For 15 years, the United Kingdom has been the undisputed biotechnology leader of Europe. Now Germany is poised to seize that title, as biotech startups sprout up across the country that once restricted genetic research.

Erich Felber, CEO of Micromet, which is developing antibody-based cancer drugs, explains just how dramatically the German biotech scene has changed: "When a scientist talked about starting up a company five years ago, colleagues thought that maybe the scientist needed the extra earnings." At the time, German scientists were more likely to be found toiling in big pharmaceutical companies, publicly supported institutes, or university labs. "But now," says Mr. Felber, "they've gone from obscure scientist to technology hero."

The turnaround was prompted by the German government's determination to kick start the country's biotech industry. With its strong history in chemistry and renowned labs like the Max-Planck Institute, Germany identified biotech as a field it could dominate. In 1995, Germany held its "BioRegio" contest, which attracted 17 regional entrants. At an Academy Award-style ceremony, the government awarded 50 million Deutsche marks (about $22 million) each to Munich, the Rhineland, and the Rhine-Neckar, which encompasses Heidelberg, a major biotech center (see "BioValley blossoms along the Rhine"). The money went to fund research centers and startups, with spectacular results. In 1999, the number of German startups grew 150 percent. Four of the seven European biotech firms that went public that year came from Germany.

The biotech explosion hasn't gone unnoticed in Britain, which is still considered the European leader. The United Kingdom's minister of science and technology, Lord David Sainsbury, reported that Germany's growing industry is a threat to that in Britain. Instead of showering money on biotech, as Germany has done, the British government supports the industry by encouraging the formation of biotechnology clusters and helping to commercialize discoveries at British universities. Britain's biotech champions say that Germany's largesse has spurred the creation of weak startups that won't make it beyond the second round of funding. "There is the argument," Lord Sainsbury says dryly, "that you can make it too easy for people."

Is Germany throwing too much money at biotech? Is easy cash allowing bad ideas to get funded? Maybe. But what's also happening, say venture capitalists, executives, and scientists there, is a cultural change that may lead entrepreneurs to embrace more risk taking. And if that attitude is the secret to success, German companies could end up dominating Europe's biotech industry.

SUPPORT GROUP

European VCs love the German government's support of biotech. Deal flow is strong. Entrepreneurs can often double, or even triple, the amount of money they've received from VCs, through soft loans from the federal and state governments. The government even guarantees half the VC's investment, should a company go belly-up.

While VCs acknowledge that due diligence is all the more important in Germany, they also argue that the government's stimulus isn't as damaging as critics claim.

"There's a lot more crap out there," says Kate Bingham, a partner at the European VC fund Schroder Ventures. "But then it's such a fertile ground for pickings. You could argue that [the money] causes a false environment, that it allows companies to get started that shouldn't get started, but as an economic development tool it works. It also lets people make mistakes, and some successes will come out of those mistakes."

Robert Zegelaar, life sciences partner at another European VC fund, Atlas Venture, couldn't be more positive about the German approach. "In a shakeout, the good will survive," he says. "Even the bad won't necessarily be out. They may end up being consolidated by the good, in which case it's helping build the critical mass these companies need." Germany now has 279 "core" biotech companies, compared to the United Kingdom's 275.

IN THE BALANCE

But Lord Sainsbury maintains that it's foolish to judge the strength of an industry by counting companies. "This is not a numbers game," he says "It's a scale and maturity issue."

Lord Sainsbury says the British industry has grown up precisely because of hard times. Two years ago, British Biotech (Nasdaq : BBIOY), one of the United Kingdom's flagship companies, was accused of misleading investors over the efficacy of its acute pancreatitis drug, Zacutex. Parliament investigated the allegations, and the London Stock Exchange eventually censured the firm. But investors fled the market and are only beginning to return.

Since the debacle, a flurry of mergers and acquisitions has helped some companies gain the critical mass they've needed. In June 1999, two therapeutic drug companies merged, the Celltech Group (NYSE : CLL) and Chiroscience. The new company now has 12 products in the pipeline, including Chirocaine, a local anesthetic. In July 1999, the Shire Pharmaceutical Group (Nasdaq : SHPGY), which specializes in developing drugs for central nervous system disorders, metabolic diseases, and cancer, acquired the American drug firm Roberts Pharmaceutical. The Celltech Group and Shire were boosted into the Financial Times' Index of the top 100 companies on the London Stock Exchange, a first for the industry. In September 2000, Celltech posted a profit for the first time.

While German biotech companies are riding high, it is the British biotech firms that tend to be undervalued compared with their American counterparts. Xenova (Nasdaq : XNVA), based outside London, has a cancer drug in clinical trials and a market cap of $78 million. Its American competitor, Immunogen (Nasdaq : IMGN), which also targets cancer, has a market cap of $1.1 billion. In another rough comparison, Cambridge Antibody Technology has a market cap of $2.2 billion, while American Abgenix (Nasdaq : ABGX) is valued at $6.6 billion and Medarex (Nasdaq : MEDX) at $4.4 billion. Cambridge Antibody Technology is developing antibody-based drugs; Abgenix and Medarex are developing monoclonal antibody drugs.

German biotech firms are much more richly valued, especially considering where they are in product or technology development. Still, most analysts and VCs don't believe the market is headed for a dramatic shakeout. Consolidation is more likely, Mr. Zegelaar says.

German companies have another appeal for investors: they tend to be platform technology companies or have technology as part of their package. Tools companies, as they are also known, are seen as less risky than drug discovery companies, whose stock prices soar and sink, depending on the outcome of the latest drug trial.

REPEAT ENGAGEMENTS

Management remains a challenge for both Germany and Britain. "A stronger management team would have known how to handle the [British Biotech] situation better," says Horst Domdey, head of BioRegio Munich. Even in the United Kingdom, where the biotech industry is seeing second-time CEOs for the first time, many companies are trying to lure back British scientists who had left for firms in the United States.

Another issue facing both countries is whether national governments will interfere with biotech. The United Kingdom has shown where it stands: after the British biotech fiasco, the government did not step in to regulate the industry. Rather, the U.K. BioIndustry Association published a code of best practices.

Even the typically regulation-loving European Commission is taking a moderate approach. Among efforts to encourage entrepreneurship throughout Europe, the commission has promised to make it easier to raise cross-border venture capital and for institutional investors to hold equity in startups. However, other regulations that seem beneficial still leave room for confusion. The commission has proposed that European orphan drugs -- that is, medications to treat extremely rare diseases -- have ten-year exclusivity periods. But the commission reserves the right to shorten that period to four years if such a drug is found to be too profitable. And while the European Medicines Evaluation Agency is considered to be more efficient in approving drugs than the U.S. Food and Drug Administration, on a country-by-country basis, European member states have yet to harmonize their own drug-assessment periods.

Drug pricing and coverage are also concerns for Europe's biotech industry. Last winter, the United Kingdom's National Institute for Clinical Excellence (the government body that approves drugs for use in the National Health Service, which provides health care for 90 percent of that country's population) decided that Glaxo Wellcome's flu drug, Relenza, was too costly. Other European governments, hoping to hold down health costs in their national services, are expected to initiate similar cost-benefit drug reviews.

If they do, pharmaceutical companies would have no choice but to lower their prices at the risk of lower returns. But for now, most of Europe's biotech entrepreneurs and investors aren't thinking that far ahead.