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See You on the Other Side - Revisiting the Biotech Graveyard

September 2011

During the period of 2008-2010, not only were the typical options of mergers, partnerships, or new investors not readily available to distressed biotech companies, but even otherwise adequately companies had great difficulty tapping into the previously available sources of capital. As such, over 35 companies were forced to decide between filing for bankruptcy or liquidation/dissolution. The industry had never experienced such pressure - FierceBiotech.com even began a feature called "The Biotech Graveyard" to track the phenomenon (Martino, 2010). While many of these distressed companies decided to close shop altogether, interestingly, a group of companies chose to file for Chapter 11 bankruptcy with the intention to reorganize and emerge as a going concern. To illustrate how unique the situation was, 20 biotech companies filed for Chapter 11 bankruptcy between 2008-2010 compared to just one filed between 2005-2007. In an unprecedented time, these companies chose to take an unprecedented path. The nagging question remains, "Where are they now?" Were they able to rise a like a phoenix out of their ashes or did they meet the same fate as those who chose to liquidate? The mercurial markets may be in our favor today, but it's never too early to plan for leaner times. Let's have a look to see what happened to all those Chapter 11's.

Of those 20 companies, four have emerged from bankruptcy as reorganized and functioning entities as of August 2011. The majority have had to liquidate their assets and fully wind down operations while a few are still engaged in bankruptcy proceedings.

Chapter 11 Outcomes of Biotech/Pharmaceutical Companies (2008-2010)

Hotchkiss' analysis of Chapter 11 bankruptcy outcomes shows that 71% of firms that filed between 1979-2002 have emerged as public or private companies suggesting, at first glance, that biotech companies are wildly unsuccessful in bankruptcy (Hotchkiss, Kose, Mooradian, & Thorburn, 2008). Are companies in the biotech industry somehow inherently disadvantaged in bankruptcy? Biotech companies are notorious for their long development timelines and high risk profile, both of which may limit their ability to reorganize in a manner that brings in near term revenue to offset costs and reduce reliance on investors/lenders. Additionally, since biotech companies are often run by founders of the technology, management may have a bias towards overvaluation of the assets leading to reluctance to divest assets to raise funds.

While those factors may play a role, it is interesting to consider that Morrison's research on small companies showed similar bankruptcy outcomes to the above analysis of the recent Chapter 11's in biotech (Hotchkiss, Kose, Mooradian, & Thorburn, 2008). Numerous studies on factors influencing bankruptcy outcomes have observed the importance of the size of a company (as measured by assets pre-bankruptcy) as a determinant of outcomes - larger companies have a higher probability of emerging as a going concern. This could mean that biotech companies simply behave similarly to other small companies across industries due to the fact that most biotech companies filing for bankruptcy are considered small companies. The correlation is undeniable; however, the underlying causal relationship has yet to be clearly established. In actuality, the reasons for the poor outcomes are likely multifold, but it is somewhat comforting to know that the biotech industry is not a complete outlier.

Comparison of Chapter 11 Bankruptcy Outcomes

If we accept that failure to emerge from bankruptcy is the "norm," then we find ourselves four "abnormal" companies, Accentia Biopharmaceuticals, Biovest International, Fibrocell Science(formerly Isolagen), and Hawaii Biotech, that have found their way out.

Accentia Biopharmaceuticals and its majority owned Biovest International both filed for Chapter 11 bankruptcy in 2008. Together, they had modest revenues of ~$20M pre bankruptcy from a couple specialty pharmaceuticals, cell-culture production services, and consulting services. However, they operated at significant losses due to investment in clinical trials for BioVax (Ph III/NHL vaccine), SinuNase (Ph III/intranasal anti-infective), and RevImmune (Ph III ready/ immunosuppressant). The companies carried significant debt in excess of ~$80M and their stock prices had plummeted more than 50% in the 6 months preceding the bankruptcy. The companies emerged in 2010 with a plan to restructure the debt, focus development on the NHL vaccine product, and increase revenues through contract manufacturing in its existing facilities.

Fibrocell Sciences filed for bankruptcy in 2009 and emerged the same year. Like Accentia/Biovest, Fibrocell had some existing source of revenue, albeit small, from sales of its skincare products and also had a late stage autologous stem cell product, azficel-T (FDA approved 06/2011, nasolabial folds). With its recent FDA approval of its first biotech product, Fibrocell has been able to raise $22.7M in private placement and increase its stock price. Through emergence from Chapter 11, Fibrocell appears to have been able to not only preserve value but build value for its shareholders.

Unlike Fibrocell and Accentia/Biovest, Hawaii Biotech is a private company that filed for bankruptcy in 2009 with no appreciable revenues and only early stage assets. In bankruptcy, Hawaii Biotech was able to sell off its Dengue Fever vaccine (Ph I) and other assets to Merck to help fund research of its other programs, West Nile Virus vaccine (Ph 1) and Tick-borne encephalitis vaccine (preclinical). Given its focus on public health concerns, Hawaii Biotech has historically been able to support a substantial portion of its work through over $50M grants and federal funding. As the company emerged from bankruptcy in June of 2011, it plans to continue soliciting grant funding, seek venture capital, and license/partner its existing protein production capabilities to bring in near term revenues.

Taking the Chapter 11 route appears to have worked out for these four companies, but it is by no means a one size fits most solution. Not only does the sheer probability of emergence weigh heavily against biotech companies, the direct costs of bankruptcy proceedings are a significant burden. According to Altman and Hotchkiss (Hotchkiss, Kose, Mooradian, & Thorburn, 2008), direct costs of bankruptcies were found to be ~6.5% of book value of assets with the percentage skewing higher for small companies given a certain amount of fixed costs associated. Forticell Bioscience, an early stage tissue engineering company, filed for bankruptcy in 2008 only to subsequently file for a dismissal due to lack of funds to support the process and unwillingness to liquidate. CEO Alan Schoenbart was quoted to have said, "Unless you have a [reorganization] plan and money, there's no point in being in court" (The Wrong Formula, 2009). As if getting out of bankruptcy wasn't tough enough, staying out of bankruptcy is an equal, and potentially greater, challenge for newly emerged companies. With 40% of companies continuing to experience an operating loss for the first 3 years after emergence, companies are at risk of having to file for Chapter 11 again, commonly referred to as a "Chapter 22" (Altman, 2009). While it may to be too soon to tell if these four companies will ultimately succeed, their journey has provided some insight into what may be critical for a biotech company to be viable in Chapter 11:

• Creating near term value adding milestones, preferably within 1-2 years

• Adding new sources of revenue

• Divesting partial assets to focus and optimize development spend

Finally, should we be so lucky to never find ourselves in the predicament of 2008-2010 again, this look into the Chapter 11's may serve as some inspiration for biotech firms, even those in good standing, to manage carefully. The markets may be less forgiving of the fast and loose management style of yesteryear. Heeding to the warning signs and implementing reorganization earlier may be ever more important to preventing the pains and losses of considering bankruptcy.

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About the author: Bertha Cheng is a Consultant at the Frankel Group. To contact her regarding this post, email blog@frankelgroup.com.

Works Cited
Altman, E. (2009). Post-Chapter 11 Bankruptcy Performances: Avoiding Chapter 22. Journal of Applied Corporate Finance , 51-61.

Flinn, R. (2011, July 20). Biotechnology Bounces Back With 46% Rise In Venture Capital. Retrieved Aug 20, 2011, from Bloomberg: http://www.bloomberg.com/news/2011-07-20/biotechnology-bounces-back-with-46-rise-in-venture-capital.html

Hotchkiss, E., Kose, J., Mooradian, R., & Thorburn, K. (2008). Chapter 14 Bankruptcy and the Resolution of Financial Distress. In Handbook of Empirical Corporate Finance (pp. 1-53). Elsevier B.V. .

The Wrong Formula. (2009, September 27). Retrieved August 20, 2011, from Crain's New York: http://www.crainsnewyork.com/article/20090927/SUB/309279993