Jenks Healthcare Business Report May 2002

In the May 2002 issue:

Big Month For Venture Capital Health Care Investments

Returns for venture capital firms may be down, but that is not stopping them from pumping money into private health care companies. With an average investment of more than $16 million, 23 companies raised almost $400 million in the past month. We hear, however, that one of the reasons for the high volume is that valuations have dropped to more acceptable levels for the investors.
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Public Equity Market

Four health care IPOs were priced in the past month, but three of them were well below their expected range. Even with the pricing cuts, one had the worst first day performance for an IPO in nearly two years. Several other IPO candidates are waiting for the fog to clear, and MedcoHealth Solutions finally filed for its $1 billion IPO.
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First Quarter Earnings

Not too many surprises on the earnings front, but more e-health companies are becoming cash flow positive.
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Acquisition Market

The technology segment dominated the M&A market in the first quarter, but other areas, especially home health and long-term care, are getting more active.
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Jenks Healthcare Business Report

Big Month For Venture Capital Health Care Investments

There are many contradictory messages being delivered to the health care investment market, but money continues to flow to the private companies. In the past month, 23 companies raised almost $400 million in venture financing, compared to a more typical month this year of 15 companies raising less than $300 million. But all we hear in the mainstream press is that venture capital firms are suffering from perhaps their worst financial results in two decades.

There are three main reasons why the investment flow into health continues at a relatively strong pace. First, venture capital firms have the money to invest, and in this market environment, despite its current problems, there are still many areas of health care that provide exciting opportunities for investors. Second, the private health care companies, especially in areas such as biotechnology and pharmaceutical development, consume a lot of money before they bring a viable product to market, so the demand for funds is always high.

Third, and perhaps most important, is that given lower returns the venture capitalists have been yielding to their investors in the past year, combined with the weak IPO market, private company valuations have been lowered enough to get the deals done. In the past, successive rounds of venture financing were almost always at higher valuation levels.

Today, this is no longer the case. Entrepreneurs (or at least many of them) have come to accept that the investment world is not what it was in the 1990s and that their companies, in many cases, may be worth less today in the private equity market than they were two years ago.

As an example of the schizophrenic market, in mid-May Charles River Ventures announced plans to slash its most recent fund from $1.2 billion to just $450 million, citing lowered return expectations in a market with excessive cash available for investment relative to attractive opportunities. But just two weeks before this announcement, Warburg Pincus LLC announced the final closing of a $5.3 billion global fund which is targeting up to 20% of the funds to be invested in health care. Of the $575 million already invested by the fund, more than $200 million is in health care and life sciences companies. In the past three years, the private equity firm has invested almost $1.5 billion in approximately 25 health care companies.

Charles River, however, is not alone in reducing the size of new funds. Other big names, such as Kleiner Perkins, Accel Partners and Redpoint Ventures, have also decided to downsize their new funds. One of the problems the venture capital industry is facing is that they usually charge an annual management fee based on the size of the fund in addition to taking a share of the gains. In a market where returns to investors are declining, and have been negative for most of the past year, it is not easy to justify a fee on a large fund that may have difficulty in finding profitable investments.

During the past month, the majority of venture capital investments have been Series A or B financings, but there were a few later stage deals, including one E Series investment. As in past months, most of the investments were in biotech or pharmaceutical companies, but service and e-health companies managed to garner some funds as well. Because of the large volume of venture capital deals, we listed most of the large transactions (greater than $20 million) in the table on page 3 and the remainder in a table on page 7.

In a case of putting its money where its mouth is, The Institute for the Study of Aging (ISOA) made its first "Founder’s Program" investment in a start-up biotechnology company dedicated to developing novel pharmaceuticals that inhibit a family of enzymes, known as aspartic proteases, for the treatment of human diseases such as Alzheimer’s disease. Based in Oklahoma City, Oklahoma, Zapaq, Inc. will initially focus on developing new compounds that block or reduce the level of a brain cell toxin called beta-amyloid, which plays an important role in Alzheimer’s disease.

The initial technology licensed to the company was developed at the Oklahoma Medical Research Foundation and the University of Illinois, and the founding scientist of Zapaq has played a leading role in determining the molecular structure of aspartic proteases and also pioneered a fundamental drug design element, the transition state analog, that is used in all marketed HIV-protease drugs today. Zapaq raised a total of $1.15 million in this seed round, of which $500,000 was provided by ISOA. Since 1998, ISOA has committed more than $16 million in support of 58 drug discovery and development companies in eight countries.

In the only Series E funding in the month, CBCA Inc. received a $30 million financing commitment from six investors, led by meVC Draper Fisher Jurvetson Fund I which provided $10 million of the total. CBCA is an administrator of employer-sponsored self-insured health benefits. The company has developed an automated (online) health benefit claims processing and payment system that is supposed to deliver greater cost control and better access to plan information. The company is currently profitable and the next financing should be an IPO.

The lead investor is an interesting case, as it is a collaborative effort between Draper Fisher Jurvetson, a venture capital firm, and meVC, which is one of the first venture capital investment management firms to provide all individuals with access to private equity investments. In March 2000, meVC launched its first fund, raising $330 million, which is publicly traded on the New York Stock Exchange under the symbol "MVC."

In a related field, Passport Health Communications raised $11.2 million in a Series B funding lead by CB Health Ventures. The company provides online insurance eligibility and benefit information for registration and pre-registration, billing and collections. The company now has a customer base of 500 hospitals, or 10% of the country’s hospitals, and 1,000 physician offices. Last year, Passport purchased Medicheck Inc., a vendor of credit/ATM card processing and check guarantee services that is focused on the health care market. That acquisition put Passport into a total of 32 states.

Will a hospitalist physician be coming to a town near you? That is what Cogent Healthcare and its investors are counting on. Cogent recently received $15 million from four previous investors plus a new one, Conning Capital. The theory behind the hospitalist model is that by having physicians available 24 hours a day, seven days a week who do nothing but inpatient care in the hospital, patient care will be enhanced and costs will decline. The goal is to reduce variations in care, establish best practices, remove barriers to effective and efficient care and to measure outcomes. The company currently is active in 11 major markets and covers more than 2 million lives. Customers include several of the largest health insurers in the country.

Read the past headlines.