COVER STORY
COVER STORY
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Stuck in first gear
Source: Financial Mail
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By Claire Bisseker
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SA's young biotech industry faces an uphill slog as private capital stays away
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Three years into the application of SA's official biotechnology strategy, the pickings are still slim.
Though universities and science councils are bursting with promising projects, and the department of science & technology's biotechnology regional innovation centres (Brics) are supporting up to 15 fledgling companies each, they have yet to hit the jackpot.
What SA's biotech community needs is a rocketing commercial success story - partly to reward government for its continued support and to attract more foreign interest but, more importantly, to convince domestic private capital that there is money to be made in biotechnology.
The chief problem plaguing the industry is that private funders haven't joined in to bolster the R450m government has invested since 2003. Without their support, the challenges faced by biotech companies may prevent the industry from reaching critical mass.
SA's biotech industry is embryonic. It consists of about 50 core start-up companies, none of which is publicly traded. Most are medium-tech, product-orientated ventures, rather than cutting-edge technology companies. More than half employ fewer than 20 people and 75% make under R10m/year. Few are profitable yet, and though there are pockets of excellence, there is no critical mass in any specific area.
Capital is a problem for start-ups in all industries but it is particularly acute for biotech companies. They typically need several rounds of funding to become self-sustainable since, by their nature, they have to survive for extended periods without a revenue stream.
Finding additional capital for Lodox, a medical device company which manufactures a low-dose X-ray system, is an uphill slog, says Horizon Equity MD Richard Flett.
Lodox, which has already benefited from several rounds of venture capital (VC) finance and has sold 10-15 X-ray units internationally at roughly US$400 000 each, needs more capital to complete its global commercial development.
Flett says American and European VC funds are excited about the technology but go cold when they realise they will have to invest outside their home markets. SA's exchange controls prevent reorganising a company to overcome this problem.
What little private equity there is in SA tends to focus on mature companies that are cash-positive, he explains. These days the industry's focus is on facilitating black economic empowerment. "The biotech industry never had much private equity capital before BEE; now there's even less," says Flett.
Also grappling to raise additional finance is Heather Sherwin, manager of Bioventures, SA's only dedicated biotech VC fund.
She says it is difficult to attract offshore funding for a host of reasons, including:
• Afro-pessimism (some international VC funds have no mandate to invest in Africa);
• The paucity of government grants (compared with the US, where up to 30% of a biotech company's R&D is paid for through grant funding);
• The fact that department of trade & industry industrial support grants are largely inaccessible to biotech companies;
• The long lead time before the money becomes available (9-12 months for some Brics compared with 3-4 months in the US and Europe); and
• SA's foreign exchange controls.
Having invested R55m across eight start-up companies since 2001, the Bioventures fund is now fully utilised and management is seeking to secure successful exits from all its investments.
Sherwin is considering a range of options, including listing some of the companies on AltX, the JSE's bourse for smaller firms. But she fears that institutional investors are too risk-averse to favour local biotech stocks.
Investors in small biotech companies would get a much higher valuation if they listed on the Nasdaq in the US because foreign analysts tend to focus on a company's technology rather than its financials, and because US investors generally understand the biotech industry better.
The only company to have listed on the Nasdaq whose management and core business is based in SA is Aplitec, the smartcard technology stock that delisted from the JSE last year with a price equivalent to about $3/share. It recently listed on the Nasdaq at $28/share.
It's a unique case of SA shareholders being able to continue holding their shares in the company and so benefit from the huge value upgrade afforded to the stock. The Reserve Bank has indicated that it is unwilling to allow such structures in future, however.
Similarly, foreign exchange controls encourage local investors who lack the cash to keep a young biotech company afloat to sell the entire company to foreign investors.
This is because exchange controls make it difficult to move intellectual property (IP) offshore. Local biotech companies may not place their IP in a US holding company in which they hold shares. The alternative is to sell the company outright.
Sherwin says deals are also lost because a listed US firm cannot buy a small SA biotech company for a portion of cash and equity. Exchange controls prohibit an SA company from holding offshore equity unless it holds more than 51% of the offshore company, so the former would have to sell its shares and repatriate the earnings within 30 days. However, in deals like these the foreign entity usually wants to lock the SA investors into an equity stake to share risk.
Even where one can theoretically get permission from the Bank to sell IP, it's an expensive process because the Bank will talk only to "authorised dealers" (lawyers and bankers) who understand the Bank's protocol. It takes anything from three to six months to get approval for the sale of IP and in the process investors sometimes lose interest.
"Foreign exchange controls are a big impediment to the industry and we're losing offshore investment because of it," says Sherwin.
The department of science & technology's head of biotechnology, Ben Durham, agrees government could do more to develop the industry by, for instance, providing tax incentives and easing foreign exchange controls to allow the sale of IP abroad. He intends to push for these reforms.
It's hardly surprising that other emerging markets, such as China and India, have leapfrogged SA by pouring resources into their biotech industries and going on marketing offensives to attract global attention.
"It's working," sighs Sherwin. "The global VC industry doesn't talk about SA anymore. It has switched its attention firmly in the direction of India and China."
India's biotech industry has evolved rapidly, growing at a rate of 40% over the past year to reach $705m in revenues. It now ranks among the world's top 10 biotech countries.
"It's a global industry and we're competing head to head with the rest of the world," says Sherwin. "Unless we devote more resources to building companies and for research grants, we won't be able to compete."
Should we even try? One approach is to focus inwards on issues affecting SA and to settle for being an R&D hub, doing the early-stage research work on contract for big multinational companies.
However, Sherwin argues that because SA's home market is so small, local biotech companies have to build a foreign market straight away. This raises the costs of doing business and protecting IP and puts them at a disadvantage against competitors in better-resourced countries.
Of Bioventures' eight investments, only one firm, Disa Vascular, which produces coronary stents, has any local sales. Even then, these are less than 5% of its total sales. Most local biotech companies involved in drug discovery have focused on cancer and heart disease because of the international market opportunities.
Despite the stumbling blocks, says Durham, the industry is further ahead in its development than he expected it would be when he was appointed three years ago.
"I feel extremely positive because the biotechnology strategy has added new money and excitement to the innovation system in SA. The strategy is stimulating, co-ordinating and driving the entire biotech sector," he says. "Even so, we're still in the early phase. It will take 20-30 years for biotech to make a substantial contribution to GDP."
Durham admits that so far the Brics have been picking the low-hanging fruit - projects begun many years ago in academia and the science councils.
He cites four that have reached commercialisation stage, all supported by the Gauteng Bric, Biopad:
• One of the most advanced is the Rhodes BioSURE Process. This world-first technology, developed through a collaboration involving Rhodes University, uses bacteria to clean and neutralise the pH of acidic mine water while treating sewage, which is added to the mix to provide the bacteria with an energy source.
A pilot plant has been set up in Springs, linking Grootvlei mine waste water with the municipal sewage outfall. The technology, which provides one solution for two problems simultaneously, is being marketed internationally.
• The SA food industry has snapped up a new blue cheese food flavourant developed by CSIR and Pretoria University researchers from an indigenous fungus. Two more flavourants are in late-stage development.
• Another Biopad enterprise has developed a new method to extract and add value to the active ingredient (aloesin) in aloe sap, the foundation for a variety of cosmetics. The aim is to export beneficiated aloe products and a commercial partner is already marketing the product internationally.
• Rhodes University, the CSIR and commercial partners have developed a probiotic product range that enhances the survival of ornamental koi fish and is already available to international markets.
Though these are success stories, they are really about successful technology development, of which SA can boast plenty of examples. What SA is short of is stories about the successful commercialisation of technology and the successful growth of small companies. That's where the crunch comes.
Cape Biotech CEO Mark Fyvie believes the Brics are starting to make an impact. He notes that the first few licensing deals between Bric-supported start-ups and pharmaceutical multinationals have taken place. More are in the pipeline.
He is also in talks with two international players who are considering locating in the Western Cape.
"One is a Californian-based biotech company with technology that we want to develop to produce cheaper, on-site diagnostic tests for TB and viral load tests for HIV," Fyvie says. "We want to build a centre of excellence to develop, manufacture and distribute these tests to all developing countries."
The other is a US-based entrepreneur who wants to establish a full R&D screening company and potentially a manufacturing plant in SA. His company uses oil emulsion technology to screen massive amounts of genetic material to find useful compounds and he is attracted to SA by its rich biodiversity.
Fyvie also notes movement in the generics field, with companies like Enaleni and Aspen well placed to go beyond the manufacture of generics and explore opportunities on the biotech fringe. In other countries, the presence of a pharmaceutical industry has been a catalyst for biotechnology development.
At the moment, biotech's contribution of about R500m/year to GDP is minuscule, but just one deal could change that.
"If we pick the right areas of research and continue to drive our incentive programmes in these areas, we'll start to be successful," says Fyvie. "SA is never going to have the best biotech industry in the world, but it will compete in niche areas and the industry could be a significant contributor to growth."
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