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CANADA YE A R IN RE VI E W

Mixed Reviews and Signs of Hope

Investors following the biotech industryin 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 flourish as it

did at the beginning of the century if solely

comparing its market performancewith

flurries 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 bil-

lion, 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 first time since 2000, the industry raised

over $100 million in initial public offerings

(IPOs). Although only four companies com-

pleted IPOs, these totaled over $160 mil-

lion, the most ever for the Canadian industry.

Funding, however, was significantly skewed to

the first quarter of 2005, when over $526 mil-

lion 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

significantly lower than they were in 2004 and

certainly significantly lower than the first two

quarters. Without a strong up-tick in financings

in December 2005, the fourth quarter would

have been as poor as the third quarter.

Major dealsThe most significant 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 significant 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. Nexiarecently 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 mil-

lion in 2005, from $13.7 billion to $13.2 bil-

liona far cry from the $17.4 billion market

cap reached at the end of 2000. These fig-

ures, reported in U.S. dollars, reflect a sig-

nificant appreciation of the Canadian dollar

against the U.S. dollar over the past twoyears. Expressed in Canadian dollars, the

2005 market cap would have decreased by

almost a billion dollars. The market cap for

the industry over the first six years of the 21ST

century has performed poorly when compared

with other sectors in the Canadian economy,

reinforcing the difficulty 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 significant market caps. These compa-

nies are currently generating revenue and are

either profitable or are on the cusp of gener-

ating profits. 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 financial services and oil and gas indus-

tries, which continue to generate significant

returns for their shareholders. This shift by

Canadian investors is likely to continue, lim-

iting the ability of earlier-stage companies to

attract investor interest and financing.The 10 largest public Canadian biotech

companies have a market cap of $10.8 billion,

up from $9.1 billion in 2004. These 10 com-

panies represent just 12 percent of the public

biotech companies, but over 80 percent of the

industrys market cap. There are 26 compa-

nies with an individual market cap of less than

$20 million and another 29 companies with

individual market caps of between $20 mil-

lion and $100 million. Based on market capi-

talization and other relative size measures,

55 of the 81 public biotech companies, or 6

percent of the public companies in Canad

would not have gone public in the U.S.

The Canadian biotech industry may

criticized as having too many small, earl

stage companies. This is also true of t

public companies, evidenced by the numb

of biotech companies with market caps le

than $100 million. The Canadian industry an

2005 2004 % chan

Canadian biotechnology at a glance 2005 ($U.S

Public company data

Revenues ($m) 2,584 2,052 26%

R&D expense ($m) 852 794 7%

Net loss ($m) 324 429 24%

Market capitalization ($m) 13,211 13,685 3%

Number of employees 7,310 7,370 1%

Financings

Public company financings ($m) 697 520 34%

Number of IPOs 4 4 0%

Private company financings ($m) 313 271 15%

Number of companies

Public companies 81 82 1%

Private companies 378 390 3%

Public and private companies 459 472 3%

Source: Ernst & YoungThe 2005 data were converted to US$ using an exchange rate of 1.21(Canadian per US$), except market capitalization, which was convertedusing 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 ratof 1.20When stated in Canadian dollars, revenues grew by 17%, R&D by 0%, andnet loss fell by 30%2004 numbers have been restated to reflect full-year results, since

estimates in Beyond Borders 2005 included some estimation of fourthquarter resultsNumbers may appear inconsistent because of rounding

Source: Ernst & Young

Canada: 2005 distribution ofbiotech companies by segment

Therapeutics 46%

Drug discovery technologiesand services 3%

Genomics,proteomics,

and enablingtechnologies 8%

Drug delivery3%

Tissueengineering8%

Diagnostics

7%

AgBio 15%

Other

2%

Industrial

8%

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particularly Canadian investors are apparentlybeginning to follow the American model of

delaying the creation of companies until they

have identified a potential product, and once

created, capitalizing these companies with

more significant 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 five or six years ago.

Moreover, the larger, more mature com-

panies are also starting to provide investors

with real returns. Canadian public biotech

companies, for the first 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 reduc-

tion of almost 24 percent. This reduction in

overall losses mirrors the U.S. drive toward

profitability. 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 signifi-

cant market maturity.

The number of public companies, despite

four IPOs, has decreased by one. The largest

loss to the Canadian industry was the acqui-

sition of ID Biomedical by GSK, discussed

earlier in the deals section of our article. Two

companies ceased trading, one went private,

and one sold all of its intellectual property(IP) to a U.S.-based private company, result-

ing in the loss offive 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 offinancing. At the end of 2005, 44

percent, or 36 of the 81 Canadian public com-

panies, 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 per-

cent 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 find-

ing it much more difficult to raise financing

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 signifi-

cantly lower than the $723 million raised in

2003 or the $600 million raised in 2001. Other

types of offerings by public companies, how-

ever, amounted to $242 million in 2005, a sig-

nificant increase from the $139 million raisedin 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 poten-

tial future financing. Many of these compa-

nies have raised convertible debt financings.

Difficulties 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 significantly reducing

their risk. Many of the companies that do not

achieve a significant scientific or commercial

milestone are likely to find the convertible

debt-holders exercising their collateral andtaking possession of the intellectual property

rather than choosing to convert.

Also, there have been a significant 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 fractionof 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 signifi-

cant 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 financing and unit issues have

punitive costs, and although they allow a com-

pany to survive for a limited time, they may,

in fact, hasten the demise of these companies

over the longer term.

Finally, the emergence of financings by

corporations monetizing their tax losses has

become popular. Previously, this was accom-

plished when companies were about to close

and was accomplished through a shell com-

pany. Now this form of financing is being

chosen by operating companies, as it is non-

dilutive 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 second-

ary 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 second-

ary rounds accounted for about half of the

secondary rounds in 2005.

CANADA YE AR IN RE VI E W

Selected 2005 Canadian biotechnology public company financial highlights(by geographic area, US$m, percent change over 2004)

Ontario 25 2,590 5,398 1,010 291 72 698 2,561

7% 28% 12% 6% 8% 55% 60% 5%Quebec 24 2,490 2,687 867 208 152 349 1,646

0% 39% 11% 57% 12% 10% 5% 8%

British Columbia 16 1,260 3,199 595 253 (4) 867 2,080

0% 8% 23% 73% 18% 105% 22% 15%

Other 16 970 1,926 113 101 104 177 408

7% 20% 12% 3% 56% 290% 27% 15%

Total 81 7,310 13,211 2,584 852 324 2,091 6,696

1% 1% 3% 24% 9% 21% 4% 9%

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

Region Number of Number Market Net Cash andpublic of capitalization loss short-term Total

companies employees 12.31.05 Revenue R&D (income) investments assets

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Transactions and collaborations

Most of the corporate merger and acquisi-

tion (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 Canadianbiotechnology 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 trans-

actions to continue to increase as these smaller

early-stage companies find it more difficult 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 develop-

ment activities. An example of a company

that has made good use of these collabora-

tions 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 shareholdervalue 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 mil-

lion of which is near term, as well as signifi-

cant future royalty payments. Another good

example is Aspreva Pharmaceuticals, which

began earning revenues in 2005 according to its

2003 collaboration agreement with Hoffmann-

LaRoche 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 phar-maceutical or large biotech companies from

Europe and the U.S. will continue to be major

value drivers for Canadian biotech compa-

nies. 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 difficult 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 for-

eign companies, including Canadian targets,

will become more popular in the future. The

American Jobs Creation Act of 2004, intro-

duced 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-lim-

ited 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 clus-

ters 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 tot

number of biotech companies found in ea

of these three provinces has shifted, with t

number of companies declining in Ontario an

Quebec. British Columbia, however, exp

rienced a growth offive companies in 200

the most of any province in Canada. Quebec

decline, from 158 companies in 2003 to 14in 2004 and 134 in 2005, has been the mo

significant, while Ontario declined from 14

in 2004 to 143 in 2005. The decline is attri

uted to a reduction in available seed fundin

especially in Quebec, where the number

governmental and paragovernmental VC

investing directly in the biotech indust

dropped significantly, as detailed in our 200

report. Further, Quebec-based VCs tired

waiting for exit strategies to materialize ha

been actively encouraging the M&A of the

investee companies. The decline in Ontar

also indicates a reduction in the number VCs willing to invest in seed or startup round

The number of public companies residing

Ontario decreased from 27 to 25, and Queb

remained constant with 24 followed by Briti

Columbia and Alberta, with 16 and 12, respe

tively. The 16 public biotech companies resi

ing in British Columbia together broke ev

and, in fact, made a small profit.

The amount of total financing raised al

mirrors the companies provincial distrib

tion. Yet British Columbia, for the first tim

attracted more investment dollars into t

biotech industry than any other province

Canada at $338 million, followed closely b

Quebec, with $318 million, and Ontario, wi

$258 million. Considering only VC financi

of private companies, Quebec has retained i

lead, with over $120 million invested, fo

lowed by British Columbia, with $105 m

lion, and Ontario, with about $80 million. T

remaining provinces in Canada reported V

investments in private companies of a litt

over $7 million, collectively. Total financi

in British Columbia grew from $173 milli

in 2004 to $338 million in 2005. Queband Ontario also grew marginally, with tot

investments in 2004 of $285 million an

$242 million, respectively.

Venture capital

While VCs invest in private and pub

companies alike, we report here on VC activ

ties concentrated in the private sector. A sign

icant amount offinancing of Canadian pub

biotech companies is now being made throug

PIPEs or convertible debentures, especial

Canadian Census 2005: Counting biotech companies by province

Source: Ernst & Young

No. of companies

Nova ScotiaNewfoundland

SaskatchewanNew

Brunswick

Prince Edward

Island Quebec Manitoba

Ontario

Alberta

British

Columbia

120

90

60

30

Private companies Public companies

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4/444 BE YOND BOR DE R S : THE GL OB AL B I OT E C HNOL OGY RE POR T 2006

the smaller, early-stage public biotech com-

panies, which cannot easily access the capi-

tal markets with normal secondary offerings.We estimate that the financing raised in these

issues exceeded $100 million in 2005, about

40 percent of the other financings.

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 financing per VC round increased

from $2.4 million to $6.1 million in 2005. VC

financing in private companies is also moving

away from seed and startup financing and

expansion financing, with 18 and 13 reporteddeals, respectively, to early-stage financ-

ing, with 20 deals reported. While seed and

startup financing rounds represent on aver-

age below $1 million, expansionfinancing on

average exceeded $6 million, and early-stage

financings are up significantly, exceeding on

average $11 million.

In 2004, Aspreva Pharmaceuticalsfinanc-

ing of $60 million was unusual for Canada

and, with the exception of an earlier Caprion

financing, the largest ever for a private com-

pany 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 five other rounds

that were in excess of $15 million. Financing

rounds of $15 million or more in Canada five

years ago could be obtained only through

a public offering. Even public companies

would have, and still have, difficulty raising

rounds the size of Gemin Xs or Zelos. This is

a beneficial trend in that rounds in excess of

$15 million let these earlier-stage companies

remain private much longer and advance theirproduct development further before going

public. This provides them with nearer-term

revenues and a better chance of attracting a

significant market following.

We believe that these early-stage large

rounds are influenced by U.S. VCs in the

Canadian market. Almost all of these large

private rounds include U.S. venture capital-

ists, 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

pursue their scientific and clinical milestones.

This is preferable to the traditional Canadian

practice of making a number of small invest-

ments, thereby creating uncertainty about

future prospects and forcing management

teams to be constantly on the road, looking

for additional financing every 6 to 18 months.

Canadian VCs have participated in many of

these large rounds, indicating a shift in phi-

losophy 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 regu-

latory authorities, enabling companies to

generate revenue and reach profitability. As

companies generate revenue and profits, 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. Amongthe 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 prod-

ucts entered Phase III trials in 2005 and 15 in

2004. As in 2004, over 20 compounds entered

Phase II trials. Certainly, the number of prod-

ucts 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 rev-

enue growth, a reduction in losses, and strong

product approvals. Companies that are delay-

ing IPOs, and private biotech companies that

are raising large VC rounds that should allow

them to mature and obtain significant financ-

ings when they do go public, could make

the Canadian industry much stronger in the

future. As the large Canadian public compa-

nies mature and generate revenues and prof-

its, they are making the biotech industry more

attractive. A combination of factors, such as

the lack of seed and startup funding, is signif-

icantly reducing the number of startups and

consolidations, resulting in a smaller industry

in Canada. The continued support of the gov-

ernment, which has identified the life science

sector as a focus in its innovation strategy, isessential and will provide basic financial sup-

port for early-stage research, as well as addi-

tional leverage for private investors.

The future of the Canadian biotech indus-

try depends ultimately on the ability of com-

panies 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.

CANADA YE AR IN RE VI E W

Capital raised by Canadian province

Source: Ernst & Young and Canadian Biotech News

Private companies Public companies$m

50

150

200

250 232.5

105.4

78.5

5.0

197.2

81.0

176.5

12.2

120.8

1.2

BritishColumbia

Alberta Ontario Quebec Other