% 24 0% 16 0% 16 7% 81 1%

2,590 28% 2,490 39% 1,260 8% 970 20% 7,310 1%

5,398 12% 2,687 11% 3,199 23% 1,926 12% 13,211 3%

1,010 6% 867 57% 595 73% 113 3% 2,584 24%

291 8% 208 12% 253 18% 101 56% 852 9%

72 55% 152 10% (4) 105% 104 290% 324 21%

698 60% 349 5% 867 22% 177 27% 2,091 4%

2,561 5% 1,646 8% 2,080 15% 408 15% 6,696 9%

Source: Ernst & Young The 2005 data were converted to US$ using an exchange rate of 1.21 (Canadian per US$), except market capitalization, which was converted using an exchange rate of 1.16 The 2004 data were converted to US$ using an exchange rate of 1.30, except market capitalization, which was converted using an exchange rate of 1.20 Numbers may appear inconsistent because of rounding

particularly Canadian investors are apparently beginning to follow the American model of delaying the creation of companies until they have identied a potential product, and once created, capitalizing these companies with more signicant funding. Venture capital (VC) rounds now average over $6 million, with many individual rounds in excess of $15 million, the same amount that would have been raised in an IPO ve or six years ago. Moreover, the larger, more mature companies are also starting to provide investors with real returns. Canadian public biotech companies, for the rst time ever, reported revenues in excess of $2.5 billion, a growth of over 26 percent compared with 2004 and a growth of over 400 percent since 2000. At the same time, total losses reported by Canadian public biotech companies declined to $324 million from $429 million in 2004, a reduction of almost 24 percent. This reduction in overall losses mirrors the U.S. drive toward protability. Fortunately, the reduction in losses was not accomplished by slashing research and development (R&D) spending, which increased by 7 percent to $852 million. This was a record year for R&D spending by Canadian public biotech companies and is over 230 percent higher than the spending by public companies in 2000. It shows signicant market maturity. The number of public companies, despite four IPOs, has decreased by one. The largest loss to the Canadian industry was the acquisition of ID Biomedical by GSK, discussed earlier in the deals section of our article. Two companies ceased trading, one went private,
42

and one sold all of its intellectual property (IP) to a U.S.-based private company, resulting in the loss of ve public companies. We expected to see more of the smaller undercapitalized public companies exit the market by acquisition, merger, or closure due to a lack of nancing. At the end of 2005, 44 percent, or 36 of the 81 Canadian public companies, had less than one year of cash. Another 10 percent had between one and two years of cash. In 2004, 56 percent had two years or less of cash, which compares with the 54 percent in 2005. However, the number of public companies with less than one year of cash has increased from 30 to 36. These smaller companies are also nding it much more difcult to raise nancing at reasonable terms. Secondary offerings in the Canadian market of pure common shares remained at about the same level as 2004, with $295 million raised, but this amount is signicantly lower than the $723 million raised in 2003 or the $600 million raised in 2001. Other types of offerings by public companies, however, amounted to $242 million in 2005, a signicant increase from the $139 million raised in 2004 and second only to the $416 million raised in 2003. This increase could be interpreted as a sign of strength and resilience among the companies, but one must consider the types of funds being raised and their effect on potential future nancing. Many of these companies have raised convertible debt nancings. Difculties in raising such funds often result in the conversion price being very close to the current market price. Further, investors prefer

the convertible debenture route, giving them collateral on IP and signicantly reducing their risk. Many of the companies that do not achieve a signicant scientic or commercial milestone are likely to nd the convertible debt-holders exercising their collateral and taking possession of the intellectual property rather than choosing to convert. Also, there have been a signicant number of private investments in public equities (PIPEs) consisting of unit investments in these corporations. Units usually consist of one common share and a warrant, permitting the holder to purchase a percentage of a common share. In todays market, these units are often priced at a discount to market, sometimes as much as 25 percent. In the past, most units contained a warrant that entitled the holder to purchase a fraction of a common share and were priced with little or no discount. Today, many units contain warrants that allow the holder to purchase one common share, and more often than not, only at a small premium to the current market price. Warrants allowing the purchase of a common share at a small premium represent a signicant overhang, depressing the growth in share value. These warrants also permit hedge funds to routinely sell the shares short if they can strike a deal with the warrant holders. Often, convertible debt nancing and unit issues have punitive costs, and although they allow a company to survive for a limited time, they may, in fact, hasten the demise of these companies over the longer term. Finally, the emergence of nancings by corporations monetizing their tax losses has become popular. Previously, this was accomplished when companies were about to close and was accomplished through a shell company. Now this form of nancing is being chosen by operating companies, as it is nondilutive and does not have punitive effects on future share values. The pure secondary issues of common shares have remained relatively stable compared with 2004. This type of secondary offering is available to companies with products in late-stage development such as Neurochem, which raised over $60 million; Cardiome, over $58 million; and BioMS, over $30 million. These three large secondary rounds accounted for about half of the secondary rounds in 2005.

B E Y O N D B O R D E R S : T H E G L O B A L B I O T E C H N O L O G Y R E P O RT 2006

Canadian Census 2005: Counting biotech companies by province

No. of companies 120 Private companies Public companies

90

60

30

Newfoundland Source: Ernst & Young

Nova Scotia

New Prince Edward Brunswick Island

Ontario Quebec Manitoba

Saskatchewan Alberta

British Columbia

Transactions and collaborations Most of the corporate merger and acquisition (M&A) activities in Canada centered on small private companies acquired primarily as a result of lack of funding. Most of these deals were for less than $10 million and are a major reason why the number of Canadian biotechnology companies declined in 2005. Examples of these transactions include Procyon Biopharmas acquisition of Bioxalis Medica, Qiagens acquisition of Nextal Biotechnologies, and Biorens purchase of Biocube. We expect the number of these transactions to continue to increase as these smaller early-stage companies nd it more difcult to raise the funds needed to continue. In 2004, Canadian companies announced over 75 collaborations. We believe that the number of collaborations decreased slightly in 2005. It is still one of the best ways for earlier-stage companies to pursue development activities. An example of a company that has made good use of these collaborations is Caprion Pharmaceuticals. Caprion announced a number of joint development and research collaborations, including a $13.1 million deal with NIAID in 2004, and followed this up in 2005 by announcing four further deals with ICOS Corporation, Wyeth, Boehringer Ingelheim, and AstraZeneca. Licensing and distribution agreements are also a popular way to increase shareholder value quickly among later-stage companies. Labopharm Inc. announced a number of these licensing agreements for its recently approved once-daily Tramadol, including a major deal with Purdue Pharmaceuticals. This agreement provides Labopharm with $20 million dollars in upfront payments, up to $150 million in milestone payments, $40 million of which is near term, as well as signicant future royalty payments. Another good example is Aspreva Pharmaceuticals, which

began earning revenues in 2005 according to its 2003 collaboration agreement with HoffmannLaRoche Inc. These late-stage agreements often include co-promotion rights and potentially give companies the ability to create sales forces and further increase shareholder value. We believe that these deals with pharmaceutical or large biotech companies from Europe and the U.S. will continue to be major value drivers for Canadian biotech companies. Further, acquisitions of small Canadian biotech companies by these larger foreign players have become the choice monetization strategy, as compared to IPOs, which have become much more difcult to achieve over the past few years and were the strategy of choice in the past. We believe that this strategy as it relates to U.S. companies acquiring foreign companies, including Canadian targets, will become more popular in the future. The American Jobs Creation Act of 2004, introduced in the U.S., permitted U.S. corporations to repatriate accumulated earnings in their foreign subsidiaries and to pay low income taxes, if they invested these funds in U.S.based assets and companies. This time-limited window encouraged many domestic U.S. transactions, shutting out Canadian targets. We expect the situation for Canadian biotech companies seeking to be acquired to improve starting in 2006. Provincial distribution With the three major biotech clusters in CanadaToronto, Montreal, and Vancouverthe provincial distribution of companies shares this clustering. Ontario has 143 companies; Quebec, 134 companies; and British Columbia, 74 companies. Almost half of the biotech companies operating in these three provinces are involved in developing therapeutics, and there does not appear to be a concentration by a particular type of biotech

company in any of these clusters. The total number of biotech companies found in each of these three provinces has shifted, with the number of companies declining in Ontario and Quebec. British Columbia, however, experienced a growth of ve companies in 2005, the most of any province in Canada. Quebecs decline, from 158 companies in 2003 to 143 in 2004 and 134 in 2005, has been the most signicant, while Ontario declined from 148 in 2004 to 143 in 2005. The decline is attributed to a reduction in available seed funding, especially in Quebec, where the number of governmental and paragovernmental VCs investing directly in the biotech industry dropped signicantly, as detailed in our 2003 report. Further, Quebec-based VCs tired of waiting for exit strategies to materialize have been actively encouraging the M&A of their investee companies. The decline in Ontario also indicates a reduction in the number of VCs willing to invest in seed or startup rounds. The number of public companies residing in Ontario decreased from 27 to 25, and Quebec remained constant with 24 followed by British Columbia and Alberta, with 16 and 12, respectively. The 16 public biotech companies residing in British Columbia together broke even and, in fact, made a small prot. The amount of total nancing raised also mirrors the companies provincial distribution. Yet British Columbia, for the rst time, attracted more investment dollars into the biotech industry than any other province in Canada at $338 million, followed closely by Quebec, with $318 million, and Ontario, with $258 million. Considering only VC nancing of private companies, Quebec has retained its lead, with over $120 million invested, followed by British Columbia, with $105 million, and Ontario, with about $80 million. The remaining provinces in Canada reported VC investments in private companies of a little over $7 million, collectively. Total nancing in British Columbia grew from $173 million in 2004 to $338 million in 2005. Quebec and Ontario also grew marginally, with total investments in 2004 of $285 million and $242 million, respectively. Venture capital While VCs invest in private and public companies alike, we report here on VC activities concentrated in the private sector. A significant amount of nancing of Canadian public biotech companies is now being made through PIPEs or convertible debentures, especially
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CANADA YEAR IN REVIEW

the smaller, early-stage public biotech companies, which cannot easily access the capital markets with normal secondary offerings. We estimate that the nancing raised in these issues exceeded $100 million in 2005, about 40 percent of the other nancings. We tracked 51 venture capital investments in private companies in 2005 totaling over $313 million with an average investment of $6.1 million. While this is a dramatic decrease from the 111 rounds recorded in 2004, the average nancing per VC round increased from $2.4 million to $6.1 million in 2005. VC nancing in private companies is also moving away from seed and startup nancing and expansion nancing, with 18 and 13 reported deals, respectively, to early-stage nancing, with 20 deals reported. While seed and startup nancing rounds represent on average below $1 million, expansion nancing on average exceeded $6 million, and early-stage nancings are up signicantly, exceeding on average $11 million. In 2004, Aspreva Pharmaceuticals nancing of $60 million was unusual for Canada and, with the exception of an earlier Caprion nancing, the largest ever for a private company in Canada. We noted that in 2005 many of our early-stage companies are attracting large rounds, with Gemin X Biotechnologies raising $50 million, Zelos Therapeutics, $42.5 million, and at least ve other rounds that were in excess of $15 million. Financing rounds of $15 million or more in Canada ve years ago could be obtained only through a public offering. Even public companies would have, and still have, difculty raising rounds the size of Gemin Xs or Zelos. This is a benecial trend in that rounds in excess of $15 million let these earlier-stage companies remain private much longer and advance their product development further before going public. This provides them with nearer-term revenues and a better chance of attracting a signicant market following. We believe that these early-stage large rounds are inuenced by U.S. VCs in the Canadian market. Almost all of these large private rounds include U.S. venture capitalists, and many were solely U.S. based. U.S. VCs have long followed a strategy of making large investments in fewer but better-screened companies and allowing these companies to
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Capital raised by Canadian province

$m 250 Private companies 232.5 197.2 176.5 200 Public companies

120.8 150 105.4 78.5 50 12.2 81.0

5.0

1.2

British Alberta Columbia Source: Ernst & Young and Canadian Biotech News

Ontario

Quebec

Other

pursue their scientic and clinical milestones. This is preferable to the traditional Canadian practice of making a number of small investments, thereby creating uncertainty about future prospects and forcing management teams to be constantly on the road, looking for additional nancing every 6 to 18 months. Canadian VCs have participated in many of these large rounds, indicating a shift in philosophy away from small rounds. Product approvals The year 2005 has been one of the best years ever for the Canadian biotech industrys product approvals. The sustainability of a biotech industry depends on the number of products approved for sale by various regulatory authorities, enabling companies to generate revenue and reach protability. As companies generate revenue and prots, they attract investors to the stock and to the biotech sector. In Canada, we tracked eight products receiving regulatory approval in the U.S. or Europe compared with seven in 2004. Among the most interesting product approvals were Biovail Corporations approval of Tramedol in the once-daily formula in the United States and Labopharms approval of its once-daily Tramedol formula in Europe. Also, Canadian companies continue to advance therapeutics through the regulatory process. Over 12 products entered Phase III trials in 2005 and 15 in 2004. As in 2004, over 20 compounds entered Phase II trials. Certainly, the number of products now in Phase II and III trials indicates that the Canadian industry has a strong pipeline.

Conclusion The Canadian biotech industry still suffers from too many, too small, and too early-stage companies, especially public companies, where 55 of the 81 Canadian public biotech companies have market caps of less than $100 million. Yet the industry is showing good revenue growth, a reduction in losses, and strong product approvals. Companies that are delaying IPOs, and private biotech companies that are raising large VC rounds that should allow them to mature and obtain signicant nancings when they do go public, could make the Canadian industry much stronger in the future. As the large Canadian public companies mature and generate revenues and profits, they are making the biotech industry more attractive. A combination of factors, such as the lack of seed and startup funding, is significantly reducing the number of startups and consolidations, resulting in a smaller industry in Canada. The continued support of the government, which has identied the life science sector as a focus in its innovation strategy, is essential and will provide basic nancial support for early-stage research, as well as additional leverage for private investors. The future of the Canadian biotech industry depends ultimately on the ability of companies to invest wisely in R&D activities, take products successfully through the regulatory process, maximize the return on investment, and present investors with an attractive risk/ reward model.

B E Y O N D B O R D E R S : T H E G L O B A L B I O T E C H N O L O G Y R E P O RT 2006