Seeking Alpha

Merger Monday Confirms An Active Stock Market - Buy Under-Appreciated Biotech

by: David H. Lerner
David H. Lerner
Short-term horizon, long-term horizon, Momentum, Multiple Discipline

I was very pleasantly surprised by the $70 billion worth of M&A announced yesterday. It confirmed that the stock market is alive and well.

I'm particularly focused on the biotech news, that it has been overlooked and that it could have a sustained rally.

Looking for alpha in this space is beyond my ken, so I invest in biotech "consolidators" like Bristol-Myers, AbbVie, and Gilead.

With Gilead's astoundingly intrepid gambit to acquire Immunomedics, I think it qualifies as a speculation as well, and so I added it to my trading account.

I take a look at the other M&A news items and I'm less than sanguine for Oracle and Nvidia.

Mergers have been lagging

Mergers for 2020 have vastly lagged last year. This has been a cause of concern for me in judging the health of the stock market. For the raison d'etres of Wall Street is not to make us rich, it's to create a source of equity capital to build companies. Our role can be compared to the remora fish that secure themselves to the leviathans and eat the rich remainder that they leave behind. Though our role is a bit more symbiotic as we do supply liquidity, price discovery and through the blessings of the short seller we present a level of policing to prevent the occasional "Theranos" that happens now and again. The stock market did not come about for our amusement or enrichment. If it's not creating true transactions like M&A and public offerings it's sickly and that does not portend well for us remoras or the greater economy.

So I heartily accepted yesterday's "Merger Monday" news. The torrent and size of the deals give me optimism that despite government intervention into our economy and markets, the underlying mechanism is returning to life. There's a very real possibility that there will be a rush of mergers before the close of the year either because of feared tax changes or the economy is returning to a bustling boil. Why do I say that? Well, this coming quarter is very likely to display the fastest growth the economy ever measured. Also, you may not have noticed but profit estimates are going up rather nicely, thank you very much. So with interest rates at zero for as far as the eye can see, biotech, which bases its value way out in the future, as the promised stream of profits are often on the come, low interest rates are more welcome to this sector than the cloud software world. I believe that with the evidence of yesterday's mergers, specifically the astoundingly well-priced purchase of Immunomedics (IMMU) by Gilead, that this is an area that should be speculated upon. Biotech's time has come once again.

Gilead (GILD) splashing out with a 108% high bid for Immunomedics for $21 billion: Game changer!

Biotech has been relatively quiescent. We've all been enamored of the WFH movement (that means "Work From Home" for your modern day Rip Van Winkles). That means demand for the likes of Zoom (ZM) and Amazon (AMZN) and not IBB, the Biotech ETF. Immunomedics's new drug Trodelvy works on triple negative breast cancer, but the modality for effecting the treatment is the holy grail of cancer cure. Yes, I said cure, cure is on offer, not 100%, but the possibility is there. Let me insert a caveat here. I'm less than informed on biotech. I hate that I can't get my arms around it. So I know there are many of you out there who will comment below "how I don't know what I'm talking about," or that there are plenty of other biotechs that also have the same capability. Good and fine, but you are the blessed 2% with PHDs or MSs or you have spent the last decade poring over Lancet or NEJM, or whatever. I salute you, and you may deposit your derision in the comment section below. I'm giving you what I think your everyday trader who pauses 60 seconds to think about what just happened yesterday and what it means for the biotech sector for them. OK?

So here's what I mean. IMMU has basically developed a guided missile of treatment. They identified a protein that's on the cancer cell. Their drug is an antibody targeting that protein on one side and on other end is a substance that's toxic to the cell. When they meet - kaboom. That means even cells that metastasize at a clump of even two, three cells, or even one can be targeted. Perhaps at some time there will be multiple protein targets, and simple blood tests that surface cancer before it can even be seen by current diagnostics. We just had the filing of an IPO for Grail Biotech that will do just that. In any case, IMMU is exciting and GILD got them for an easy 108% above the last close.

In yesterday's CNBC interview GILD's CEO intimated that while Tradelvy has been approved for triple neg breast cancer it has broad applications to other cancers like lung cancer solid tumors.

Trodelvy sold well in its first two months on the market. In addition, there was Sunday's call to analysts. Gilead chief medical officer Merdad Parsey said that his company has seen unpublished data on Trodelvy that suggests the drug will be of use against a broad range of solid tumors, including bladder and lung cancers. Trodelvy's sales in breast cancer would widen, too, if it gets approval as a first-line treatment for tumors that show drug-resistant genetic characteristics

The first reaction by analysts and market commentators was a wringing of hands and gnashing of teeth.

We heard a bunch of the naysayers say nay yesterday. I don't agree. GILD is expecting the acquisition to be accretive to earnings by 2023. So even without future indications, IMMU will contribute to earnings in three years. Three years is the typical return on investment for equipment. This is in my mind an astounding bargain. In addition, I'm saying that biotech is just too cheap overall and that there has to be other bargains out there. More on that later. So let me defend GILD a bit further. They have $15 billion in cash right now lying around doing nothing. It can't even earn interest. So really the purchase is $5 billion that will be borrowed essentially for nothing. I know, I know, you as a shareholder want that $15 billion. You want that in dividends or stock buybacks? No, you don't. GILD is uniquely suited to do what most of us can't - sift through all the dross of biotech fly specs and surface the ones that are worth an investment. You also know that existing approved drugs while throwing off astounding levels of cash are a wasting asset soon to be relegated to the generic drug pile. So you don't want that cash. You want them to put that cash to work. I for one am very excited by this news. So I bought GILD and I think it has a lot of room to run. Look at this one year chart here.

That little fuschia arrow on the right is where GILD is now. The big mountain of gains to the left was due to the excitement over Remdesivir which is still very much alive and will have a further role to play in fighting COVID-19. In fact, yesterday we heard news that Eli Lilly (LLY) and Incyte (INCY) are introducing a drug working with Remdesivir that adds to positive effects for recovery. Olumiant is a special immunosuppressant in a phase-3 study, looking for emergency use approval from the FDA.

That aside, since I'm a dummy when it comes to picking out up-and-coming biotechs, I'm investing in the medium-sized biotech consolidators like GILD, but also Bristol-Myers (BMY) that just acquired Celgene, and AbbVie (ABBV) that just bought Allergan. I believe that they will acquire smaller tuck-in acquisitions that will provide more beta. In the meantime, they throw off a nice dividend while you wait. They are all in my investment account that I never talk about because I intend to buy and hold them forever. However, I think GILD will be a runner now, and so I have it in my speculation account as well.

Lest I forget there was other major M&A news yesterday

Merck (NYSE:MRK) invested $1 billion in Seattle Genetics (SGEN) Antibody blood conjugates. Also this weird development with TikTok that I'm not sure how to categorize, and the very interesting Nvidia (NVDA) news about acquiring ARM Holdings for $40B, (see below). Let's also not forget that Verizon (NYSE:VZ) bought TracFone for a cool $9B whew!

Oracle (ORCL) may have bitten off more than it can chew

There has been a feeding frenzy over the acquisition of TikTok. Apparently, the assumption is that TikTok has an AI that can do it better than anyone else. What happens if they are wrong? What happens if this is just a random "fad?" By fad, I mean that teenagers that are amazingly fickle have decided that TikTok is the bee's knees like they decided that Snapchat was hot at one point.

I think it's the growth, TikTok DAU shot up like crazy, so everyone assumes its the algorithm

It might just be a fad. I think that's what Oracle is counting on, that they could stand up an AI algo that is "good enough." I'm going to say "be careful what you wish for" - ORCL may have bitten off more than it can chew. Like the dog chasing the car and finally catches it - then what?

Maybe fad isn't the right word. It caught on, and because of the network effect it will have staying power until it doesn't. However it's not being categorized as an acquisition, and I'm not even sure the deal they submitted with CFIUS will get approved. I would be cautious about jumping on ORCL. I bought on the rumor and sold it before the news. I could be wrong, but if it isn't a full acquisition and they have to stand up a working AI back-end for it, it could be a very thankless job.

In a similar vein, I think Nvidia's (NVDA) ARM Holdings acquisition is a "no bueno" as well

In this case, the value of ARM itself is not in question. It was a jewel when Masayoshi Son stole it, and it will be so when NVDA tries to acquire it. I believe there are huge antitrust issues, sovereign issues with the UK, and China will take years to approve. This can be an equally huge distraction for NVDA and at its current lofty (though justified) valuation. I see a danger of a big deflation in its value as uncertainty creeps in as the deal drags on.

One of the founders of ARM, Hermann Hauser, said he and many others were concerned that the UK would lose jobs and influence and argued ARM's business model would be compromised. He stated, "Surrendering UK's most powerful trade weapon to the US is making Britain a US vassal state," Hauser wrote in the open letter, which was published yesterday.

He called on Boris Johnson to force Nvidia to sign legally-binding terms agreeing to preserve UK jobs, maintain ARM's market neutrality, and secure exemptions from US rules that would ban ARM from dealing with China. If the UK government can't secure these commitments, Hauser said it should support an IPO of ARM on the London Stock Exchange. I think NVDA has opened a nasty can of worms. Of course, if NVDA does crater, you will hear me shouting from the rooftops to buy, buy, buy.

Speaking of which, what did I buy yesterday…

I started a position in Vroom (VRM) like I said I would. I bought a bunch of SPACs which I'm not ready to reveal right now. SPACs have just become so nuts that I need to write a piece just to talk about them. I'm building a position in Rocket Mortgage (RKT), more on that tomorrow. Also like I said I'm creating a speculative position in GILD in addition to my investment. I also rolled my DraftKings (NASDAQ:DKNG) calls up and out to February liberating some premium and then spreading them once again to hopefully generate further revenue by Oct. 2.

Disclosure: I am/we are long VRM. 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.

Additional disclosure: I started a position in VRM, RKT, and GILD. I also rolled my DKNG position up and out to February and re-spread with short calls and an Oct 2 expiry