Biodefense: Live By Government Contracts, Die By Government Contracts

by: Tal Ben-Ami

The term "industrial complex" has come to mean taxpayer money funneled to favored companies. Call it government spending, call it boondoggling, call it a gravy train, it's all the same thing. There are quite a few industrial complexes out there, but by far the most infamous is the military-industrial complex where government spends taxpayer money on entire wars, making the favored defense companies very rich.

The big three, Lockheed Martin (LMT), Northrop Grumman (NYSE:NOC) and Raytheon (RTN), are about to be in big trouble, and this has major implications for the smaller, more speculative companies in the nascent biodefense subsector such as Emergent Biosolutions (NYSE:EBS), Pharmathene (PIP) and Soligenix (NASDAQ:SNGX) that have been getting some investor attention lately due to current events. I am not the first one to say this, nor will I be the last, but at some point in the near future, governments worldwide will simply be forced to drastically cut back spending, the US especially. The money simply is not there to support it anymore. When this does happen, companies dependent on government contracts will not have time to adjust and Lockheed, Northrop, and Raytheon along with other smaller biodefense companies will be in dire straits, the latter group perhaps not surviving at all.

As for the degree of dependency, whereas much of defense proper slowly became more and more dependent on government, biodefense has been born and raised on government contracts. 20 years ago for example, Raytheon only made 48.9% of its revenues from government deals. Last year it was 73% (page 7). As for Lockheed, in 1992, 59.4% of total revenue (page 42) came from government. By 2012, that number ballooned to a whopping 82%. Northrop has been the exception which, unlike the other two, has been 90% dependent on government contracts for decades. And biodefense, as we will see, is and has always been nearly 100% dependent on government contracts.

Why the past success of defense proper is not translatable to biodefense

The biodefense subsector did not develop organically like Raytheon or Lockheed. It consists of smalltime companies that haven't accomplished much of anything except, at most, getting some money from the government to develop vaccines against bioterrorism threats. People can try to point to the Raytheon and Lockheed successes to date to extol the virtues of investing in federally funded companies, but the analogy doesn't work. War is inherently destructive, making the industry extremely profitable. War feeds on itself, governments get more greedy, and you can't reuse bombs. You have to keep buying more.

But biodefense? Where is the money in that? Let me begin with the most "successful" of them, Emergent Biosolutions. EBS has what any development stage biotech would consider a great success, and that is an FDA approved treatment for a deadly disease. In the case of EBS, that disease is anthrax, and the vaccine is BioThrax. Essentially all of EBS revenues come from the US Department of Health and Human Services, which stockpiles BioThrax. Revenues were $215.9M in 2012 (page 1). $215.3M was from the HHS, and the rest was from international and domestic customers. Other than that, EBS has a failed Lymphoma vaccine called HuMax-CD4 which died in phase II, and some other clinical and preclinical experiments.

Not to mention, BioThrax was approved through the FDA Animal Rule, because you can't exactly do a phase III on hundreds of anthrax patients that don't exist, complete with placebo to test a control. So we don't even know if this thing works on humans in the first place. And really, how much more BioThrax is the HHS going to buy and stockpile at the CDC?

Let's move on to Pharmathene. PIP is the proud recipient of $550M in government grants since its founding in 2001, to develop, you guessed it, another anthrax vaccine. And, also, an anthrax treatment for those already infected. And yes, a nerve agent antidote in case of chemical warfare. It has an accumulated deficit of $200M. From Pharmathene's 10-K:

For the foreseeable future, we believe our main customer will continue to be national governments, primarily the U.S. government. Substantially all of our revenues to date have been derived from grants and U.S. government contracts. There can be no assurances that existing government contracts will be renewed or that we can enter into new contracts or receive new grants to supply the U.S. or other governments with our products. The process of obtaining government contracts is lengthy and uncertain.

If the government cuts the company off, it's not like it can get some other sponsor for nerve agent antidote. Nobody wants it. It's useless, except in the event of a chemical weapons attack, in which case you're not going to be charging people in a mad panic for the treatment anyway.

Last but not least is Soligenix. This company has been around since 1987, doing pretty much nothing noteworthy. In the 90's it went through various dilutions and a 1:100 reverse stock split, and for some reason the government picked it up, gave it a few million dollars of which it has $3.8M (page F7) left, and told it to manufacture, yet again, another anthrax vaccine, this one called VeloThrax. And one for ricin, too.

Unlike the other two companies above, Soligenix does actually have an interesting and market-valuable product candidate called ThermoVax which enables vaccine to survive higher temperatures for a longer period of time. But being dependent on the Feds for funding, the valuable ThermoVax project could die at any minute, especially considering two other companies are getting anthrax vaccine funding and one of them is already FDA approved.

Point being, if you're going to invest in government contractors, you should have done it 20 years ago. And government funding cannot a company make. When government spending hits the inevitable wall, the bigger they are, the harder they fall. And the small anthrax companies will not escape the fire either.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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