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>>> Opinion: We’re in the year of the biotech buyout, and here are five prime targets



By Michael Brush
Jan 23, 2017



http://www.marketwatch.com/story/were-in-the-year-of-the-biotech-buyout-and-here-are-five-prime-targets-2017-01-23?siteid=yhoof2



One catalyst: Big drug companies are running out of ideas


If Princess Leia were a biotechnology investor, she’d be chanting: “Help me, mergers and acquisitions, you’re my only hope.”

This little snippet of Wall Street gallows humor comes from Baird biotech analyst Brian Skorney — his stab at taking some of the edge off the sturm und drang that investors feel about a sector that just keeps getting pounded by concerns about politicians whacking drug prices.

Biotech investors have good reason to be depressed. The S&P 500 biotechnology industry index fell 14.4% last year, compared with a 9.5% gain for the S&P 500 Index SPX, -0.31% So far this year the group hasn’t done much, other than decline when Donald Trump mentions drug pricing.

Now, though, as Skorney alludes with his Princess Leia quip, biotech investors are pinning their hopes on buyouts to bail them out. Lucky for them, their wishes will be fulfilled. For the five reasons I cite below, 2017 will be the year of the biotech takeover.

Indeed, if you look closely, a biotech buyout fever is already taking hold, and it is rewarding investors handsomely. January isn’t even over, and there’s already been a string of deals that have enriched investors.

• Takeda Pharmaceutical bought cancer drug maker Ariad Pharmaceuticals ARIA, +0.02% for a 75% premium. Because of the deal, Ariad was up 277% since I introduced it in my stock newsletter, Brush Up on Stocks, in January 2015 as a buyout candidate. It was up 400% since I reiterated it on Feb. 7, 2016.

• Derma Sciences DSCI, -0.71% jumped 40% after it agreed to be acquired by Integra LifeSciences IART, +0.02%

• CoLucid Pharmaceuticals CLCD, -0.05% advanced 32% on news that Eli Lilly LLY, -0.21% will buy it.

• Valeant Pharmaceuticals VRX, -4.31% agreed to sell Dendreon Pharmaceuticals to Sanpower Group, a Chinese company. (The deal put a bid under Valeant’s stock, but then it gave back the gains.)

This is just the beginning. “2017 is likely to push biopharma deal making to new heights,” predicts Ernst & Young’s Andrew Forman, in a research note called M&A Outlook and Firepower Report 2017.

Here are five reasons why he’s likely to be right, and five stocks that look like prime buyout candidates.

1. Biotech companies are telling us they are on the verge of a buyout binge

In an Ernst & Young poll conducted late last year, 43% of biopharma executives said they had five or more deals in the works, compared with just 6% last April. Gilead GILD, -0.66% CEO John Milligan recently said in an interview that buyouts would be a “critical” part of what the company will do this year to put new products in its pipeline.

2. Big drug companies are running out of ideas

It’s easy to see why these executives are cueing up takeovers. Only 22 drugs got approved by the Food and Drug Administration (FDA) last year. That was the lowest number since 2010 and less than half the 45 approved in 2015. Submissions of “new molecular entities” (drugs unlike any approved drug) were down to 37 from 46.

And what is getting approved is far less likely to be a blockbuster. The top 10 drugs launched in 2010-2015 brought in $40 billion in 2015, says Skorney. The next top 10 drugs are projected to earn $31 billion in 2022. None of the top 10 drugs, by estimated 2022 revenue, will have been approved after 2014. “Fewer and fewer drugs appear to have massive mega-blockbuster potential,” he says.

This means that many drug companies are becoming more and more dependent on a narrower base of products. Celgene CELG, -0.42% is a good example. It reported $11.2 billion in revenue last year, and almost $7 billion of that came from Revlimid, a cancer drug.

Skorney chalks all of this up to an “innovation gap.” And guess how biopharma companies will fill the gap? Yep. By buying other companies. Skorney cites Amgen AMGN, -0.78% and Gilead as two companies with particularly large holes to fill, and the cash to do it via acquisitions.

3. They’re also running low on tricks

“Large drug companies have been making money doing things that are artificial and unsustainable. Like price increases, inversions and financial engineering,” says Brad Loncar, a cancer-company expert at Loncar Investments. Inversions are when companies locate their headquarters in a low-tax country and run global revenue through that office. Financial engineering includes maneuvers like stock buybacks. And you know about price increases if you have been in the medical system lately.

The problem with these tactics is that they don’t really create long-term value for shareholders, and they can’t go on forever. Both the government and insurance companies are pushing back on price hikes. Washington may crack down on inversions. And buybacks can only help so much.

“Because those things are coming to an end and the environment for the pharma industry is becoming much more challenging, companies are having a real problem posting revenue growth,” says Loncar. “The only way they can get revenue growth is to buy it.”

4. Biopharma companies have lots of firepower to make deals

More than ever in recent years, big pharma companies have the firepower necessary to do deals to build out sales and pipelines, says Forman, at Ernst & Young. He puts the figure at $600 billion. That could increase by at least $100 billion if U.S. companies are allowed to repatriate earnings at a favorable tax rate, a plan politicians in Washington, D.C., are considering.

Twenty potential buyers tracked by Skorney at Baird have $300 billion in cash available. The biggest buyout war chests were at Johnson & Johnson JNJ, +0.22% ($42 billion); Amgen AMGN, -0.78% ($38 billion); Gilead ($32 billion); Allergan AGN, -0.16% ($27 billion); Merck MRK, -0.42% ($25 billion); Pfizer PFE, -0.19% ($24 billion); and Novartis NVS, -0.88% ($23 billion).

5. Targets now look a lot cheaper than they did a few years ago

Thanks to the big hit to biotech stocks last year, many companies in the space are now a lot cheaper. Buyers get more bang for their buck, and that makes deals more tempting. “The last time biopharma valuations experienced such acute declines was during the 2008 financial crisis,” says Forman, at Ernst & Young. “This pronounced downturn was quickly followed by a handful of 2009 mega-deals. So there’s a precedent for big pharma ramping up deal making in 2017, and potentially dominating mergers and acquisitions for several years.”

Five buyout targets

If you want to hunt for biotech buyout targets on your own, here’s some general guidance. Look for companies that already have products approved, plus products that are close to approval and likely to get it. “A lot of companies don’t have the luxury of time to buy something early stage. They need revenue,” says Loncar. “The companies in the sweet spot are ones that have late-stage assets.”

Here are five examples from biotech analysts and my stock newsletter. I’d never own a company just for the buyout potential. Because you never really know whether this is going to happen. It’s best if they have thriving products and pipelines so they can also simply succeed on their own. I believe that’s the case with all of these.

Vertex VRTX, -0.64%

This is Skorney’s top large-cap pick for 2017. This stock has been weak because of concerns about the sustainability of sales of its Orkambi, a cystic fibrosis drug, and also where the next leg of growth will come from.

Skorney thinks recent expansion of this drug for use by children, and growth in Europe will help. He also likes the pipeline, which includes early- and late-stage development of new cystic fibrosis drugs, several of which are being studied for use in combination with other drugs. As for buyout potential, “Vertex is always high up on everyone’s target list,” says Skorney. Especially if we see positive study results. We should learn more about that this year.

Acadia ACAD, -2.48%

It’s not always true, but often in life where there’s smoke, there’s fire. Acadia has been rumored as a buyout target several times in the past half year. Rumored potential buyers have included Pfizer, Biogen BIIB, -0.44% Gilead and Teva TEVA, -2.12% Who knows if Acadia will ever really get bought, but the speculation makes sense since Acadia fits Loncar’s checklist of qualities for potential buyout candidates. Its drug Nuplazid has been approved for a kind of psychosis experienced by Parkinson’s disease patients. This drug might also work against several other mental illnesses including Alzheimer’s disease, psychosis and schizophrenia.

Incyte INCY, +0.61%

Incyte is a throwback to what biotech companies were meant to be, says RBC Capital Markets analyst Simos Simeonidis. It’s built on “great science” that has helped it develop several drugs, and it continually reinvests in its own research.

Incyte’s main product is Jakafi, which is used to treat rare cancers. Sales growth is solid. Key products in development include baricitinib for use against rheumatoid arthritis and skin ailments, and another cancer drug called epacadostat. Incyte just scored a deal to test epacadostat in combination with Keytruda, a successful cancer drug offered by Merck. That could be a big deal. Incyte has nine other molecules it discovered in earlier-stage clinical development. “This combination of growing revenues and strong R&D makes Incyte a solid acquisition target,” says Simeonidis.

BioMarin BMRN, -0.82%

BioMarin has five approved drugs and over $1 billion in annual sales, with lots of potential growth on the way. Two drugs are poised for approval and launch (no guarantees). They are Brineura for batten disease, a neurodegenerative disorder; and pegvaliase for phenylketonuria, or an enzyme deficiency that causes the buildup of an amino acid in the body.

BioMarin has a pipeline of drugs, like BMN 270, a gene therapy for hemophilia; a treatment for a rare disease called Sanfilippo syndrome, which makes it hard to break down certain sugars (named after the doctor who discovered it); and vosoritide, which may treat dwarfism.

This combo of approved products and more on the way makes BioMarin a potential buyout candidate, says RBC Capital Markets analyst Michael Yee.

Tesaro TSRO, -0.06%

This company has a drug on the market called rolapitant, which is used to treat nausea from chemotherapy. And it has a potential blockbuster, says Loncar, in niraparib, which is a cancer drug. “Their data look terrific. They are really close to the finish line.”

At the time of publication, Michael Brush held shares of ACAD, INCY and BMRN. Brush has suggested ACAD, INCY and BMRN in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program

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