2007: The Year Pharma Fell in Love With Biologics

Pharmaceutical companies' love for biotech has been generally anemic: Johnson & Johnson's (NYSE: JNJ  ) lackluster relationship with Amgen (Nasdaq: AMGN  ) in the late 1980s is a prime example. But it looks like 2007 will mark a new era for these associated industries.

The reason for pharma's newfound infatuation is quite clear. Many pharmaceutical companies are facing a patent cliff in the coming years, with numerous small-molecule drugs losing market exclusivity. The companies need to replace all of those blockbusters with something.

While they could stick with small-molecule medicine, drugs made by biotech companies -- called biologics -- offer a distinct advantage. Unlike small-molecule drugs that see generic competition as soon as their marketing exclusivity runs out, biologics have a de facto marketing exclusivity even after they go off their U.S. patent. That's because unlike other countries, the U.S. has no pathway to grant FDA approval of generic biologics. At some point, Congress will jump in and give the FDA that power -- but until then, biologics look like a pretty good replacement for the drugs going off-patent.

Examples abound
The year started with AstraZeneca picking up MedImmune for the hefty price tag of $15.2 billion. That equated to about 10 times MedImmune's revenues, which even at the high margins biologics enjoy was still a whopper of a price tag.

Then in September, Bristol-Myers Squibb (NYSE: BMY  ) went for a pipeline filler rather than a stable of already approved drugs and grabbed privately held Adnexus Therapeutics for $430 million. That was a pretty expensive purchase for one drug in early-stage clinical trials, but Adnexus has a robust preclinical pipeline that should result in more drugs moving into the clinic for trials fairly soon.

Even larger-than-life Pfizer (NYSE: PFE  ) said at the Bear Stearns Health Care Conference that it was getting into the act by developing biotech drugs in house. Swiss-based Novartis has also announced the formation of an in-house biotech unit.

Who's next?
Now that Biogen Idec (Nasdaq: BIIB  ) has taken down the for-sale sign, what biotech companies are left to be picked up?

As my Foolish colleague Brian Lawler astutely points out, the most likely reason Biogen wasn't able to find a buyer was that its partnerships made purchasing the company difficult for most pharmaceutical companies. Therefore, the most likely candidates to get swallowed up are companies such as Genzyme, which hasn't licensed the rights to any of its top-selling products to other companies. Even if the company doesn't get picked up, it has the advantage of collecting all the revenues from the drugs.

Unlike Biogen, PDL Biopharma (Nasdaq: PDLI  ) seems determined to break itself apart, but given the industry's appetite for approved drugs with long patent lives, it doesn't look like a fire sale is occurring. The company was able to fetch $200 million for its second-highest-grossing drug, IV Busulfex. That leaves it in a better position to be bought by a company interested in its biotech aspects, including the royalties it receives from other companies selling humanized monoclonal antibodies.

Infatuation turns to stalking
My theory is that you should never buy a company because there's a chance it will be bought out. That's just bad logic, and, as the Biogen shareholders who bought in at $80 per share can attest, it's sometimes very costly.

Nevertheless, it's clear that pharma has an appetite for biologics that's quickly turning into an obsession. Whether they buy companies outright or just license the rights to drugs in development, my guess is that there will be more money flowing into biologics.

While the prices pharma is willing to pay for biotech companies may be overblown, its logic for investing in biotechs seems pretty sound. At the very least, it gives investors a reason to research biotech investments. Just don't get caught up in the hoopla. Wait for a company such as Genentech (NYSE: DNA  ) to grow into its expansive P/E before investing.

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