Credit Crisis Hits Drugmakers

Earnings releases and their associated conference calls for developmental-stage drugmakers are usually pretty boring. Occasionally, a company will save something interesting for the release, but in general, they're pretty much a snooze-fest.

Not this quarter.

Cash has always been a crucial component to developing drugs, but the credit crunch has taken it to a new level as managements talk up a storm about how they're going to survive the crisis. Dilutive financing just isn't a good option in this slumping stock market.

More drugs than cash
You'd think that Exelixis (Nasdaq: EXEL  ) would be screwed because GlaxoSmithKline (NYSE: GSK  ) chose not to develop an additional drug from its partnership, but management sounded borderline giddy about the decision. At the very least, they're relieved that the decision is finally made and they can talk to other companies about partnering their drugs.

And boy do they have a lot of potential drugs -- nine to be exact. Management seems confident that their discussions with "multiple pharma companies about partnerships for several of the compounds" will come to fruition in the next few months; they're guiding to end the year with at least $200 million of cash, but only had $135 million in the bank at the end of September. While I think a deal is likely to get done soon, the company isn't under a gun. Exelixis does have a currently untapped $150 million line of credit, which should keep it from having to take a lowball offer out of desperation.

CEO George Scangos recently said, "Companies that don't have a lot of cash or assets to generate cash" are in trouble. Obviously he doesn't rank his own company among them.

And let's not forget, Fools, not only will a new partnership help infuse the company with cash, but it'll also cut its burn rate since a licensing deal will likely fund further clinical development of the drug -- definitely a good thing with its first drug still some time away from market.

Got it done already
In contrast to Exelixis, fellow Rule Breakers pick Vertex Pharmaceuticals (Nasdaq: VRTX  ) has already licensed the ex-U.S. rights to its top compound, hepatitis C treatment Telaprevir, to Johnson & Johnson (NYSE: JNJ  ) . It does have one other compound, VX-770, which has shown tantalizing early clinical data in treating cystic fibrosis patients. While it could find a partner for VX-770 or sell off the U.S. rights to Telaprevir, neither seems necessary at this point.

Vertex is sitting on a pile of cash $920 million high. From selling its royalty stream for Glaxo's HIV treatment Lexiva to additional trips to the secondary-offering well, Vertex has been grabbing cash left and right. Just in time, I'd say.

In case you're wondering -- and you wouldn't be the only one -- most of that stockpile is tucked away in short-term, government-guaranteed securities. It's unlikely we'll see a huge write-off, like Bristol-Myers Squibb (NYSE: BMY  ) took, from a company that covets its cash so deeply.

Stepping in for a rescue?
While I've highlighted two companies that look like they're in a good position, even in this buyers' market, for pipeline drugs, there are certainly enough health care companies out there that are trading near their cash levels. Here are a few I found using the CAPS screener:

Company

Recent Price

Cash Per Share

Supergen

$1.24

$1.33

Helicos BioScience

$0.89

$1.15

Arena Pharmaceuticals

$3.07

$3.10

Nabi Pharmaceuticals

$3.58

$3.08

Lexicon Pharmaceuticals

$1.39

$0.80

Javelin Pharmaceuticals

$1.54

$0.69

Source: Motley Fool CAPS.

Now you could buy those companies hoping that a pharmaceutical company will come in and scoop them up, but that just sounds like gambling to me. A much better choice would be to buy a pharmaceutical company like Novartis (NYSE: NVS  ) that has a truckload of cash waiting to be unloaded while avoiding being stained by all the blood in the streets. Both Novartis and Glaxo have indicated willingness to pick up some companies on the cheap.

Pfizer (NYSE: PFE  ) , the drugmaker with the largest truck, has proven it can do it as well. Earlier this year it snatched up Encysive Pharmaceuticals for almost nothing after the drug developer failed to navigate through the Food and Drug Administration requirements. Without an infusion of cash, expect a lot of drugmakers to fail to make it that far.

The well-run drugmakers will make it through the credit crunch though. Smart investors just need to find developmental-stage companies that can manage their money well or invest in large pharmaceutical companies that can hopefully spot a bargain when they see one.

Find out why Exelixis and Vertex were picked for the Motley Fool Rule Breakers newsletter by grabbing a 30-day trial subscription. You'll get access to all our back issues and be able to see the most recent picks as well.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Pfizer, Johnson & Johnson, and Glaxo are Income Investor picks. Pfizer is an Inside Value recommendation. The Fool owns shares of Pfizer and Exelixis. The Fool has a disclosure policy.


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