Big Mergers Could Mean Sweet Gains for Biotech

Talk about a winter of discontent…

Over the past seven weeks, we’ve seen quite possibly one of the best examples of stock market fear in history.

Actually, it’s not fear. It’s pure irrationality, as top-quality stocks have been spanked down to bargain-basement levels, despite no discernible change in their businesses.

But business is still booming in the biotech sector…

Over that time, we’ve seen three huge buyouts occur in the Big Pharma/biotech area…

It started in January, with the news that Pfizer (NYSE: PFE) would shell out $68 billion to buy Wyeth (NYSE: WYE).

And things really got rolling this week, with the news that Merck (NYSE: MRK) will acquire Schering-Plough (NYSE: SGP) for $48 billion and that Roche (RHHBY.PK) and Genentech (NYSE: DNA) have finally concluded protracted negotiations that will see Roche buy the biotech superpower for $47 billion.

Total value of done deals: $163 billion. And in a market where access to capital has supposedly dried up.

The question is: Could these Big Pharma mergers signal a shift in sentiment and a bottom for the broader stock market?

If you’re looking for a simple, one-word answer… no.

But if you don’t take your investment advice from such in-depth, hard-hitting features as the “Lightning Round,” I invite you to keep reading…

The Credit Is There… But Only For The Right Deal

There’s no doubt that it’s tough to get credit these days. But as the merger deals above show, capital is clearly available for the right deals.

For example, in order to finance its deal with Genentech, Roche issued nearly $33 billion in notes. In addition, Pfizer received over $22 billion in loan commitments from various banks to complete its transaction. And similarly, J.P. Morgan (NYSE: JPM) slapped down $8.5 billion so Merck could fund its deal with Schering-Plough.

Again, this has occurred during one of the most fear- and panic-ridden periods in stock market history. And it’s come despite frequent comparisons to the Depression Era. Listen to the media too much and you’d expect to see the world in a grainy, brown hue every time you look out the window.

Don’t get me wrong here: I’m keenly aware that the economy is in bad shape. No one has ever accused me of being a Polyanna. But my point is that it’s not necessarily all doom-and-gloom (as some would like you to believe).

These healthcare/biotech mergers indicate the beginning of a thaw in credit markets and hopefully the start of a healing process for the markets. Notice that I’m not calling it a “bottoming process” because as I said last week, I do believe we’ll see new stock market lows.

But as more deals get done, investor and lender confidence will slowly return to the market. And I do think more acquisitions are imminent - particularly within the biotech sector…

The Biotech Sector - A Wave of Consolidation

The biotech sector is likely in store for a wave of consolidation. While the above-mentioned Big Pharma companies have boosted their pipelines and created massive biopharma companies with their acquisitions, there are still many pharmaceutical companies that desperately need to fill their pipelines.

And that bodes well for biotech - particularly when you consider that the largest biotech company after Genentech is Amgen (Nasdaq: AMGN), which boasts a market cap of $48 billion.

After that, Gilead Sciences (Nasdaq: GILD), which just announced a $1.4 billion takeover of CV Therapeutics (Nasdaq: CVTX), is next at $40 billion. Then the market thins considerably, with only three companies that have market caps over $10 billion and 11 companies with market caps of $1 billion or more.

For example, Merck could buy Biogen (Nasdaq: BIIB) and Genzyme (Nasdaq: GENZ) for less than it cost the firm to buy Schering-Plough.

The point is: Even though the biotech sector has outperformed the S&P 500 during the bear market, many biotech stocks have become cheap.

In fact, pharmaceutical companies wouldn’t even need to raise capital to buy a BioMarin (Nasdaq: BMRN), or Xcelerated Profits Report portfolio member Medivation (Nasdaq: MDVN) and many others like them.

Our 2 Favorite Emotional Friends: Fear And Greed

When managements are scared they hunker down and hang on to capital. But when opportunistic executives add to their businesses - even during downturns - that kind of optimism and activity is healthy. They’re essentially expressing their confidence that conditions will improve.

Remember… emotions control the stock market as much as fundamentals. And as we’ve mentioned in previous columns, fear and greed are the two main players. So when investors see this kind of activity, they start to think about their own opportunities, rather than cowering in the corner in the fetal position like so many have for the past few months.

Big Pharma Falls For Attractive Biotech

As we’ve seen recently, Big Pharma has already fallen for some of the most attractive biotech names. And as some more choice companies begin to get snapped up, you might see a rush into the sector by other Big Pharma firms to grab the existing quality companies before someone else does.

Mix in this momentum with some speculation and that could kick prices higher, causing Big Pharma executives to pull the trigger before valuations get too expensive.

The economy is still bleeding, but these recent acquisitions indicate that the patient is no longer spurting blood all over the emergency room floor. Eventually, it will stabilize and walk on its own again.

When it does, the strongest drug companies will be the ones that took advantage of this unique opportunity to fill their pipelines with products from inexpensive biotech companies.

Disclosure: None

Comments

[wdhalgren:]

"When it does, the strongest drug companies will be the ones that took advantage of this unique opportunity to fill their pipelines with products from inexpensive biotech companies."

Several problems with your analysis. First, most biotechs don't have a single drug in their pipeline that will ever reach market. Generally, if they have a drug that truly looks promising, they're no longer cheap.

Second, there is a serious problem for big pharma buying companies like Genzyme or Biomarin. Genzyme can charge 750,000 a year for one of it's glycogen storage drugs and get away with it. If big pharma tries that, they quickly accumulate protesters at the front gate talking about exploitation.

Third, acquisition of established biotechs is usually not acretive for big pharma because the valutaions are too high. It's hard for a company at two times revenues to acquire a company at 8 times revenues and come out looking good, even over a longer period. Historically, those type of acquisitions haven't been positive for the big pharma acquirer's stock price (see AZN buyout of Medimmune and the market response).

Not to say that that big pharma can't profit from acquiring smaller companies, but they have to be very smart, and try to buy companies with early stage drugs before the market realizes the value. There's not going to be some wild rush of biotech acquisitions.

Mar 13 09:35 AM

[Marcap:]

I agree! Big Pharma have very deep pockets, and are often able to merge with, or take over the smaller Biotech companies somewhat inexpensively, relatively speaking. This quite often presents excellent opportunity for Biotech shareholders to realize significant gains, as shares in those companies suddenly rise from quite often just a dollars if not pennies, to many dollars per share.

The trick however is to do a lot of research, and find Biotech firms in the very early stages of product development or trials. One needs to find companies which have sufficient funding to see their projects completed, but of course where no big news on their products have yet been announced, and certainly where no rumors of a merger have been placed on the table. Once products are ready for market, or even rumors of a merger begin, the stock usually jumps significantly in price over a very short period of time. Then its often too late to make the really big gains.

There are many such companies just waiting to be discovered.

Mar 13 10:05 AM

[Furd Turgeson:]

Wdhalgren, you are right on the money with your analysis. Great retort.

Mar 13 12:21 PM

[User 357469:]

Clearly you have no clue about the Pharma business or else you would know just how inaccurate your statements are.

On Mar 13 09:35 AM wdhalgren wrote:

> "When it does, the strongest drug companies will be the ones that
> took advantage of this unique opportunity to fill their pipelines
> with products from inexpensive biotech companies."
>
> Several problems with your analysis. First, most biotechs don't have
> a single drug in their pipeline that will ever reach market. Generally,
> if they have a drug that truly looks promising, they're no longer
> cheap.
>
> Second, there is a serious problem for big pharma buying companies
> like Genzyme or Biomarin. Genzyme can charge 750,000 a year for one
> of it's glycogen storage drugs and get away with it. If big pharma
> tries that, they quickly accumulate protesters at the front gate
> talking about exploitation.
>
> Third, acquisition of established biotechs is usually not acretive
> for big pharma because the valutaions are too high. It's hard for
> a company at two times revenues to acquire a company at 8 times revenues
> and come out looking good, even over a longer period. Historically,
> those type of acquisitions haven't been positive for the big pharma
> acquirer's stock price (see AZN buyout of Medimmune and the market
> response).
>
> Not to say that that big pharma can't profit from acquiring smaller
> companies, but they have to be very smart, and try to buy companies
> with early stage drugs before the market realizes the value. There's
> not going to be some wild rush of biotech acquisitions.

Mar 13 12:44 PM

[blonde molly:]

what aboout the obama factor on big pharma with his not believing that drug companies should be profit-making companies?

will this view not kill their growth and earnings, even if he doesn't get all he wants passed against them?

Mar 15 02:57 AM

[joe1234234:]

The problem is there is still a DOTcom bubble and a tech stock hype. Look at some of these laughable websites to bio tech research. Geron corp being one of the biggest of the fruads. I say that backed with most real nuerologists point of view, and that is the whole thing is a scam. Anyway, tech stocks and dotcoms were hot one minute, and worthless the next day...back right around march in 00...coincedentally. My advice, stay away from tech stocks. Unless they are validated by the scientific community, and not some qwerky video on a website.

Mar 15 09:08 PM