by James Brumley | April 25, 2014 10:55 am
With this week’s round-robin of acquisitions, sales and swaps among Novartis (NVS), GlaxoSmithKline (GSK) and Eli Lilly (LLY), investors who have recently — or not so recently — fallen in love with pharmaceuticals were given yet another reason to expect big, M&A-driven gains from the sector.
And truth be told, it’s not an illogical presumption.
The Lilly/Novartis/Glaxo mix ‘n’ match was unveiled just a couple of days after it was announced that Pfizer (PFE) had mulled the purchase of AstraZeneca (AZN). Although that deal was nixed a few months ago before any seriously considered offer was put on the table, it became clear that Pfizer was shopping, and that AstraZeneca was open to being shopped.
Also stirring the pharmaceuticals acquisition pot on Tuesday was news that Valeant Pharmaceuticals (VRX), with verbal support from Bill Ackman, was making a $45.7 billion bid for Botox-maker Allergan (AGN).
Given the apparent revival of buyout-mania after the biotech sector took a 40% tumble between early March and mid-April, trader optimism surrounding pharmaceuticals was equally quick to recover (spurred by a heavy dose of IPOs from the industry).
But those investors might want to take a longer, philosophical look at some of the more recent biopharma acquisition plans and public offerings.
While deals are still happening, they’re less and less exciting as fewer and fewer compelling buyout targets are left in the industry’s ether. The next stop might be an end to merger-mania altogether.
But that’s an even bigger problem: That merger-mania was the best thing going for pharmaceuticals. With that support no longer in place, the remaining pharma names might be set to cyclically underperform for the next few years.
That’s apt to be an unpopular premise.
The market has poured into pharmaceutical stocks and new biotech names at an accelerated clip since early 2012, hopeful the sector would sidestep any sort of pullback that tends to crimp other sectors from time to time. And truth be told, the biotech and pharmaceutical industries do tend to march to the beat of their own drummer. They’re still cyclical in their own way, however, and it might well be the case that the cycle peaked when the underlying stocks did in February.
There are two finite clues that suggest pharmaceuticals like AstraZeneca, Allergan or Eli Lilly have begun a period of lackluster results. In no particular order:
It wasn’t that long ago that pharmaceutical companies were shopping — aggressively — for new drugs that showed promise, with little regard for the risk involved.
Case(s) in point: In late-2011, Gilead Sciences (GILD) bought Pharmasset for $11 billion, mostly to obtain Pharmasset’s early-Phase 3 hepatitis C drug PSI-7977. Shortly after that, Bristol-Myers Squibb (BMY) paid $2.5 billion to acquire Inhibitex, mostly to get its hands on Inhibitex’s Phase 2 hepatitis C drug INX-189. The Inhibitex-made drug ultimately failed, making the $2.5 billion spent on its acquisition a complete waste. PSI-7977 has since gone on to be approved as the HCV treatment known as Sofosbuvir, or Sovaldi, but not before hitting a developmental stumbling block that limited its usage. Specifically, a test of the drug in combination with ribavirin indicated that six out of eight null-response (to interferon) patients saw a relapse within a month. The drug was expected to perform much better. As the company’s COO, John Milligan, said at the time, “”Maybe we were a little more enthusiastic than we should have been.”
Subsequent treatments of different forms of the infection have since proven more effective, so much so that Sovaldi was approved in December of last year as the world’s first non-interferon treatment for certain types of hepatitis. But, the drug still wasn’t quite was expected when Gilead shelled out $11 billion, and with a typical full-treatment price of $84,000 to $162,000 per patient, the true marketability of the drug remains in question.
In retrospect, the Gilead and Bristol-Myers acquisitions may have been more of an effort to stave off the risk of another player owning those drugs and bringing them to market. Yet, at the time — and even in the aftermath of the setbacks — those buyouts were simply deemed the cost of doing business … a necessary risk in the name of science.
Fast forward to today.
While one could argue that Pfizer wanted AstraZeneca mostly for its cancer immunology programs, there are easier ways to refill a pipeline with cancer therapies than to buy an entire company that is known as dealing with patent cliff problems of its own.
And the Pfizer/AstraZeneca deal was probably the most speculative of this week’s biopharma acquisitions. Novartis is simply buying GlaxoSmithKline’s existing cancer unit, while Glaxo will be receiving Novartis’ existing vaccine portfolio. There are a few trials underway within both of the divisions that will be changing hands, but none of them are expected to be game-changing anytime soon. Allergan also is already a well-established enterprise, with little risk, but little additional upside ahead.
In other words, pharmaceutical companies are no longer playing offense but instead are playing defense, looking for acquisitions based on convenience and cost reductions more so than growth opportunities.
The next step in this evolution is a reluctance to acquire other companies for any reason at all.
As of March 20, 24 biotech companies have gone public this year. That’s a huge number. For perspective, there were only 37 biotech IPOs in all of 2013 (and that was a record-breaking year … the average has been about a dozen per year since 2000).
At the current pace, we could see a whopping 100 or so biotech IPOs in 2014, leaving any prior year’s biotech IPO headcount in the dust.
“But isn’t a wave of new biotech and bioharma stocks an indication of strong interest and confirmed opportunity?” Maybe, but more likely it’s a sign of exhaustion. Remember, homebuilders couldn’t build houses fast enough in 2007. There weren’t enough tech stocks to go around in 1999. The widely held euphoric assumptions then were dead wrong.
There’s another red flag stemming from the plethora of biopharma IPOs we’ve seen of late, though.
Truth be told, biopharma startups would prefer to be acquired or partnered with while they’re private entities. The valuations tend to be better, and the hassle of keeping investors satiated is sidestepped. The fact that these companies are being forced to enter the public-capital markets for funding actually implies there’s not a great deal of faith in their underlying science.
If there was, Big Pharma would be providing more funding for them.
To be fair, it’s not a flawless theory. The pharmaceutical industry has not only continued to make new drugs, but the advent of genome mapping, immunology and other new sciences has given the industry new ways to develop even more therapies.
It’s conceivable that all these new publicly traded companies will eventually justify themselves. And it’s conceivable that Big Pharma will decide to once again view acquisitions as a means of garnering new drugs rather than as a means of improving logistics.
Conceivable, though not likely … at least not in the near-term.
Like any other industry’s stocks, pharmaceutical stocks and biopharma are cyclical. The ebbs and flows here are driven by a changing technologies and an ongoing flux between a risk-on and risk-off attitude. Risk was “on” in 2012 and 2013 after being “off” between 2008 and 2011. If the pattern repeats itself, the next couple of years aren’t going to be nearly as rewarding as the last couple have been.
And it looks as if the downside of the cycle might have already begun.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
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