Human Genome Sciences: Avoid This Sinking Ship

Jul.12.12 | About: GlaxoSmithKline (GSK)

It has recently been reported that GlaxoSmithKline (NYSE:GSK) has lined up alternative candidates to replace the entire board of directors of Human Genome Sciences (HGSI). This move comes as it considers options after its hostile bid of $2.6 billion for Human Genome was rejected. The giant British pharmaceutical company will wait to see the results of a separate initiative by Human Genome to find another buyer in a separate process of auction before deciding what to do next. The Human Genome board of directors has rejected the $13 per share offer from GSK, and set a deadline of July 16 for offers from other interested parties.

Meanwhile, GSK has taken its offer directly to the company's shareholders, and extended the validity of the tender offer to July 20. The proposed move to replace the board of directors is designed to underline the seriousness of GSK's interest in Human Genome and to scare away other potential acquirers. In any case, GSK has an advantage over other potential buyers because of its existing partnership with Human Genome Sciences on key drugs.

While this takeover drama unfolds, there are several things that investors should keep in mind. The first thing is that getting FDA approval for a drug is only part of the battle. Marketing and distribution is as critical to success. Benlysta is the first lupus treatment to be approved in the last 50 years, and by now, sales should have soared. Human Genome attributes disappointing sales to the ebb and flow nature of the disease, but I consider it equally likely that poor marketing and the cost of around $35,000 annually have played a large part in the lagging sales.

We saw a similar situation with regard to Provenge, the prostate cancer treatment from Dendreon (NASDAQ:DNDN) where the price tag of $93,000 discouraged physicians and patients alike. In addition to the pricing, Human Genome needs to fix its sales and marketing effort. A deal with GSK makes a lot of sense, because it co-developed Benlysta, and holds the licenses for two more phase 3 drugs from HGSI. No third-party acquirer can hope to get the kind of benefits from the deal that GSK can. Patience is a must, especially if you recall that Sanofi (NYSE:SNY) took nine months before it was able to acquire Genzyme.

There is much more to the drugs pipeline from Human Genome than just Benlysta. Raxibacumab, which is a treatment for inhalation anthrax, received two orders from the U.S. government even though formal FDA approval has not been received. However, this is not the only treatment in the market and Emergent BioSolutions (NYSE:EBS) has four anthrax related drugs in research and development and has signed a multi-year contract with the Centers for Disease Control and Prevention. Of the two drugs in phase 3 trials being co-developed with GSK, Albiglutide is a treatment for type-2 diabetes in a highly competitive market.

Development of Albiglutide appears to be satisfactory and it would be the third approved drug in this class. Amylin (AMLN) developed the first drug in this class, Exenatide (Byetta) which is injectible twice daily and Novo Nordisk (NYSE:NVO) has developed Liraglutide (Victoza) which is injectible once daily., Amylin is being acquired by Bristol-Myers (NYSE:BMY) at a 10% premium to the market price of Amylin shares. The other drug, darapladib, inhibits biological enzyme activity and reduces the chances of a stroke or a heart attack in patients who already suffer from coronary heart disease.

The major problem in the current situation has been that there seems to have been no meaningful dialogue between GSK and Human Genome management. Instead, when GSK took its takeover bid hostile, Human Genome reacted by implementing a poison pill that would make it almost impossible for GSK to complete the takeover without the co-operation of the present board of directors. The plan has an expiration period of one year and GSK requires that the poison pill be dissolved before they proceed with their offer. This cat and mouse game is likely to go on for several months but there is very little suspense about the outcome.

In my view, Human Genome's board has very little up its sleeves in terms of its bargaining position with GSK. The company has reported losses of $381 million in 2011 and $233 million in 2010, and has attributed these losses to the expenses incurred on Benlysta. GSK is already heavily invested in the company and is unlikely to walk away from the table except as a last resort. Given the links between the two companies, it is extremely unlikely that a white knight will appear to replace GSK. Given the dynamics of this current situation, potential buyers of Human Genome are far more likely to pursue other acquisition opportunities.

There are only two possible solutions to this situation. GSK could increase its offer. On the other hand, GSK could withdraw its offer and leave Human Genome to its own resources. As I noted earlier, Human Genome's track record so far on Benlysta is anything but inspiring. Should GSK withdraw, the share price is likely to reduce sharply. In any case, I believe that the run-up in share price has already been substantially completed, and the only scope for an upside is if GSK sweetens its bid by a couple of dollars per share. I certainly would not recommend buying a stock with such limited growth potential.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.