The Biotech Buyout Binge:
Why these three stocks could double your money in the next 12 months
By William Patalon III, Executive Editor, Money Morning
Big drugmakers are scrambling.
Right now, some of their most-lucrative blockbuster drugs are coming “off patent” – meaning they face the loss of $170 billion in annual sales.
But I’m going to let you in on a secret that Wall Street investment pros would rather not have the little guy ever learn: The very same problem that has Big Pharma execs wringing their hands even as you read this is also creating one of the biggest profit opportunities we’ve seen in years.
To show you what I mean, let me tell you two quick stories.
The Secret Path to Biotech Profits
First, late in my business journalism career, I spent three years covering the biotech sector. Let me tell you: That reporting job brought me to a very quick understanding of just how challenging this business really is.
Wall Street and Big Pharma executives beat the drum about their successes – the new “miracle drugs” that treat or cure obesity, arthritis, depression and cancer. We hear about those achievements all the time.
What I found in my reporting, however, was that the failures dwarf the success stories.
The failure numbers are downright mind-numbing.
For every 1,000 “compounds” (drug candidates) that enter laboratory testing, only one will ever make it to human testing. Indeed, once a company develops a drug, it’s usually looking at about three-and-a-half years of testing in the lab before it can even apply to the U.S. Food and Drug Administration (FDA) for approval to begin testing in humans.
Of all the drug candidates that enter Phase I trials – the first of three phases that mark the path to FDA approval – only one in five ever makes it to market.
The bottom line, as I discovered, is this: It can take 10 to 12 years and $1 billion or more to develop a new drug.
For Big Pharma CEOs who are staring at eroding patent coverage and searching for replacement blockbusters, that’s too much time and way too much risk.
They’re not abandoning internal drug development. But they’re also pursuing an alternative strategy: Sniff out the small players already developing the new potential blockbusters and either buy the drug, or buy the company outright. That urgent multi-billion-dollar shopping spree is going on right now… boosted to the max by a need to keep boards and shareholders happy.
As Merck & Co. (NYSE: MRK) CEO Kenneth Frazier recently told an investor group: “My goal is to augment the pipeline. The way to augment is to find those assets that we can acquire.”
That’s easier said than done.
For one thing, Big Pharma/Big Biotech companies are fat with cash. That means there’s a lot of competition in the search for new drugs or entire companies to buy. For another, there’s a “scarcity of growth assets,” as Goldman Sachs Group Inc. (NYSE: GS) said in a new report.
Although that supply/demand scenario is a tough one for Big Pharma, it’s a terrific one for investors like us: It puts pressure on the suitors to buy whatever’s available. And it means the prices will be high when they do.
And, as my second story demonstrates, those deals do happen. In fact, our subscribers recently reaped a big payday from just that kind of deal.
A Big Payday … With More to Follow
Back on Aug. 11, 2011, on Private Briefing’s first day of publication, our inaugural recommendation was Galapagos NV (PINK ADR: GLPYY), a Belgian baby biotech that is operating a series of its own drug-development programs.
Just six months later, on Feb. 29, Abbott Labs Inc. (NYSE: ABT) said it would pay Galapagos as much as $1.35 billion for the rights to an experimental rheumatoid arthritis (RA) drug that would compete with a Pfizer Inc. (NYSE: PFE) offering.
To understand just how big this deal was, let me give you a little context. Galapagos has a market cap of only $435 million. And this is just one of the drugs that company has in development.
How did our subscribers do? Well, at their post-deal peak, Galapagos shares were up 103.5% from where we’d originally recommended them.
In short, investors who acted on our recommendation more than doubled their money in just six months.
And there’s more where that came from – lots more, Keith Fitz-Gerald, our chief investment strategist, told me during one of our most-recent private briefings.
“You know, BP, biotech stocks continue to do well around the world – not surprising, given the optimism that more FDA approvals may be in the works in 2012 than in past years,” Keith said, using the nickname he has for me. “Personally, though, I'm far more excited by the potential for mergers and acquisitions, particularly when it comes to early stage companies working on vaccines and oncology. Both sectors are key acquisition targets for Big Pharma, offering quicker time to market and potentially bigger delivery pipelines.”
The way Keith explains it, by reaffirming his zero-interest-rate policies, U.S. Federal Reserve Chairman Ben S. Bernanke is making it far more cost-effective for larger companies to acquire proven technologies. That’s a safer strategy than to sink years worth of R&D into projects that may or may not turn into profitable ventures.
Our Biotech Buyout Strategy
For investors, there’s nothing sweeter than buying a stock because you’re betting on a buyout – and being proven right. But your best bet is to pick stocks that you won’t mind owning for a while if no buyout offer surfaces.
What we’ve done for you here is to identify three biotech-buyout candidates that are great “buys” whether they get bought out or not.
But we chose carefully. We have created a low-risk/high-payoff strategy with more than one way to profit. Indeed, because of the quality of the companies we chose, the fact that all are focused on cancer treatments, and the timing (with the potential for a spring run-up), we’re giving you the chance to reap a payoff in three ways:
- In the near-term, as a “trade:” Because all of these companies are at least partially focused on cancer therapies, any of the stocks could benefit from the so-called “ASCO Effect.” That gives traders a shot at some extraordinary near-term profits between now and June, when the big annual meeting of the American Society of Clinical Oncology (ASCO) is held. Every year, in what’s become a spring rite, a couple of cancer-related biotechs see their stocks zoom in advance of the ASCO meeting. Keep in mind, though, they often plummet after this sprint. Last year, for instance, OXiGENE Inc. (Nasdaq: OXGN) rocketed from $1.55 in mid-April 18 to $5.60 on May 12 – a 261% run in less than 30 days. By October, however, the stock had fallen all the way to 92 cents.
- In the intermediate term, as “buyout-binge” targets: If either of these companies are taken over, it will likely happen at a hefty premium to market prices. Given the big return in a short period, this is obviously the optimum goal. But there’s a fallback profit scenario – and it’s a nice one, indeed.
- In the longer-run, as an emerging biotech: Even if none of these firms are snapped up in near-term buyouts, you still have a shot at substantive profits as their drug-development programs move forward. They will either bring the drugs to market or, like the afore-mentioned Galapagos, will sell them to a Big Pharma suitor. Either way, the stocks will surge.
Here are our three buyout candidates:
- Vical Inc. (Nasdaq: VICL)
- Celldex Therapeutics Inc. (Nasdaq: CLDX)
- And Pharmacyclics Inc. (Nasdaq: PCYC)
Let’s look at each company in more detail.
Biotech Buyout Candidate No. 1: Vical Inc. (Nasdaq: VICL), recent price $3.09
This San Diego-based biotech is shaping up as a potential two-way winner. That’s thanks to what one researcher described as “paradigm-changing DNA vaccines and cancer immunotherapies.” The company is a frequently mentioned buyout candidate, and it seems the buyout would come at a large premium. Yet if it were to remain independent, Vical could develop groundbreaking treatments for such maladies as metastatic melanoma.
Its drug candidate Allovectin-7® is an immunotherapy that’s in the latter part of a Phase III trial involving patients with metastatic melanoma. According to our research, right now there are no effective treatments for metastasized melanoma. (Currently approved therapies are toxic.) No surprise, then, that global market-potential estimates for just this application range from $500 million to $1 billion a year – which is 2.2 times to 4.4 times the company’s current market value of $235 million.
And that’s just for the one drug. Vical has other compounds in development, too.
Earnings are negative – but improving. The company lost 92 cents a share in 2007 – and its bottom-line deficit had narrowed to only 10 cents a share for 2011. Vical recently had cash of $50.43 million and no debt.
Wall Street’s one-year target price for Vical shares is $6 – which is 94% higher than the recently closing price.
Biotech Buyout Candidate No. 2: Celldex Therapeutics Inc. (Nasdaq: CLDX), recent price $5.12
The Needham, Mass.-based Celldex has a whole pipeline of drug candidates being developed for cancer and other tough-to-treat diseases.
Celldex’s weapon of choice: an antibody-focused “Precision Targeted Immunotherapy Platform,” or PTIP.
This approach uses a complementary portfolio of monoclonal antibodies, antibody-targeted vaccines and so-called “immunomodulators” in optimized combinations to create new drugs that go after specifically targeted diseases. In fact, one researcher – clearly taken with Celldex’s technological approach – referred to the venture as “the first antibody-based combination immunotherapy company.”
Wall Street’s one-year target price on the stock is $8.83 – which would represent a 72% gain from recent levels. This stock traded above $17.40 back in March 2007 and again in June 2008.
In any event, the market cap of $295 million would make Celldex an easy buyout target for a bigger company.
Biotech Buyout Candidate No. 3: Pharmacyclics Inc. (Nasdaq: PCYC), recent price $28
Headquartered in Sunnyvale, Calif., Pharmacyclics is a clinical-stage biopharmaceutical company headquartered in Sunnyvale, Calif. It is focusing on the development and commercialization of small-molecule drugs for the treatment of cancer and other immune-mediated diseases.
Pharmacyclics is currently developing PCI-32765 for the treatment of diffuse large B-cell lymphoma, mantle cell lymphoma and multiple myeloma. The drug is in Phase II clinical trials. Known technically as the Bruton's Tyrosine Kinase (BTK) Inhibitor PCI-32765, the treatment is generally viewed as the most exciting development to come out at the June 2011 ASCO oncology conference, and was widely written about.
And the bullish news headlines didn’t end there.
Last August, Pharmacyclics and Janssen Biotech Inc., one of the Janssen Pharmaceutical Cos. of Johnson & Johnson (NYSE: JNJ), agreed to develop and commercialize PCI-32765, as an oral, first-in-class BTK inhibitor that would be used for treating non-Hodgkin’s Lymphoma, Chronic Lymphocytic Leukemia and Multiple Myeloma. The deal called for Pharmacyclics to receive an upfront payment of $150 million, with additional possible payments of as much as $825 million in development and regulatory milestone payments.
Industry experts say the deal stands as tangible affirmation of the value of the technology.One expert even said the drug candidate has “blockbuster potential.”
“The combination of robust clinical data in difficult-to- treat tumor types, exceptional tolerability, and once-daily oral administration produce a formidable combination of attributes for any cancer drug candidate,” John McCamant, editor of the The Medical Technology Stock Letter, wrote in February.
Pharmacyclics has frequently been cited as a possible takeover target. Although the company’s market cap is currently about $1.95 billion, in the present cheap-moneyenvironment – and with such promising drugs in the pipeline – the cost of a buyout wouldn’t be at all prohibitive for a large suitor.
Company insiders certainly appear bullish. Over the last six months, insiders were net buyers of more than 1.34 million shares – representing about 2.47% of the company’s total float of 54.25 million shares. That rates as one of the biggest insider purchases of late for a company hitting new 52-week highs.
Indeed, McCamant, the Medical Technology Stock Letter editor, recently noted that Pharmacyclics CEO Robert Duggan owns almost 25% of the company. That’s a tangible sign that the company’s top executive knows that his own venture has a lot of upside potential.
Roth Capital recently boosted its target price on Pharmacyclics shares to $42 – which would represent a 50% gain from current levels. And Marshall Gordon, a healthcare analyst with the New York-based asset manager Clear Bridge Advisors, said the recent gains Pharmacyclics shares have seen only partly reflect the long-term potential for this stock, which he says could go to $60. A move of that magnitude would represent a 114% return from the recent price of $28.