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Big Pharma has a Big Problem

|Includes: BIIB, BMRN, BMY, CELG, JNJ, Merck & Co Inc. (MRK), NVS, PFE, SNY

In the cellphone world, it’s all about “apps.”

In the oil and natural gas industries, it’s all about supplies.

And in the healthcare sector, it’s all about pills. Lots and lots of pills.

Blue pills, purple pills, sleeping pills, anti-depressants. They’re everywhere. It’s big business for Big Pharma and the companies are very good at marketing their products.

Comedian Chris Rock referred to this trend, noting that drug companies keep naming symptoms until they find one that you have:

Are you sad, are you lonely, are you hot, are you cold? You gotta take this pill! And they don’t even tell you what the pill does… they just keep naming symptoms. I saw a commercial the other day that said, “Do you go to bed at night and wake up in the morning?” I got that! I’m sick, I need that pill!”

America’s big pharmaceutical companies push their drugs on the public harder than any street corner dealer – and it’s proven to be a highly effective and lucrative strategy. In 2009, for example:

  • Merck (NYSE: MRK) earned $12.9 billion on sales of $27.4 billion.
  • Pfizer (NYSE: PFE) earned $8.6 billion on revenue of $50 billion.
  • Novartis (NYSE: NVS) earned $10.3 billion on sales of $44.3 billion.

Good news for them. But what about investors?

The Clock is Ticking

There’s a huge problem looming for these mammoth pharmaceutical companies.

Starting as soon as next year, many blockbuster drugs will lose their patent exclusivity, which will open the floodgates to generic drug competition.

Pfizer’s massive Lipitor drug is one of them. Bad news, considering it generated $11 billion in sales last year. Another $3 billion worth of drugs will also go generic next year.

And it gets worse in 2012. Over $30 billion worth of brand-name drugs will face cheaper competition. That includes Merck’s Singulair, Pfizer’s Viagra and Forrest Labs’ (NYSE: FRX) Lexapro.

So what are the Big Pharma firms doing about it?

Biotechs on the Buyout Block

The executives at these drug giants aren’t sitting around, sipping Cognac and reminiscing about the glory days. They’re busy building up their drug pipelines by partnering with other companies. In some cases, they’re acquiring them outright.

And not all the objects of their affection are tiny biotechs that require a roll of the dice and a large tolerance for risk.

Already, we’ve seen Roche buy major biotech firm, Genentech. And another big biotech,Genzyme (Nasdaq: GENZ), is reportedly a target of Sanofi-Aventis (NYSE: SNY).GlaxoSmithKline (NYSE: GSK) and Johnson & Johnson (NYSE: JNJ) are also being mentioned as possible suitors of Genzyme.

Here are a few others that could be acquired in the next 12 to 18 months.

  • Bristol Myers Squibb (NYSE: BMY)

Over the past few years, this large cap drug company has been repositioning itself as a biopharma organization.

While it loses its patent exclusivity on Plavix next year, Bristol-Myers has a deep drug pipeline. Within it are some very promising cancer drugs that the firm acquired when it bought Medarex last year.

While Bristol-Myers boasts a market cap of over $42 billion, it’s still small enough and attractive enough for one of the drug giants to acquire it. Right now, it’s trading at a reasonable valuation and offers a dividend yield of over 5%.

  • Biogen (Nasdaq: BIIB): With a solid drug pipeline and a blockbuster multiple sclerosis drug in Tysabri, which doesn’t face generic competition until 2015, Biogen could be an attractive takeover target. Activist shareholder Carl Icahn is pushing for the company to be sold.
  • Celgene (Nasdaq: CELG): Some of the healthcare media are speculating that Celgene could be bought out, too. Many large cap pharmaceutical companies would love Celgene’s oncology portfolio, its $2.6 billion in annual sales and earnings per share of over $2. However, the stock is already trading at takeover-like valuation. It’s hard to imagine a pharmaceutical company CEO justifying paying a premium over Celgene’s current price.
  • BioMarin (Nasdaq: BMRN): If the companies I mentioned a moment ago are interested in acquiring Genzyme for its rare disease drugs, they should consider BioMarin in this area, too. BioMarin specializes in rare diseases, whose drugs command premium pricing. Additionally, BioMarin has already proven it can bring drugs to market, as it’s expected to generate nearly $400 million in sales this year and earn $0.10 per share.

Bottom Line: Many pharmaceutical and biotech stocks are cheap right now. And with demand for medicine only increasing and the potential for mergers and acquisitions in the sector heating up, now is a good time to take a look at the group.

Hoping your long go up and your shorts go down,

Marc Lichtenfeld

Disclosure: none