Is M&A the New R&D?

by Marc Lichtenfeld, Investment U Senior Analyst
Wednesday, January 25, 2012: Issue #1694

You don’t find too many wealthy do it yourselfers. While some people of means still enjoy putting in the hard work, knowing that a project was done correctly, most prefer to supervise, letting someone else to the heavy lifting.

It’s like that in the pharmaceutical sector, as well. Large drug companies, loaded with cash, are paying exorbitant prices to add drugs to their pipelines. In all fairness, they’re still developing their own therapeutics and are spending more on research and development, but often the quick fix for an ailing pipeline is to pull out the checkbook and purchase mid- or late-stage development drugs.

And the premiums being paid are astronomical lately. Pharmasset was just acquired by Gilead Sciences (Nasdaq: GILD) for $11 billion, an 89% premium to where Pharmasset was trading before the deal was announced.

Bristol-Myers Squibb (NYSE: BMY) will pay a 163% premium for Inhibitex (Nasdaq: INHX) in a deal that involved six bidders.

These kinds of premiums have investment bankers salivating – putting in even longer hours than usual, trying to set up richly valued deals.

For the acquiring pharmaceutical company, a purchase speeds up the process of getting a new drug to market by cutting out the earlier stage development process, where many drugs never prove to be worth anything.

By the time a drug is in Phase II or III, it has at least shown some potential that it could make it to the market. Of course, many drugs still fail in those stages, but at that point, the company is at least halfway to the end zone rather than starting from scratch.

For the biotech company, the acquisition grants them the resources they need to complete their scientific work, as well as the ability to make the drug a commercial success. For shareholders, they get an immediate and often substantial windfall.

So let’s take a look at a few companies I expect to be bought in the next 12 months.

Onyx Pharmaceuticals (Nasdaq: ONXX) – In a recent interview with Bloomberg, CFO Matt Fust said the company is an attractive target for acquirers. If that’s not putting out an “Open for Business” sign, I don’t know what is.

Onyx is the developer of kidney cancer drug Nexavar, which generated $250 million in sales in the third quarter, although Onyx’s take was $75 million because of its partnership with Bayer AG. Nexavar is also being studied in breast cancer, thyroid and lung cancer.

Onyx has another partnership with Bayer on a colon cancer drug that could be approved later this year.

AMAG Pharmaceuticals (Nasdaq: AMAG) – Another company whose executives, for all intents and purposes, acknowledged the company is for sale.

In his presentation at the J.P. Morgan Healthcare Conference earlier this month, new CEO Frank Thomas said, “…should we remain an independent company” several times.

It would not be a surprise to see the company taken over, as some activist investors have been pushing the company hard for a sale, forcing out former CEO Dr. Brian Pereira. The former chief was seen as an impediment to the company being acquired, and AMAG’s shares jumped 18% the day it was announced he was being replaced.

AMAG has one approved drug, Feraheme, for chronic kidney disease, and should have Phase III data for the drug in the broader indication of iron deficiency anemia. The company has $229 million and no debt.

Incyte Corporation (Nasdaq: INCY) – Incyte Corporation won FDA approval in November for its myelofibrosis drug Jakafi. It’s the first drug approved for the rare disease. Myelofibrosis is a disorder that causes bone marrow to be replaced by scar tissue and leads to, among other things, an enlarged spleen.

The company has a partnership with Eli Lilly (NYSE: LLY) on its Phase II candidate for rheumatoid arthritis. It has a deep pipeline with one Phase III drug and six Phase II drugs.

The stock has had a big run since Jakafi was approved, climbing from around $12 to $18. But it’s still trading below its 52-week high of $21.15, reached before Jakafi was approved.

Lastly, one of the company’s directors purchased 50,000 shares in the open market last week, putting nearly $900,000 of his own money to work.

I suspect a big pharma company is going to see a lot of value in Incyte’s pipeline and approved product.

Good Investing,

Marc Lichtenfeld