Isis declines on earnings, Lilly note conversion but 5.5% convert finds bids; Quest, LabOne higher

By Ronda Fears

Nashville, Aug. 8 - Biotech stocks took a hit Monday, mirroring losses in the broader market on rising crude oil futures. For biotechs, however, there were a number of factors related to the selloff, not the least of which was an expose in the Seattle Times weekend edition that cited more than a score of cases where doctors conducting drug trials leaked information to analysts and hedge funds before the data was official.

The news article was circulated across trading desks and the fund manager community as well as splashed on CNBC, and the biotech indexes suffered.

Mentioned specifically in the article were situations involving Isis Pharmaceuticals Inc., Eyetech Pharmaceuticals Inc., Encysive Pharmaceuticals Inc., Cell Therapeutics Inc., ImClone Systems Inc., Genentech Inc. and Amgen Inc. All those stocks were lower in trade Monday.

"If the SEC investigates this, these shares will tumble," one buyside analyst remarked. "Actually it could be a time bomb."

Isis Pharma, at least, was in trade also because of earnings that it released before the opening bell, traders said. Elsewhere in secondary activity Quest Diagnostics Inc., a leading provider of diagnostic services to laboratories and other medical services, Monday announced that it has agreed to pay $934 million in cash to buy rival LabOne Inc. Both those stocks were up, in addition to the LabOne convertible that Quest will assume.

Primary quiet ahead of Coley

On the primary side of the market, there were a couple of sizable PIPE deals, from Large Scale Biology Corp. and Genta Inc., but otherwise it was a quiet day for capital-raising efforts.

The market is anticipating Coley Pharmaceutical Group Inc.'s initial public offering this week along with a couple of secondary stock sales from Kosan Biosciences Inc. and BioDelivery Sciences International Inc. after Nastech Pharmaceutical Co. Inc. pulled its follow-on deal late Friday.

Kosan shares on Monday closed off 34 cents, or 3.55%, at $9.25. Some fans are buying on the weakness, "everyday," as one put it. He cited a Credit Suisse First Boston report last week pitching the stock with an outperform rating on a view that with two novel clinical programs in oncology for a market cap of $260 million the stock is a steal.

BioDelivery shares ended Monday lower by 5 cents, or 1.89%, at $2.60.

JMP Securities analyst Charles Duncan said in a report Monday that financing and M&A support continue to support growth in the biotech industry and he expects activity to be robust for the remainder of the year.

Of particular note, he said, is the success of recent follow-ons, suggesting that investors are looking to build positions in small- to mid-cap biotechs. Specifically, he cited the Rigel Pharmaceuticals Inc., BioMarin Pharmaceutical Inc. and Keryx Biopharmaceuticals Inc. deals, since those stocks are on average 17% above their deal price.

Large Scale inks equity line

Large Scale Biology said Monday it has received a $15 million equity line from Brittany Capital Management Ltd. under which Large Scale may sell shares to Brittany at a 7% discount to the then-market price of the stock over a 10 trading-day period.

There is a $2 million minimum to each draw over the three-year term of the agreement.

Also Monday, Large Scale said it raised $1 million from promissory notes issued to the company chief executive officer Kevin Ryan and board chairman Robert Erwin. The notes bear interest at Prime rate plus 200 basis points or 7.25%, whichever is greater, and mature on Jan. 31, 2006.

Proceeds from the equity line will be used to retire bridge debt and for working capital. Proceeds from the notes will be used for working capital. Based in Vacaville, Calif., Large Scale Biology develops therapeutics and industrial proteins, vaccines and diagnostic products to characterize and treat diseases.

Large Scale Biology is scheduled to report second-quarter results after Tuesday's market close, with a conference call slated at 5 p.m. ET. The shares ended Monday up 7 cents, or 8.64%, to 88 cents.

Isis earnings drag on stock

Isis Pharma shares were more likely responding Monday to news from the company rather than the Seattle Times piece, traders said. While the stock slumped more than 5% at one point of the session, sellside market sources said the Isis 5.5% convertible bond due 2009 was better bid and ended the day off just about a quarter-point at 88.

The stock closed out the day off by 24 cents, or 4.25%, at $5.41.

Before Monday's open, Isis reported a second-quarter net loss of $19.7 million, or 34 cents a share, compared with a net loss of $26.1 million, or 47 cents a share, in second-quarter 2004. Revenue was $10.6 million, up from $9.8 million. Isis' recently announced collaboration with Pfizer Inc to discover drugs for ophthalmic diseases contributed to the company's second-quarter 2005 revenue.

The company expects, consistent with previous guidance, a 2005 pro forma loss from operations will be in the low $50 million range.

Isis ended the quarter with cash and equivalents of $59.6 million and working capital of $46.3 million. At year-end 2004, Isis had cash and equivalents of $103.9 million and working capital of $82.2 million.

Lilly converts loan to Isis shares

Isis also reported Monday said it extended its collaborative agreement with Eli Lilly & Co Inc. Under the extension, Isis will convert a $100 million loan from Eli Lilly into 2.5 million shares.

B. Lynne Parshall, Isis' chief financial officer, said that as a result of cost containment measures implemented earlier this year, the company's cash burn decreased by more than 30% to $23.2 million compared with $33.5 million for the second quarter of last year.

The impact to the balance sheet from the Lilly note conversion will be reflected in the September quarter as a reduction in long-term debt and a decrease in stockholders' deficit. The loan had funded a four-year strategic research collaboration with Lilly.

In connection with the extension on the collaboration agreement, Lilly has agreed not to sell the conversion shares until the fourth quarter of 2006 - assuming the collaboration is not terminated earlier, in exchange for certain credits against milestones and royalties in the event of a stock price decline.

"Lilly is willing to lock up 2.5 million shares they bought at $40 a share," said a sellside market source. "Isis is the only antisense story we have seen with some real activity. Genta and American Power Technology Inc. both are dogs. Lilly really wants access to two more compounds. To me, this is still a buy."

Genta taps PIPEs for $17.5 mln

Coincidentally, Genta Inc. said Monday it agreed to sell $17.5 million of its common stock to a group of institutional investors, offering roughly 19.1 million shares in the deal. The company sold 19,021,740 shares at $0.92 each, which will boost outstanding shares by about 20%.

Genta shares dropped 19 cents, or 15.57%, to close at $1.03 on Monday.

Based in Berkeley Heights, N.J., Genta's research portfolio comprises two primary areas, DNA/RNA medicines - which include drugs that are based on chemical modifications of oligonucleotides - and small molecules.

The company's lead product from the DNA/RNA medicines program is Genasense, which completed phase III trials in combination with chemotherapy in the treatment of malignant melanoma, chronic lymphocytic leukemia, multiple myeloma, nonsmall cell lung cancer, small cell lung cancer and prostate cancer.

Its lead product from the small molecule program is Ganite, which is used for treatment of cancer-related hypercalcemia that is resistant to hydration.

Genta's preclinical pipeline includes research programs in antisense, RNA interference and decoys.

Quest up on LabOne purchase

Quest Diagnostics Inc., a leading provider of diagnostic services to laboratories and other medical services, Monday announced that it has agreed to pay $934 million in cash to buy rival LabOne Inc., which provides drug tests and other services. Actually, however, Quest said it was buying LabOne to jump into the area of risk-assessment services for life insurance companies.

On the news, Quest shares added $1.71, or 3.6%, to close at $49.21.

"They paid a lot. I'm surprised it is an all-cash deal, and a little skeptical about it being accretive to earnings in 2006," said a buyside market source based in Pittsburg. He added, though, "I would expect Quest to trim some fat from LabOne and end up with a MUCH leaner & more profitable prospect. This isn't their first time around."

Under the deal, Lyndhurst, N.J.-based Quest would acquire all outstanding common shares of LabOne for $43.90 per share, nearly a 17% premium to LabOne's closing share price of $37.64 on Friday.

LabOne shares Monday climbed $5.18, or 13.76%, to close at $42.82, and traders said a good portion of the activity in LabOne shares was hedge funds scrambling to cover short positions as well as risk arbitrage players getting involved.

Make-whole props up LabOne

The value of the deal includes the assumption of $132 million in LabOne convertible debt, and convert arb holders in the convertible lost a couple of points, but the 3.5% issue was propped up by a make-whole provision that kicked in because of the all-cash takeover, a sellside market source said.

"It looks like those bonds came in just a couple of points, from about 4.5 points to under 1 point taking into account the additional shares of stock bondholders are going to get - something around 3.50 to 3.75 shares per bond as per the make-whole matrix in the prospectus - given the takeover offer o $43.90 a share," the sellside analyst said.

The 3.5% convertible gained 9.5 points on an outright basis, trading up to 125.

Without make-whole protection the bonds would have traded down to 111 or 112, another sellside market source told Prospect News. The 13 to 14 point difference would have really hurt holders, but as it is, the bond feature worked and the source said holders come out about even.

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