BioWorld Today Columnist

Back in the early 1990s when I was toiling as editor-in-chief of then-startup BioWorld, I came across a strange press release. It announced the acquisition of two Canadian biotech companies by Consolidated Mining, a public company on the Vancouver stock exchange. Being a na ve scientist "gone bad," I could not figure out what the heck mining had to do with biotech.

The nice man at Consolidated introduced me to the entertaining world of public shells - those strange zombies on stock exchanges, those undead entities able to confer access to public investors on the lucky acquisition.

That shell evolved into Micrologix, now Migenix, which acquired two other companies and evolved away from its original fish vaccines to include anti-infectives and treatments for neurodegenerative diseases.

These days, the shell game has taken on a new urgency thanks to the refusal of investors to indulge in cash infusions at the pace and valuation desired by the 3,000-plus biotech companies out there spending.

Mean Markets

History tells us that when public markets are recalcitrant, bankers show great creativity in finding ways for transactions (and those lovely fees) to occur.

Are private investors not biting, and are the public markets not valuing your company nearly as highly as your current investors wish? Bankers with M&A books almost always show up in times like these, but experience has shown us that biotech teams hate being acquired. Arguments over relative valuation and whose management team gets to run the show have killed many mergers.

But reverse mergers just might give biotech teams a chance to have it both ways - access additional capital and still stay in control! Many of the deals to date have merged private biotech firms into essentially empty public shells that used to encapsulate businesses far removed from the biotech world. Some of my favorites: Advanced Cell Technologies and a maker of Hopi Indian dolls, Minster Pharmaceuticals and RII plc (former soviet insurance companies), Halozyme Therapeutics and Global Yacht Services, Rexahn Pharmaceuticals and Corporate Roadshow.com, and DNAPrint Genomics with S.D.E. Holdings I Inc., which used to handle restaurants and prepaid phone cards. Polymedix Inc. won’t even reveal the identity of its public shell.

Role Reversals

The approach has become so popular that articles about reverse mergers and how to use them have shown up on Nature Magazine’s Bioentrepreneur website, along with more conventional business journals. In most cases, the transaction is used to keep the biotech part of the business afloat.

Nathan Drona, managing director of Challiss, a New York based investment bank specializing in life sciences, says there are two types of public shells: failed businesses and acquisition entities.

"Failed business" are just that, leading to restructurings where all business activities of the company are halted. The 1990s provided many failed internet/ecommerce companies or resource/mining exploration companies around the globe.

"Acquisition entities," sometimes called "blank check companies," are formed specifically to find a private company suitable for an acquisition via a reverse merger. They are often referred to as "clean shells" - since there was no prior business, they should be relatively free of liabilities.

Usually, the shareholders of the company to be acquired by the shell control the combined entity by owning the majority of shares, and thereafter refocus the newly designed public company toward the business aims of the acquired company.

Typically, the shell company has three possible types of assets: cash, a pre-existing SEC registration and public listing, and sometimes management or directors with relevant experience. Drona pointed out that new investors can forget there are two sides to a balance sheet, and hidden, unidentified or unresolved liabilities often are reasons to stay away from shells.

Drona said: "Investors continue to believe that attaching their business to a NASDAQ-listed entity will create a Shangri-La of wealth. Shells are successful only a very small percentage of the time and only when very sophisticated investors are involved."

My favorite strange merger took place in the rough market of 1999, when investors wanted only dot.com stocks, and even Kleiner Perkins had turned away from biotech. Procept Inc., of Cambridge, Mass., was working on a gel to prevent sexually transmitted diseases and chemosensitizers to make cancer cells more susceptible to chemotherapy. It also was running out of cash.

Management put out a press release with that ominous phrase, "in order to maximize shareholder value," announcing its decision to merge with Heaven’s Door Corp., of Coral Springs, Fla., a website providing one-stop shopping for the funeral services industry. The CEO, John Dee, predicted the potential market for pre-planned funerals in the U.S. alone was $85 billion! All I know is that Google has 40 million references to funeral services, but none appears to refer to the former Procept.

Biotechs Becoming Empty Shells

Perhaps all this is a sign that biotech has turned into a mature industry, generating its very own shells. A recent news report showed the tide of shells that started flowing into biotech back in the early 1990s has reversed itself.

Montréal-based Nexia Biotechnologies Inc. had been creating transgenic goats that made spider silk in their milk. The company raised C$67(US $57.4) million by 2003 but was going broke by 2005. A big chunk of the biotech assets were sold to Pharmathene (which itself is using a reverse merger with Siga to gain access to public markets).

Late last year, Alberta lawyer David Tonken and an associate bought 26.5 percent of Nexia, with an eye to making good use of what they saw as a "clean shell" possessing a neat balance sheet, updated financial statements, and a $50 million loss for a new owner to use against its own tax bill.

Tonkin is thinking that oil and gas is the right industry for Nexia, leaving biotech behind. Hey, maybe Consolidated Mining will be reborn!