Buyout Picks In Healthcare For 2014

by: EnhydrisPECorp

When the history books are written, I suspect 2014 will go down as the year of the buyout in the healthcare sector. My belief stems from the fact that over $100 billion in revenues are about to be lost by major pharmas by the so-called "patent cliff" over the next two years. And some of these big players have sat idle for far too long. In fact, the major themes among pharmas losing blockbusters have been restructuring to lower costs, planned stock buybacks to keep share prices high, and liquidating non-core assets. Over the long term, it's not hard to see why this strategy equates to a zero sum game.

To remain at the top of the pack, players like Merck (NYSE:MRK) and Bristol-Myers Squibb (NYSE:BMY) are going to have to start to pull the trigger on deals that enhance their commercial and clinical pipelines. Pressing this issue even further, valuations across the sector have blown through the roof. While one could see this as an unsustainable bubble, major players risk paying even more of a premium if they sit on their hands much longer. After all, Sanofi (NYSE:SNY) paid $20 billion for Genzyme only a few years ago in what looked like a terrible deal at the time, but it's turned out to be more like buying a money tree.

So my view is that deals like Shire's (NASDAQ:SHPG) recent buyout of ViroPharma are a sign of the times. I expect no less than four major deals to go through this year, based on the need of major pharmas that are cash rich.

With that said, buyouts will not, and never do, occur willy-nilly. They tend to occur for a couple of reasons. First, a synergy needs to be a created. Basically, the buyer wants to augment one of their core business areas. Secondly, you need to factor in potential cost-savings, which can come in a variety of forms such as reduced R&D costs, opportunity costs, and potential tax savings. Indeed, tax savings are the reason why Irish pharmas tend to bubble to the top of buyout lists. And finally, the deal has to create all-important growth opportunities.

Now I'll be the first to admit that predicting buyouts is insanely difficult because these deals tend to come out of nowhere, and obvious candidates like BioMarin (NASDAQ:BMRN) never seem to get more than a wink and a nod from potential buyers. So with this in mind, I tried to come up with an "unconventional" list of potential buyout picks.

To do so, I took a top down approach by thinking about who's the most needy and what they will be looking for in terms of an acquisition.

Viewed this way, I believe AstraZeneca (NYSE:AZN), Merck, and Eli Lilly (NYSE:LLY) are bound to make deals soon. So here is my list of who they may try to walk down the aisle with this year.

AstraZeneca making a play to dominate the diabetes market

AstraZeneca's profits have been drying up ever since losing patent protection for some of their best selling products last year. To stem the tide, the company has decided to consolidate their diabetes assets by buying Bristol-Myers out of their collaboration, and pushing its glycemic control drug Farxiga successfully through the regulatory process this week. Farxiga, however, faces still competition in the Type II diabetes market, and as a result, it's unlikely to be a blockbuster.

So I expect AstraZeneca to go out on a limb this year and enter the insulin delivery market. And there is only one name that comes to mind: MannKind (NASDAQ:MNKD).

If Mannkind's ultra-fast acting, inhalable insulin product Afrezza is approved this year, I expect a bidding war to start, and AstraZeneca to be in the mix. There are a ton of naysayers surrounding MannKind but I just don't get their point. Afrezza has successfully completed two late-stage trials, it's inhalable, and the potential market size is absolutely enormous. Because it would be a direct competitor to Novo Nordisk's (NYSE:NVO) and Eli Lilly's injectable products, you had better believe these two are going to make a tender offer.

There has been a lot made about why Alfred Mann hasn't entered into a licensing deal yet, with the product's potential approval only months away. My view is that his advanced age is going to be key going forward. Put simply, I think he's going to sell the company to the highest bidder, and walk into the sunset. But he's not going to do it cheaply. Having invested around $1 billion of his money and the diabetes market on the verge of breaking $50 billion in sales, I expect the deal to come in around $8 billion minimum.

In sum, MannKind is my favorite takeover target this year, with AstraZeneca and Eli Lilly being two top bidders.

Merck may eye vaccine makers

Merck is no stranger to making huge deals to acquire intriguing pipelines, and it is currently bleeding money from lost patent protections. So I fully expect them to be aggressive in going after ways to stop the bleeding.

The good news is that there are some very compelling buyout possibilities in the vaccine space for Merck this year. One of Merck's core businesses is vaccines, and as such, I think there are three companies that could fit the bill.

1. Dynavax (NASDAQ:DVAX) - Heplisav is an experimental Hep B vaccine that could be approved in Europe this year and in the U.S. in 2016. Merck already has a recombinant Hep B vaccine, so they are no strangers to this market opportunity.

2. Inovio Pharmaceuticals (NYSEMKT:INO) - VGX-3100 is a cervical dysplasia vaccine candidate set to report mid-stage results by mid-2014. Merck is the maker of the infamous Gardasil, so there would be an interesting synergy created with a merger.

3. Novavax (NASDAQ:NVAX) - developing state-of-the-art influenza vaccines that would compete directly against Merck's Afluria.

Looking at these three possibilities, I think Novavax makes the most sense. It offers a diverse platform that is rapidly progressing through clinical trials, with multiple potential blockbusters on tap. A Merck-Novavax deal thus looks quite compelling, in my opinion. That said, Roche (OTCQX:RHHBY) could be lurking in the background, making Merck pay a premium to pursue this opportunity.

Summing up, my two buyout picks this year are MannKind and Novavax. They offer buyers compelling synergies, cost-savings, and strong potential for growth.

Disclosure: I am long NVAX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.