Is the biotech sector gearing up for a wave of merger mania?

Conditions seem ripe. After lining their pockets with record-breaking piles of investor cash in 2000, biotech firms are finding the pickings a bit slim this year. That's setting up a nice game of

Survivor:

Biotechs with bulging wallets are in a position to gobble up brethren with nothing but two nickels to rub together.

But don't expect a mass rush to the deal table. Slumping stock prices are forcing companies to tread lightly. And the underlying strength of the entire sector -- including an unprecedented number of drugs in the development pipeline -- means that mergers will be struck not as a survival tool, but to make already strong firms stronger.

"What you'll see in the next six to nine months is big biotech companies buying small biotechs to create a deeper and more diversified drug development pipeline," says John McCamant, editor of the

Medical Technology Stock Letter

. "These days, taking one or two shots on goal

with potential new drugs is too risky."

Wall Street money flowing into biotech has slowed dramatically. In 2000, publicly held biotech firms raised $29 billion, shattering all previous records, according to

Burrill

, a biotech merchant bank. That figure included $10 billion raised in the first quarter of 2000 alone.

But in the first three months of this year, only $1.4 billion was raised, mainly from $711 million in secondary offerings, according to Burrill. While $1.4 billion is nothing to sneeze at, financing activity for the rest of the year is not expected to rise anywhere near last year's level, given the turmoil on Wall Street. The

American Stock Exchange Biotechnology Index

is off 23% from the start of the year, underperforming the

S&P

by 13%. And the three biotech

IPOs launched this year are all trading below their offering prices.

It can cost anywhere from $50 million to $200 million to fund the late-stage testing and paperwork required to get a single drug through the approval process. Being able to fund this expensive drug development work -- and do it over and over again -- will fuel merger activity this year and determine whether a company ends up a buyer or a seller, biotech observers say.

So who are the likely buyers? The usual suspects: Big-cap biotechs.

Amgen

(AMGN) - Get Report

has more than $2 billion in cash and cash equivalents in its corporate coffers, according to figures compiled by

Lehman Brothers

.

Celera

(CRA)

,

Genentech

(DNA)

,

Human Genome Sciences

(HGSI)

,

Immunex

(IMNX)

and

Millennium Pharmaceuticals

(MLNM)

all have more than $1 billion in cash on hand. Other companies with healthy cash accounts include

Abgenix

(ABGX)

,

Protein Design Labs

(PDLI) - Get Report

and

Biogen

(BGEN)

.

Pharmaceutical giants could also jump into the market. Biotech companies typically ink drug development and marketing alliances with big drug makers, but as was the case with

Johnson & Johnson

(JNJ) - Get Report

buying

Alza

(AZA)

for $10 billion in stock at the end of March, mergers do happen.

The list of sellers is harder to pinpoint. McCamant of the

Medical Technology Stock Letter

says any biotech company with less than 18 months of cash left should be looking for a deal.

Stock prices are down, and they don't look like they're coming back anytime soon," he says. "If you're a company that's running out of cash, you'd be smart to be proactive about finding a merger partner," he says.

Scott Morrison, national director of the life sciences practice at

Ernst & Young

, paints with a slightly broader brush. Of the approximately 550 publicly held biotech firms in the world, only about 100 have the

market capitalization and fund-raising chops to push ahead with a viable drug development effort. The rest -- 450 companies -- are vulnerable for a takeover, he says.

"Any biotech company with a market cap below $150 million could be a target in this market. It's that simple," Morrison adds.

Biotech observers say a representative sampler of possible merger targets -- companies with promising drugs but handicapped by small market valuations or a dearth of cash on hand -- might include

Triangle Pharmaceuticals

(VIRS)

, which has several promising HIV drugs in development;

Corvas

(CVAS)

, which is developing a drug to prevent life-threatening deep vein thrombosis (blood clots in the legs or groin caused by surgery);

United Therapeutics

(UTHR) - Get Report

and its roster of experimental drugs to combat vascular disease; and

Ortec International

(ORTC)

, which has developed a cultured skin product to treat wounds.

Again, it's not known whether any of these firms are actively seeking merger partners, but observers say their current profile could put them on the seller's side of the deal table.

But while an uptick in M&A activity is predicted, a huge wave of consolidation is unlikely. Most buyers still want to pay for deals with a mixture of stock and cash, so weak stock prices could keep some potential buyers on the sidelines. And buyers are going to be picky about their targets, looking for deals that fit their corporate strategies and augment existing drug development efforts.

Millennium is one biotech firm planning on acquisitions to bolster its roster of potential drugs. The company, with six experimental drugs already in various stages of testing, reiterated plans this week to acquire another four or five potential drugs, either through acquisition or licensing deals.

This is a strategy that's paid off for the company in the past. Its most advanced drug candidate, the lymphocytic leukemia drug Campath, is awaiting approval from U.S. drug regulators this quarter. Millennium acquired Campath when it purchased biotech firm

LeukoSite

in October 1999. "It's critical for biotech companies to have a diverse and high-quality drug pipeline. Having one or two drugs isn't enough," says Morrison. "This is difficult for even the biggest companies like Amgen to grapple with, so you will see companies using cash to buy pipeline, especially when the market is down and the opportunities are out there."

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