As the economy foundered last fall, drug industry insiders looked forward to an M&A frenzy. But with a few exceptions, deals occurred only at the top of the food chain, leaving few crumbs for those at the bottom.

The three megamergers involving six of the world's top 15 drug firms by market capitalization -- Pfizer Inc.-Wyeth, Merck & Co.-Schering-Plough Corp. and Roche Holding AG-Genentech Inc. -- have not just grabbed headlines but could hasten a biotech shakeout as Big Pharmas turn their cash and attention on each other.

Few believe the megamerger trend has run its course, which means more top firms will remain distracted.

"Realistically, they can't focus on anything else," says Barbara Kosacz, who runs the life-sciences practice at Cooley Godward Kronish LLP in Palo Alto, Calif. "They may in the future be more aggressive, but for some period of time while they all digest one another, [it's] all quiet on the Western front."

Big Pharma business development offices won't go completely dark, but finishing deals, integrating teams, sifting through vast portfolios and sending out pink slips will curtail dealmaking for months. That's bad news for biotechs, who count on Big Pharma money to compensate for public and private investors' lack of interest.

Any softening of buy-side interest could make or break dozens of biotechs. At the end of 2008, one-third of the 360 public biotechs had less than six months of cash left, according to Burrill & Co. LLC in San Francisco. That figure doesn't include private companies that have seen venture funds dwindle and the initial public offering window slam shut. Fourth-quarter bio-
pharma venture fundings made up the lowest quarterly total since early 2003. The last biotech IPO was in March 2008.

For biotechs and their investors, the reality is a smaller pool of buyers. Even before the Pfizer and Merck deals this quarter, buyers were getting picky. According to Dow Jones VentureSource, there were 24 acquisitions of venture-backed U.S. biotechs in 2008, the fewest since 2003. The $206 million raised through M&A in the fourth quarter was the skimpiest quarterly total since mid-2003. So far in 2009, there are three buyouts.

On the public side, deals should continue, especially for firms with marketed products.

That's why CV Therapeutics Inc., whose Ranexa treats chronic angina, attracted on March 12 a $1.4 billion bid from Gilead Sciences Inc., which topped an earlier $1.1 billion bid from Japanese firm Astellas Pharma Inc.

But don't expect big public biotechs like Gilead, which wants to expand beyond its best-selling HIV/AIDS franchise, or Celgene Corp. and Genzyme Corp., to fill the deal gap. One reason, says Celgene vice president of corporate strategy Chris Garabedian, is that companies such as his have "been able to deliver more earnings with less expense than Big Pharma" and are loath to take on development expenses with little revenue attached -- which describes most struggling biotechs these days.

Many in the industry won't shed tears as biotechs close up shop. "Zombie" firms have lived for years, hustling more funds while never getting a product to market. "Over the years, some companies were financed that maybe shouldn't have been," says Transcept Pharmaceuticals Inc. CEO Glenn Oclassen. "The zombies just keep raising money, but that won't happen anymore."

Last fall, months after a planned IPO fell apart, Oclassen reverse-merged his private firm into the public shell of Novacea Inc., a San Diego company whose lead product, a prostate cancer drug, failed in late-stage trials, leaving it with cash, a stock ticker and very little else.

Combined, the firms had an estimated $96 million at year's end. Transcept will update its numbers March 23, but Oclassen says he has enough money if the Food and Drug Administration asks for more tests of its sleep aid Intermezzo, a reformulation of zolpidem, the generic form of Ambien. Intermezzo completed Phase 3 trials last year and is now under FDA marketing review.

The wild card in all this is partnering. License deals, in which biotechs sell rights to their top compounds for up-front and contingent fees, are crucial forms of financing. In 2008, the average up-front payout across 131 reported license deals was $33 million, according to Deloitte Recap LLC. That average will undoubtedly drop, even if license deal volume doesn't. Licensing transactions will be more of the "keep hope alive" variety that "with the up-front, you'll keep the lights on while you search around for more meaningful finance," says David Schulman, a partner at Dechert LLP in Washington.