Threshold team @ Nasdaq

Redwood City biotech company Threshold Pharmaceuticals was one of the Silicon Valley high fliers, until last week when it lost more than three-quarters of its stock value. The company offers quite a lesson — and causes concern about other biotech shares going forward, which have been a bright spot in the valley.

We are astonished that Threshold got hit like this. The company’s chief executive, Barry Selick, seemed so confident barely two months ago, and with good reason. Threshold was the only IPO for the first several months of 2005, and its stock was one of the best performing last year, increasing 114 percent.

We talked with Selick for this story in April that discusses the decline of the Silicon Valley IPO. We asked him why biotech companies like Threshold have bucked the trend, able go public even without the prospect of making money for three or four years. Indeed, half of the eight companies that went public in Silicon Valley last year were biotech related. And Threshold is developing drugs to cure important health problems like cancer and benign prostatic hyperplasia.

The reason for Threshold’s stock market success, said Selick, is that the company had passed through its first two clinical trials flawlessly. Passing the third set of clinical trials looked like a sure bet, or at least that’s what investors had concluded, he said. Investors can “get in and look at the results of the phase two clinical result, and they’re smart enough to judge the likelihood of a translation into a successful third trial,” he told us. “There’s an enormous interest in the potential value creation that comes from successful phase three clinical trial results.”

The problem is, investors weren’t “smart.” They misjudged badly, because Threshold reported adverse results in the third trial of its experimental prostate drug last week, which caused the stock plunge. Six men had developed irregular liver enzyme levels.

So now Threshold is facing losses of $46 million a year, and a key third phase has bombed.

Have public investors become too trusting of biotech companies?

Well, they are more cautious than they were five years ago. During our call, Selick had told us that five years ago, “investors were willing to bet on much earlier, pre-clinical companies.” His point is that investors have since become more conservative, by at least waiting until trial two. Still, maybe that’s not even enough. Brainflash!: Maybe you need to wait until a drug is actually approved by the FDA before taking a company public. Ah, but then who would fund it, if not the public?

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