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The Pharma sector has seen considerable merger and consolidation activity over the last couple of years. Pfizer (NYSE:PFE) bought Wyeth and Merck (NYSE:MRK) picked up Schering Plough in two of the larger mergers among many other smaller combinations. I believe merger activity could pick up again as the environment seems ripe for increasing activity.

There are a variety of factors driving consolidation including slowing revenue growth among the larger players; they have not been able to develop new products/drugs as commercially successfully as in the past. Patent expirations, higher costs to bring a drug to market, government cost containment efforts and an increasingly more stringent regulatory environment are also among the most prominent reasons. These trends are likely to continue for the foreseeable future. Given that, which companies are still available and would make likely takeover targets? Here are two to consider:

Gilead Sciences (NASDAQ:GILD) - Gilead Sciences, Inc., a biopharmaceutical company, engages in the discovery, development, and commercialization of therapeutics for the treatment of life threatening diseases worldwide. GILD sells at 10 times this year’s earnings and under 9 times next year’s consensus. It has over $2.50/share in net cash on its books.

GILD has a stable of HIV drugs in its portfolio and is working on the second generation of its HIV pipeline (Btripla and QUAD). Gilead also is selling at the very bottom of its five year range of valuation measured by P/E, P/S, P/CF, and Price to Book. It has an A- rated balance sheet.

Credit Suisse and S&P both have a price target of $48 on the stock, over 20% above the current price. Gilead Sciences has a very low valuation, core products, and a promising HIV pipeline that make it a good buy in its own right. The fact that it could make an attractive pickup to one of the major Pharma companies looking to fill out its portfolio, is frosting on the cake.

Forest Labs (NYSE:FRX) – Forest Laboratories, Inc. develops, manufactures, and sells branded and generic forms of ethical drug products. Its principal products include Lexapro for the treatment of depression in adults and adolescents, and generalized anxiety disorder in adults; Namenda for the treatment of Alzheimer's disease; Bystolic for the treatment of hypertension; and Savella for the management of fibromyalgia.

The company has over $13/share of cash on its balance sheet. FRX is selling at 9 times earnings. The company is facing a patent cliff as Lexipro’s patent expires in March 2012 and FRX looks to have trough earnings of $1.20 in Fiscal 2013. Gilead is also selling at the bottom quartile of its five year range of valuation measured by P/E, P/S, P/CF, and Price to Book. The company has at least 10 promising drugs in the pipeline including Dallsresp, Linaclotide for IBS, and the antidepressant Viibyrd.

Credit Suisse has a price target of $41 on Forest Labs, which is approximately 25% above its current price of $33.16. Given its pipeline and Lexipro expiration, I think both the company and a large Pharma competitor could be motivated to initiate a merger.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GILD over the next 72 hours.

Source: 2 Pharma Stocks That Would Make Ideal Takeover Candidates