Only a year ago, private-equity groups had a healthy appetite for biotechs and little competition, naming their price for upstart firms desperate for cash, then quickly selling them to big drugmakers for hefty profits. Now, there are signs private investor groups are being squeezed out of the market they helped create, resulting in a dramatic shift in investment strategy in the pharmaceutical industry, The Star-Ledger of New Jersey writes.

“Competition from private-equity funds that had a ready source of cash is not there,” Marvin Artis, a pharmaceutical mergers and acquisition specialist at the Reed Smith global law firm, tells the paper. “The deals that require a huge amount of financing, they are just hard to get done.”

A global credit crunch tied to the subprime mortgage meltdown has made it more difficult - and less lucrative - for private-equity firms to finance deals. The “credit squeeze” means the days of using inexpensive debt to pay big sums for a company then flip it for a high return are all but over. As a result, big private-equity players - names such as Canaan Partners, Fortress Investment Group, Palo Alto Investors, Quaker BioVentures - are settling for lower returns on smaller deals, says Artis.

Armed with cheap debt and piles of cash from investors seeking higher returns than the stock market, private-equity groups gobbled up a string of small and mid-sized life sciences companies during the past two years. But the marketplace for biotech M&A, the paper writes, has changed.

Desperate for new products, drugmakers are snatching biotechs and specialty players. In recent months, Bristol-Myers Squibb paid $430 million for Adnexus Therapeutics, Glaxo spent $1.65 billion for Reliant Pharmaceuticals and Merck bought NovaCardia for $325 million. Meanwhile, venture capitalists poured a record $9.1 billion into privately held biotechs and medical device makers last year, according to PricewaterhouseCoopers and the National Venture Capital Association.

But the simultaneous trends have put a damper on private-equity groups looking for lucrative biotech deals. “Big Pharma is becoming increasingly aggressive about the amounts they will pay and the type of deals they will do,” says John Crowley, ceo at Amicus Therapeutics, a biotech that went public last year. There is so much competition, Crowley says venture capitalists have begun to take the unusual step of holding on to their shares in upstart companies longer. Since Amicus went public eight months ago, “we haven’t had a single VC sell a share in our company.”

In fact, so much Big Pharma and venture money is available that mergers and acquisitions have replaced initial public offerings as the “exit strategy” of choice for investors in upstarts. According to Thomson Financial, the average takeout price was $207 million in in 33 biotech mergers last year in which the value of the deal was disclosed, nearly double the $108 million average in 31 mergers in 2006. IPOs, meanwhile, have generated slim returns, an average last year of $60 million. As a result, IPOs are another round of financing instead of an “exit” for venture capitalists and other early investors.

The receding importance of private equity in life sciences has created an opening for small, cash-rich investors to scoop up shares of small- and mid-market companies, says Frank Abella at Investment Partners Group, who cites King Pharmaceuticals, a generic maker, as an example. “This is the best of all worlds for people with cash,” he tells the Ledger. “It is truly an unbelievable time. There are not enough buyers of these companies who are willing to step up to the plate.”

Source: The Star-Ledger of New Jersey (which owns Pharmalot)