Subscribe to Money Morning get daily headlines subscribe now! Money Morning Private Briefing today's private briefing Access Your Profit Alerts

How to Profit From This $70 Billion Buyout Binge

In a special report last April, we told you that 2012 was shaping up as the year of the "Biotech Buyout Binge" – a feeding frenzy of takeover deals that would pump up biotech stocks in a big way.

We even showed you how to profit.

As it turns out, we were right on target – with our prediction and with our picks.

Dealmaking did escalate, and the hope for windfall profits did serve as a catalyst for biotech stocks. All three of the stocks we recommended in that report soared by double-digit amounts, paced by blood-cancer researcher Pharmacyclics Inc. (Nasdaq: PCYC), which soared as much as 148% (it's still up nearly 127%). And we still like all three stocks.

Galapagos NV (PINK ADR: GLPYY), a biotech we'd recommended earlier (but mentioned in that report) is up 166%, and Permanent Wealth Investor Editor Martin Hutchinson says it could still be a "10-bagger" from here (see editor's note for details).

I'm talking about these winners for two very good reasons.

First, as longtime Private Briefing subscribers know, we take great care to follow up on recommendations we've provided, predictions we've made and trends we've been following.

But the second reason is even more important: Dealmaking had a huge impact on the biotech sectors overall returns in 2012.

But that impact could be even bigger this year.

The five largest Big-Pharma players – including Bristol-Myers Squibb Co. (NYSE: BMY), Pfizer Inc. (NYSE: PFE) and Merck & Co. Inc. (NYSE: MRK) – were holding more than $70 billion in cash and cash equivalents at the close of the third quarter. Having spent the last couple of years streamlining operations and incorporating earlier buyouts, you're going to see these behemoths embark on unprecedented shopping sprees – and can expect to see deals as big as $20 billion.

"With sales declining for the first time in 2012, it is only a matter of time before shareholder returns follow suit – unless [Big Pharma] can find new sources of growth," accounting-and-consulting firm Ernst & Young said in a report released Monday. "With few options for organic growth, pharma needs transactions … [and] the pool of potential suitors that could pay up to $20 billion has swelled."

It's the so-called "patent cliff" that's sparking the biggest fears. Right now, some of the biggest drugmakers have some of their most-lucrative blockbuster drugs coming "off patent" – meaning these companies face the loss of $170 billion in aggregate annual sales.

As I learned during my business journalism career (I spent three years covering the biotech sector), it can take 10 years to 12 years and $1 billion or more to develop a new drug. 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.

That's too much time and too much risk (as we've seen from some well-chronicled research failures in recent months).

CEOs figure that it's better to go out and buy a "bolt-on" product line or even an entire company that has an already approved drug, or a promising compound that's already involved in late-stage clinical trials.

According to some nifty new research by Bloomberg News, there have been 676 takeovers of pharma and biotech firms in the last three years. The average disclosed deal size was $328.7 million, and the average premium was 38%. Only two deals topped $10 billion, and the largest was the 2011 Sanofi SA (NYSE ADR: SNY) buyout of Genzyme Corp. for $20.1 billion.

And that's just what we're going to see more of this year.

Dealmaking is dominating the discussions at the annual JPMorgan Chase & Co. (NYSE: JPM) Healthcare Conference in San Francisco – where there are 8,000 attendees and 600 companies represented.

Take Novartis AG (NYSE ADR: NVS), the No. 2 drugmaker in Europe. Diovan, the company's blood-pressure treatment, lost patent protection in the U.S. market last year. And Gleevec, the company's cancer drug, starts losing patent protection in the United States in 2015 and Europe in 2016.

Novartis CEO Joe Jimenez says his company won't be dropping any $10 billion buyout bombshells, but did concede that investors "may see us do more bolt-ons – between $2 billion and $4 billion."

There's plenty of firepower out there: Of that $70 billion in cash I earlier mentioned, Pfizer alone held $23 billion, Johnson & Johnson Inc. (NYSE: JNJ) and Merck had $18.1 billion.

If you want to play the 2013 version of the "Biotech Buyout Binge," there are three rules you need to follow in order to maximize your potential profit and minimize your possible risk:

  • Biotech Buyout Binge Rule No. 1: Don't buy a stock just because you're hoping for a buyout. In fact, the potential for buyout should actually be a secondary or tertiary reason for making the investment. You want to look for a biotech or small-pharma player whose shares you're willing to hold even if there isn't a buyout.
  • Biotech Buyout Binge Rule No. 2: As a direct follow-on to Rule No. 1, look for stocks where there are other potential catalysts for profit. If you re-read our "Biotech Buyout Binge" report from last year, you'll see that's just what we did. And even though none of these companies were snapped up, every single one of these stocks was up by a double-digit percentage at some point after we made the recommendation – and Pharmacyclics doubled. What are these "other" potential catalysts? The chance for a drug approval, or even for some strong results from a later-stage clinical trial, are two good examples. A partnership with a bigger, deeper-pocketed partner is another.
  • Biotech Buyout Binge Rule No. 3: Don't overstay your welcome. In other words, manage your risk. Yes, I know I say "manage-your-risk" all the time. But that's not boilerplate. I come in here and write these columns each day because we really want you to make money – and really hope the insights that we share to lead to a better life for you. Part of that involves managing your risk. For instance, if you invest in a company that ends up as a buyout play, but the stock is trading 5% below the tender-offer price, don't wait the four, five or six months it will take for the deal to be consummated: It's not worth risking the windfall you have in hand (the deal could get spiked, or the market could crash) just to add a few percentage points to your return. Make sure to use "trailing stops," or "average into the investments. And if the stock you buy ends up doubling in a very short period, consider selling half to recoup your original outlay – which means the stake you continue to hold is pure profit.

Here are a couple of plays to consider right now.

  • Celldex Therapeutics Inc. (Nasdaq: CLDX): One of the three stocks profiled in our "Biotech Buyout Binge" report, the Needham, Mass.-based Celldex has a whole pipeline of drug candidates being developed for cancer and other tough-to-treat diseases. Its weapon of choice: An antibody-focused "Precision Targeted Immunotherapy Platform," or PTIP. The stock is up nearly 35% since we published that report, but there are additional catalysts. As we told you back on Dec. 11, the company just reported strong Phase III test results for its CDX-011 breast-cancer drug. The company has multiple drugs in development and with a $452 million market cap could be an inexpensive, but robust, acquisition for an oncology player. The one-year consensus target is $10.57 – 48% above yesterday's close.
  • Cyclacel Pharmaceuticals Inc. (Nasdaq: CYCC): One of two biotechs profiled back on Dec. 5, the Berkeley Heights, N.J.-based Cyclacel is a development-stage biopharmaceutical firm that's working on a unique, oral treatment for several kinds of cancer, including the blood affliction Acute Myeloid Leukemia (AML). With a market cap of less than $49 million, Cyclacel is very cheap for a company with a drug in Stage III clinical trials, though it's in a bit of a race against another biotech with a rival drug in development. Cyclacel's drug, called Sapacitabine, is being evaluated in the Phase III trial under a so-called "Special Protocol Assessment" agreement with the FDA. As one report noted, this agreement hints that the FDA has confidence in the design of the trial. Cyclacel has frequently been mentioned as a buyout target. For what it's worth, analysts have slapped a one-year target price of $17.50 on the stock – 204% above yesterday's closing price. But short interest has recently soared, underscoring that this is definitely a high-risk stock – even more so than the much-more diverse Celldex.

For other recommendations, take a look at the "Biotech Buyout Binge" report, and also the Dec. 5 Private Briefing story "Are These the Next Two Blockbuster Biotechs?" And watch for additional recommendations.
See you tomorrow.

[Editor's Note: We recommend investors employ a "trailing stop" of 25% on all holdings. And with high-risk/high-potential-return stocks such as the ones we profiled today, we also recommend that investors look to "average in" while also being certain to observe careful position-sizing limits in any investments they make.]

Leave a Reply

Your email address will not be published. Required fields are marked *

Some HTML is OK