Analyzing 5 Biotech Stocks And Their Takeover Potential

by: Helix Investment Research

Many investors and market followers believe that mergers & acquisitions in the biotechnology sector will be a dominant theme of 2012. In a previous article, we covered how investors can cash in on this trend using two ETF's. While this reduces risk, it also reduces the potential rewards. In this article, we will explore the takeover potential of 5 biotech stocks, for investors who have a higher risk tolerance. While no one can ever be sure that a company will be acquired, analyzing broader industry trends can offer clues as to which companies could be acquired, and which ones will not. While this list in no way covers every company in the sector that has been the subject of takeover rumors, these 5 companies are ones that have had the greatest deal of speculation regarding their futures as independent companies.

  1. Idenix (NASDAQ:IDIX): With Bristol-Myers (NYSE:BMY) buying Inhibitex (NASDAQ:INHX) and Gilead (NASDAQ:GILD) buying Pharmasset (VRUS), Idenix is one of the last 2 independent drug companies with hepatitis C products in development. The entire craze over hepatitis C companies is due to the fact that they are developing the next generation of therapies, none of which use interferon, therefore bypassing its side effects. Given the fact that Idenix has a tremendous amount of scarcity value, and is a "pure play" hepatitis C company, it is entirely possible that it will be taken out. Idenix rallied sharply when the Inhibitex deal was announced, due to speculation about its future. We think that the temptation to build a hepatitis C franchise will be too great for a large pharmaceutical company to pass up, and that sooner or later, Idenix will be acquired.
  2. Achillion Pharmaceuticals (NASDAQ:ACHN): This company's CEO has openly stated that his company is up for sale, and the surge in deals in this space makes a sale seem like an even greater possibility. Like Idenix, Achillion is a "pure" play hepatitis C company. But it has another characteristic that improves its chances of receiving a takeover. bid The usual "people familiar with the matter" say that Achillion is a "cleaner acquisition target" than Idenix because of the fact that Achillion has 3 hepatitis C drugs in clinical trials, and that it is unpartnered. However, a wave of insider selling at Achillion could be an indication that no sale is imminent. Recent SEC filings show that executives at Achillion have sold tens of thousands of shares. While these weren't outright sales, and were an exercise of options, it would make no sense to exercise these options now if a sale were approaching. Achillion executives would not be breaking any insider trading laws if they waited until a sale was announced to cash in their stock options when the shares were at a much higher price.
  3. Vertex Pharmaceuticals (NASDAQ:VRTX): If Pfizer (NYSE:PFE) is the king of all drug companies, Vertex is the Pfizer of the hepatitis C space. Unlike all the hepatitis C companies that have been acquired, Vertex has actual product to sell. Incivek has been approved for sale since May, and the company has a great pipeline of drugs in development, focusing on a variety of diseases, especially cystic fibrosis. Vertex, however has several factors that distinguish it from its peers in this space. The company became profitable in the third quarter, and it has a market cap approaching $8 billion. The premium necessary for a takeout would push the price tag over $10 billion, and that is a large enough number to make big pharma think twice. Speculation regarding Vertex has centered around Johnson & Johnson (NYSE:JNJ), given that the two are partners on Incivek, and Abbot Labs (NYSE:ABT), which has no hepatitis C franchise. Vertex has the added benefit of a strong pipeline, which could make the company more appealing to a big pharma player.
  4. Human Genome Sciences (HGSI): The more Human Genome Sciences' stock price falls, the more takeover speculation surrounding the company increases. GlaxoSmithKline (NYSE:GSK) is at the center of this, given that it is the company's partner on Benlysta, the first new lupus treatment in 50 years. In addition, much of Human Genome Sciences' pipeline is being developed in partnership with GlaxoSmithKline. While many see this as a sign that Human Genome Sciences will eventually be wholly integrated into GlaxoSmithKline via a takeover, we see it differently. The only people to know more about what is going on at Human Genome Sciences than GlaxoSmithKline are the executives of Human Genome Sciences itself. And if GlaxoSmithKline has not seen anything to make it want to bid for the company, why should any other company? And in addition, the precipitous drop in Human Genome Sciences' stock places its board, as well as that of GlaxoSmithKline, in a quandary. Human Genome Sciences will demand a substantial premium to where the stock used to trade to make its shareholders whole. Even an Inhibitex-like premium may not be enough. Rumors of a bid have pegged its price at $25 per share, which would be a premium of over 164%. That would break the previous record of 162%, set by Genzyme in its purchase of AnoMed in 2006. Can GlaxoSmithKline convince its shareholders to go for such a deal?
  5. Alexion Pharmaceuticals (NASDAQ:ALXN): When Sanofi (NYSE:SNY) acquired Genzyme, a driving force behind the deal was Genzyme's position as the largest drug company focused on orphan drugs and diseases. For those unfamiliar, orphan drugs are those that are classified by the FDA as treating a specific, and extremely rare disease. They usually get faster review, clinical trial tax incentives, and longer exclusivity periods. With Genzyme removed as a standalone company, the largest remaining orphan drug biotech company is Alexion Pharmaceuticals. The company's main drug is Soliris, which treats PNH, a very rare and life-threatening disease where the body destroys its own red blood cells. In addition, Soliris treats aHUS, an extremely rare genetic disorder that causes uncontrolled blood clots that damage and destroy a person's vital organs. Soliris is currently the only treatment available for these diseases. Alexion is conducting trials to expand the use of Soliris and has a promising pipeline of drugs in a variety of disease categories. Alexion's specialization in orphan drugs and diseases gives it the ability to charge much higher prices for its drugs, for there are no alternatives to its treatment. This is why Alexion itself recently acquired Enobia Pharmaceuticals, which also specializes in orphan drugs and diseases. Alexion will pay $610 million upfront and up to $470 million in milestone payments. Alexion is solidly profitable, making it an appealing takeover candidate for any number of large pharmaceutical companies who need to replenish their pipelines. Goldman Sachs lists Alexion as one of its top takeover candidates for 2012 because of the company's leading position in orphan drugs and diseases. However, a deal for Alexion will be no small matter. The company already sports a market capitalization of almost $14 billion, and the premium needed to convince the company to sell would most likely push the price to $20 billion, if not more. There are not many drug companies that can digest a $20 billion price tag. Furthermore, we think that any company that acquires Alexion would most likely exit the deal market, for a takeover of that size would leave little financial flexibility for more deals. Thus, there would be one less acquirer in the market.

For investors looking to cash in on the surge in biotech mergers & acquisitions, these 5 companies could be a compelling investment. For those investors who do not wish to play this trend via ETF's, these companies offer the chance at larger profits, but at the cost of increased risk. But if you are an investor who is comfortable with that, these companies can be a source of great profits if takeovers do occur.

Disclosure: I am long VRTX, HGSI, ALXN, PFE, BMY, GILD, VRUS. We are long VRTX, HGSI, ALXN, PFE, GILD and BMY via 2 ETF's the First Trust NYSE Arca Biotechnology Index Fund (NYSEARCA:FBT) and the PowerShares Dynamic Pharmaceuticals Portfolio (NYSEARCA:PJP). In addition, a mutual fund we own gives ALXN a weighting of 1.19%, and gives VRUS a weighting of 2.57%