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OTTAWA - The Canadian biotech sector faces a funding crisis that threatens the sustainability of the industry as dismal stock-price performance makes it increasingly difficult to attract new capital, Ernst & Young says in study released Tuesday.

In 2007, the value of Canadian life sciences companies fell by 26 per cent, funding to public companies fell by almost US$900 million and the number of companies shrank by 14 per cent, the global biotech study revealed.

Those trends show no signs of abating in 2008 and without action will result in the sector, which lost 64 companies in 2007, continuing to falter, said Rod Budd, Ernst & Young's Canadian life sciences leader.

"It's not a sector very much in favour with investors because they haven't had good returns over the past years, and therefore the public is staying away in droves,"said Budd.

"Large institutions are not taking an active role and certainly a lot of the portfolio managers don't have any weighting. So therefore the public companies are having a great deal of trouble attracting interest.

"The sustainability of the industry - until companies can maintain profitability - is dependent upon corporations in the industry being able to fund the necessary capital to advance their research and development efforts," Budd said.

But the trend there is in sharp decline. Canadian biotech firms raised about $700 million in 2007, with about half of that amount coming in the first quarter. At the same time, they spent or lost about $722 million over the year.

Not only did the year produce no net increase in funding, the final three quarters did not produce enough to even fund the "burn rate" at which companies use existing capital.

"When you start running into a scenario where you're spending more money than you're able to raise you're going to have a natural reduction or shrinkage in the sector," Budd warned.

Weighing on investor sentiment toward the sector is its extreme volatility in share prices, where a poor drug-trial result can quickly knock 40 to 50 per cent off the value of a stock. As well, few Canadian players have achieved the kind of revenue streams and profitability that would diminish the volatility inherent in a speculative company dependent on a narrow product pipeline.

The inability of the sector to attract investment has meant "the IPO market in Canada has been closed in Canada since 2005,"the report said. "There was only one Canadian IPO in 2007."

As a result, Canadian players are being forced to partner their drugs prematurely or for less than optimal value because they are having trouble funding expensive clinical drug trials, it said.

Funding is still flowing to private companies, with venture capitalists pumping 72 per cent more into the sector in 2007 - to $350 million from $205 million the year before.

But even those companies' valuations are impaired by an equity market that has no interest in new issues and which has driven down the prices of already public companies.

The sector - clustered mostly in Montreal, Vancouver and Toronto - employs about 15,000 people at 404 companies, 82 of which are publicly traded. They generated $2.7 billion US in revenue in 2007.

That number of companies still places Canada about fourth in the world. But in terms of market capitalization, or the total value of company shares, Canada's $10 billion is a far cry from the $370 billion in the U.S., although not so far off the $80-billion combined market cap of the European biotech sector.