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Tax Reform: Paving The Way For M&A In The Pharma And Biotech Sectors

Summary

A wave of mergers and acquisitions is about to reshape the pharmaceutical industry.

Investors should consider a basket of shares of developing biotech companies, either through an ETF structure or individually allocated within a portfolio.

Investing in smaller, emerging pharmaceutical companies could pose great risks, though there is greater opportunity.

The next trend in pharma and biotech investments could favor emerging companies rather than industry giants. A wave of mergers and acquisitions is about to reshape this industry as tax reform makes it easier for U.S. companies to access capital previously held overseas.

The new tax reform’s impact on the biotech sector

President Trump's Tax Cuts and Jobs Act was signed into law on December 22nd, 2017. As of January 1st, 2018, U.S. companies benefit from a lower corporate tax rate and lower tax rates on repatriated funds.

In the past, U.S. companies were taxed by foreign countries and paid a 35 percent tax on earnings brought back to the U.S. The new tax bill replaced this with a one-time charge. Congress believes the reform will result in companies bringing back approximately $339 billion over the next 10 years.

More accessible funds could translate into mergers and acquisitions for large companies looking for return on investment. Prior, big pharma companies have kept a significant percentage of revenues overseas, meaning that this tax reform could transform the biotech sector and unlock tremendous value for investors.

While there have been no announcements regarding M&A plans, Ian Read, the CEO of Pfizer, has been quoted in 2017 saying "we have a core competency in business development and integrating companies, and we'll continue to use it." An Oxfam report estimates that Pfizer is one of the top five U.S. companies with the most cash overseas.

How much money will be available for acquisitions?

Pfizer isn't the only big pharma company potentially interested in acquisitions. Medtronic CEO, Omar Ishrak, signaled that the reform has made 55 percent of the company's cash more accessible and is expected to pay a one-time charge of $2-$3 billion to bring this cash stateside. Additionally, Celgene can now more easily access up to 60 percent of its cash.

This change in tax rate for repatriated funds couldn’t come at a better time, as many big pharma companies look to replace revenues from expiring drug patents.

In 2018, patents for drugs such as Symbicort, LYRICA and Fentora will expire. The FDA requires companies to put new treatments through three rounds of trials, and this process can take up to 10 years, with costs of more than $1 billion before approval. For big pharma companies, it may be more cost-efficient to acquire a smaller company with a recently-approved drug or a promising treatment approaching FDA approval. Reducing time to market for a new drug by targeting emerging companies engaged in clinical testing can provide these companies with an accelerated path to the replenishment of their drug pipeline and revenue stream.

Yet, this isn't a new trend in the biotech industry. Celgene Corporation recently purchased Juno Therapeutics for $9 billion and Gilead Sciences paid $11.9 billion to acquire Kite Pharmaceuticals. Both of these were particularly interesting acquisitions due to Juno’s and Kite’s research in the emerging CAR-T space.

Moreover, Johnson & Johnson recently paid a $13.6 billion charge to bring overseas capital back to the U.S. Amgen is reportedly holding over $38 billion overseas, while Celgene is estimated to have $9 billion according to Bloomberg. The top five pharma companies could have a total of $250 billion overseas, suggesting massive potential to unlock value in the biotech sector going forward.

Not all of this cash will be repatriated, some will go toward R&D, stock buybacks and investments. However, mergers and acquisitions rank high on the list of investments, since only five percent of known medical conditions have a treatment. There is a huge market for new treatments, and acquiring a smaller biotech company that is nearing FDA new product approval can be the most cost-effective and timely approach for pharma companies to replace revenues from expiring drug patents.

What does this mean for investors?

Investors should consider a basket of shares of developing biotech companies, either through an ETF structure or individually allocated within a portfolio. In the event of a potential acquisition, companies with promising treatments can often fetch significant acquisition premiums from buyers.

Although, investing in small companies in this sector carries higher risks. Many of these companies are developmental, and it is precarious to predict the outcome of drug trials. Stock valuations can often trade up in anticipation of promising clinical results or a positive FDA approval. However, an adverse FDA decision or underwhelming trial results also brings downward pressure on the company’s stock price. Investors should consider the risks of investing in this sector and take a diversified approach to gain optimal exposure to emerging opportunities.

Companies developing new vaccines, molecular testing, immunotherapy, oncology, research on rare diseases, gene editing and CAR-T cell therapy are attractive candidates for acquisition as they demonstrate breakthrough treatments addressing critical, unmet needs.

There are also risks associated with investing in development stage biotech companies. Clinical trials are expensive, and companies largely depend on patient volunteers. Furthermore, development stage companies have significant funding requirements and oftentimes finance those needs through secondary offerings of stock. Investors looking to gain exposure to the biotech sector would be wise to consider spreading the risk across a range of companies working on a variety of treatments. Having a background in medicine or working alongside a financial advisor with experience in the biotech sector will also help investors position their portfolios to take advantage of industry consolidation as a result of the tailwinds created by the recent tax legislation.

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

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: Securities offered through Kalos Capital, Inc., and investment advisory services offered through Kalos Management, Inc., ("Kalos") both at 11525 Park Woods Circle, Alpharetta, Georgia 30005. Caliber Financial Partners, LLC, is not an affiliate or subsidiary of Kalos. Member FINRA/SIPC. 

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