After successfully commercializing what became the world's most successful drug by annual sales numbers, Gilead Sciences (NASDAQ:GILD) has been forced to live with endless investor anxiety. What will it do with all of that cash generated from its hepatitis C portfolio? It surely has to do something, right?
The pressure has only increased after the company cut prices for the drugs in an effort to keep the competition at bay, which resulted in a 30% decline in hepatitis C revenue in the third quarter of 2016 compared with the year-ago period. Throw in a steady stream of pipeline failures, and it's easy to explain Wall Street's lust for M&A.
Incyte (NASDAQ:INCY) has been near the top of the list for Gilead Sciences and other major pharma companies for quite some time now. It's lead drug, Jakafi, has conquered nearly all challengers on the horizon, opening up what could be a $2 billion market opportunity for the drug. An impressive pipeline adds to its potential.
However, while Incyte is a great company, it is not a great company to acquire. Why? It's simply too expensive. Luckily, Gilead Sciences has other options available -- and some are closer than investors may realize.
Incyte looks like a value trap
The Janus kinase inhibitor specialist ended 2016 at roughly $100 per share and a market cap of $19 billion -- a relatively steep price for any potential acquirers. Then Incyte proceeded to gain 17% in the first two weeks of 2017, which pushed its market cap over $22 billion and likely cooled off any speculation of an inevitable acquisition.
To be fair, Incyte gained ground on the heels of great news. Before the J.P. Morgan Healthcare Conference, it announced an expanded collaboration agreement with Merck that would advance a combination therapy of Keytruda and epacadostat into late-stage trials for four additional indications. The combo is already being investigated as a treatment for melanoma, so the potential market opportunity just took a major leap higher. Additionally, Incyte management announced that it believes recent JAK inhibitor failures from competitors -- including Gilead Sciences -- will push Jakafi's peak annual sales from $850 million to $2 billion.
That's all well and good, but there's no denying that Incyte stock is a bit expensive. While traditional valuation metrics are often thrown out the window when you're discussing biopharma, the company's $22 billion market cap is supported by just over $1 billion in annual revenue. That number is growing, but a trailing P/E ratio of 158 hints that a lot of future sales growth is already priced into the stock.
A promising pipeline could still provide firepower for investors. However, the company's currently hefty price tag makes it difficult for a potential acquirer to put a value on growth potential. Don't forget that a buyer would need to pay a premium to close a deal and appease shareholders. If it didn't make sense for Gilead Sciences to purchase Incyte at $15 billion or $18 billion in 2016, then why would it make sense to pull the trigger at $22 billion -- plus a premium -- now?
Instead, investors may want to consider a more realistic potential buyout target: Galapagos (NASDAQ:GLPG).
Galapagos looks like a steal
Compared to Incyte, Galapagos is relatively cheap at just $3.2 billion. That's a reasonable valuation for a company without a product on the market. But if Gilead Sciences is looking for products that could reach market quickly, or a large influx of new shots on goal, then it would be difficult to find a better target than Galapagos.
The Belgium biotech boasts one phase 3 trial, four phase 2 trials, three phase 1 trials, five preclinical trials, and 20 discovery programs. That includes programs for osteoarthritis and cystic fibrosis, partnered with Servier and AbbVie, respectively. Its most advanced drug candidate, a JAK1 inhibitor called filgotinib, is partnered with Gilead Sciences in three separate trials targeting rheumatoid arthritis, Crohn's disease, and ulcerative colitis.
The collaboration didn't come cheap. Gilead Sciences paid $300 million up front and made a $425 million equity investment in the innovative upstart. Galapagos is also entitled to receive milestone payments of up to $755 million, sales-based milestone payments of up to $600 million, and tiered royalties on global sales that start at 20%. That's a lot of dough, partially because the market opportunity for the three autoimmune diseases is enormous. The global markets for ulcerative colitis and Crohn's disease alone are expected to reach a combined $11 billion by 2022.
The growth potential is impressive for successful therapies -- and so are the potential milestone payments. Luckily, Gilead Sciences' equity investment may prove strategic. How so? It means the Hepatitis C pioneer now owns 14.7% of Galapagos, which would make any potential acquisition 14.7% cheaper. If the company's pipeline heats up and other biopharmas start inquiring about an acquisition, then Gilead Sciences owns a sweet bidding advantage over its peers.
What does it mean for investors?
Gilead Sciences will likely continue to face investor and analyst pressure to pull the trigger on an acquisition. That's par for the course once a biopharma hits a certain level of success. Long-term investors should hope that management continues to remain patient for the right opportunity to present itself, rather than make a kneejerk reaction that results in wasted cash and a lower ROI -- events that are at higher risk for any acquirer of Incyte. The good news is that if clinical trials with Galapagos progress successfully, then investors may get both great value and tremendous growth potential if Gilead Sciences decides to take action.