M&A buoys small caps but the action is elsewhere

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Yesterday’s flurry of good news gave biotech’s benchmark investor index a big bounce. The Nasdaq biotechnology index reversed the trend of the past two months with the fourth-biggest jump of 2014 as jubilant investors perceived the sector's appetite for deals to be growing, and Gilead’s record-smashing Sovaldi launch helped dispel the gloom that has pervaded the sector for weeks.

The M&A reality is a little bit more complicated than the perception, however. While there has been a healthy hunger for takeouts this year, GlaxoSmithKline and Novartis showed that peer-to-peer exchanges are in focus for big pharma, while Valeant’s hostile challenge to Allergan prompted suggestions that the latter company might try to grow bigger to defend itself. Thus, as long as so many biotechs remain on a valuation bubble, big and speciality pharma will probably not look downward for targets and will prefer to haggle with their equals.

Blistering start

So far, 2014 has been a bumper year for pharma and biotech M&A, with assets valued at $36.5bn changing hands in the first quarter (Q1 M&A data underline strong sentiment in life science sector, April 10, 2014). If megamergers are excluded, this is the biggest quarterly outlay since before the start of the banking crisis in 2008.

The second quarter looks to be on track to top that already. Up until yesterday, assets worth $9bn had already traded hands. Novartis’s dealmaking with Glaxo amounted to $23.1bn; so far, Valeant Pharmaceuticals and its partner-in-arms Pershing Square Capital Management have offered $48bn for Allergan, a number that is likely to have to rise for any takeout to happen.

Including the $48bn bid for Allergan, deals announced in the second quarter already total an incredible $71.2bn. So if Valeant is ultimately successful, this year would absolutely smash 2013’s M&A total of $75.6bn (Pharma M&A values buoyed by climbing asset prices, January 23, 2014).

Glaxo's chief executive, Andrew Witty, said the flurry of dealmaking at the top end of the sector was being driven by companies taking a long view of their need to prepare for patent expiries and coming market changes. “What you’re beginning to see is the behaviour of players needing to be thoughtful about how they need to be positioned over the next decade based on how strong they feel today, catalysed by price pressures they feel around the world,” he said during yesterday's press conference.

Who is buying what

What big companies are finding hard to justify are the prices commanded by development-stage biotechs. Even with the deflation of March and April, many of these groups remain expensive – bubble poster child Intercept Pharmaceuticals, for example, is more than four times the price it was on December 31, 2013, even though it has lost more than a third of its peak value (Interview – Overnight sensation Intercept settles down for hard yards, April 15, 2014).

A look at EvaluatePharma data shows that M&A activity this year has been largely marked by moves on commercial-stage companies or units, with Actavis’s $25bn bid for Forest Laboratories accounting for a big chunk of the total.

A deeper look shows that the last billion-dollar big pharma plays for pre-commercial companies were in 2012, when Bristol-Myers Squibb bought Inhibitex for its hepatitis C assets, and AstraZeneca bought Ardea Biosciences for its gout candidate lesinurad. Both happened in the first half of that year; it is no coincidence that early 2012 was also when biotech stocks began to outperform the stock market dramatically, a situation that has only begun to reverse in the last two months.

With Allergan now playing defence against Valeant’s hostile approach, the Botox maker could try to add some heft to price itself out of the market. A sizeable acquisition that lowers its own tax rate could go some way to satisfy its existing non-hostile investors - an advantage that Valeant's Canadian base can offer - and it is no coincidence that shares in Ireland-domiciled Shire or Perrigo jumped yesterday.

Such opportunities are rare, a term Mr Witty also used when sizing up the potential offered by the Novartis transactions announced yesterday. But they have tangible value, something that the pre-commerical groups cannot boast. Biotech traders who have changed their investment strategies based on yesterday’s M&A news might find their gains illusory.

To contact the writer of this story email Jonathan Gardner in London at jonathang@epvantage.com or follow @JonEPVantage on Twitter

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