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2 Clear Signs That Biotechs and Pharmaceuticals Have Peaked

Be wary of the recent M&A buzz for pharmaceutical stocks, not to mention a slew of biotech IPOs

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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.

Source: iStockphoto

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:

#1: Pharmaceuticals’ Acquisitions Are Becoming Less Meaningful

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.

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