Biotech Mergers and Acquisitions are Here to Stay; Here's How to Play
It's difficult for the average market participant to assess biotech companies to build a position in any one stock. It is much easier to understand the economic imperative of large pharmas and biotechs to acquire smaller biotech companies to get their drug pipeline. Sometimes large pharma companies even go out and buy really big biotechs, for e.g. Bristol-Myers (NYSE:BMY) spending tens of billions of dollars to buy Celgene (NASDAQ:CELG). It was mostly about CELG's internal drug pipeline and its own investment in small development-stage biotech companies that justified the risk. The best way to participate in deals like Pfizer (NYSE:PFE) buying Array BioPharma (NASDAQ:ARRY) is through XBI. This has effectively become a vital ecosystem where small biotechs go public to fund their development, starting from basic research to Phase 1-2-3 trials and even some sales. Once they prove traction in selling their drug, a huge pharma company like Pfizer comes in and buys them and marries them with their huge sales and marketing machine.
XBI is the non-cap weighted ETF for biotech companies. This means that each company stock in the ETF no matter how big is represented equally. So the largest biotechs have the same influence on the price as the smallest. I am not trying to leverage my knowledge of biotech here; what I am doing is leveraging the wealth creation of this market sector by understanding the economics. There is another biotech ETF, IBB, and it IS Cap-Weighted. If you feel that the large-cap biotechs are being underpriced by the market, then perhaps you can avail yourselves of going long on IBB. To my mind, XBI should find a place in your long-term investment account, but also as a long-term speculation. I think the stock market is very healthy and that mergers and acquisitions will happen regularly and owners of XBI will benefit.
Mergers are a Sign of a Healthy Stock Market, as are IPOs
I also believe in the consolidation of the Exploration and Production Energy sector. I don't believe that Occidental Petroleum's (NYSE:OXY) acquisition of Anadarko (NYSE:APC) is a singular phenomenon. You hear constant chatter about Pioneer Natural Resources (NYSE:PXD), EOG Resources (NYSE:EOG), Diamondback (NASDAQ:FANG), and Parsley (NYSE:PE) being acquisition candidates; likely that people are talking about them probably means that there is some deal discussion, but maybe it's WPX that gets bought. What I am saying is, I published an E&P list a few weeks ago; select several names and build positions, also go ahead and buy XOP, the E&P ETF. I also believe that consolidation in the Defense sector is going to go full speed ahead with the news of the combination of United Technologies (NYSE:UTX) and Raytheon (NYSE:RTN).
The bottom line is, the economy is doing great, and it's reflected in the stock market. IPOs are going great guns, and also these sectors: biotechs, energy, and defense. There are even discussions of mergers between auto manufacturers going on. You don't have these types of activities if we had an economy in disarray or the regulatory environment is unstable. Perhaps a way to participate in IPOs is to buy the owner of the NYSE, which would be the Intercontinental Exchange (NYSE:ICE). A way to participate in the M&A world is to look at the boutique advisors. I will list a few names here, but I am not ready to really get behind any one name. I am just saying that if you agree that M&A will be a growing trend in our economy, it pays to understand what name benefits. Companies like Moelis & Company (NYSE:MC), Lazard (NYSE:LAZ), Greenhill (NYSE:GHL), Evercore (NYSE:EVR), and Jefferies (NYSE:JEF) should be studied and considered for investment. Again, I am not ready to make any recommendation, and perhaps it might be better to buy Goldman Sachs (NYSE:GS) or Morgan Stanley (NYSE:MS) as the way to go.
Trim, Trim, Trim
It's not too late to generate cash by trimming (3% to 5%) every position in your speculative accounts. If you do make a purchase today, try to pay for it by selling a current holding. My discipline calls for generating cash of 25-35% to prepare for the coming leg down. In my opinion, we are in the most volatile environment in a number of years. All you need to do is look at a one-year chart to see it. I have already laid out the reasoning for the upcoming drop; just go back and read the previous articles. If you have any questions, please comment below. Civil comments/questions will get civil answers.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.