Out With Hedge Funds, In With Blue Bloods: Vertex Transforms Investor Base Via Stock Sale

Vertex Pharmaceuticals has been around the block with biotech hedge funds. These are the people who aim to get rich trading volatile stocks second-to-second, and make big bets, long or short, on whether an experimental drug will work. Now that Vertex has passed some of the riskiest stages of drug development, the company figured it was time for steady, buy-and-hold investors to support the next phase, as it morphs into a commercial player.

That was one of the insights that I gathered yesterday in a conversation with Vertex chief financial officer Ian Smith. He was in a pretty good mood—as you might be too, if you’d just helped your company raise $320 million in a secondary stock offering. The financing is important because it gives Vertex (NASDAQ: VRTX) enough cash to operate until it introduces its lead drug to the market and starts generating positive cash flow, according to analyst Thomas Russo of Robert W. Baird & Co. Especially in the midst of a recession, that’s good news for Vertex’s 1,300 employees in Cambridge, MA, and 200 in San Diego.

But beyond the stability that comes with the dollars, Smith was just as enthused about being able to recruit the type of long-term shareholder he wants backing Vertex for the next five years. Vertex was able to attract these blue-bloods because of growing interest from investors in a pair of drugs that aim to transform the standard of care for patients with hepatitis C and cystic fibrosis. Since these drugs have continued to make important progress, and telaprevir, the hepatitis drug, is thought to be worth at least $2 billion a year in U.S. sales by 2013, Vertex saw an opportunity to invite in new investors who want to hold onto shares throughout that trajectory, not just between now and next Tuesday. To get some insight into the company’s thinking, look at its stock chart from 2007, when shares fell 37 percent, even though the company continued to make progress.

“We as a company have been trying to align our shareholder base with the progress of the company,” Smith says. “These are people who invest for the long haul.”

Smith wouldn’t give all the names yet of the new crew of investors, but this deal went to a small number of investors—three “anchor” funds that took the biggest stakes, two other “high-quality” funds, and a few others, Smith said. What they all have in common is that they like to invest in late-stage biotech companies that have cleared major risky steps, and need to get to the next level. These funds typically backed some of the industry’s bellwethers–Genentech, Gilead Sciences, Biogen Idec, and Celgene—when they reached this stage, Smith says. One of them is San Francisco-based Capital World Investors, although he said he couldn’t yet name the others.

Smith, as well as other Vertex leaders, have been cultivating relationships with the new investors over a period of months, he says. They were generally attracted to the company because the risk in Vertex has been decreasing over the past few months. Since it has completed dosing in one of the pivotal telaprevir studies for hepatitis C, the program has been expanded to several opportunities within that disease category, and the company has advanced toward a pivotal trial of a second drug candidate for cystic fibrosis, Smith says.

“Telaprevir has been moving through a subtle, but important, de-risking period in its current Phase III development program,” Russo wrote in a note to clients yesterday. “Combined with competitive positioning that looks even better in recent months, Vertex appears to be on the cusp of multi-billion dollar commercial success in hepatitis C. This has not gone unnoticed by investors.”

Of course, nothing has been stopping those investors from buying shares on the open market, although anybody with enough loot to buy up several million shares at once also can drive up the share price in the process, which undermines their ability to get the best deal. So Vertex gave them the option to buy new shares directly from the company at a relatively slim 56 cent discount to Wednesday’s closing price on the open market.

Selling those shares directly has the benefit of bringing new capital into the company, but usually carries the disadvantage of diluting the value of existing shares and driving down the price. That didn’t happen with Vertex today. After the deal was announced, its shares actually rose $1.14 to $33.70 today at the close. One reason, Smith says, may be that Vertex only was willing to offer the new investors an “undersized” stake, which he hopes will leave these funds hungry to buy more shares on the open market over the next several years.

“If you have billions of dollars under management, and an investment in a company of only tens of millions, it’s not worth your time to track it,” Smith says. “What you want is for them to take a starting position, and to build from there over time.”

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