Over the past sixteen months, Gilead Sciences (GILD +0.62%) has doled out $11.565 billion on share repurchases and $3.187 billion on dividends, for a grand total of $14.75 billion on shareholder rewards. While a rich shareholder rewards program is generally a good thing, Gilead has lost a stunning $53 billion in value and experienced a 16.5% drop in quarterly revenues over this period. Put simply, I find this biotech's capital allocation strategy bizarre in light of its eroding fundamentals and dire market sentiment.
When faced with a similar situation due to the patent expiration of its acid reflux medication Nexium, AstraZeneca (AZN +0.00%) was quick to suspend its share repurchase program in order to preserve capital and later apply its substantial savings on value-creating activities like acquisitions. Gilead, in my opinion, should have followed Astra's bold example once Gilead's hepatitis C revenues started to dip. Here's why.
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Gilead could have had over $45 billion in its war chest
Gilead ended the first quarter of 2017 with $34.0 billion of cash, cash equivalents and marketable securities. So by simply suspending share buybacks -- buybacks that have done absolutely nothing to stop the decline in its share price, mind you -- Gilead could have built a monstrous cash position in excess of $45 billion at this stage.
Why is $45 billion a nice figure to have in the bank? It's all about potential acquisition targets, and the amount of leverage Gilead may have to employ to dig its way out of this hole. Let's consider some scenarios.
Gilead's first problem from an M&A standpoint is its use of debt to partly fund the share repurchases in question. These senior note offerings, after all, have significantly weakened the biotech's balance sheet over the past sixteen months. Point blank: the company's trailing twelve-month debt to equity ratio of 139.49% isn't ideal heading into a largish acquisition that may require further debt-financing. Any sizable uptick in debt may now result in a significant credit downgrade, especially with the biotech's hepatitis C revenues continuing to drop.
The point is that Gilead is probably going to be reluctant to employ much, if any, debt-financing in an acquisition scenario due to the sizable amount of leverage already on its balance sheet.
And that's one key reason why analysts have repeatedly suggested that either Incyte Corp. (INCY +1.72%) or Vertex Pharmaceuticals (VRTX 0.79%) may ultimately be Gilead's chief acquisition target. These two companies have market caps that would allow Gilead to avoid additional debt (Incyte's market cap is $25.5 billion and Vertex's is $28.9 billion). At the same time, however, Incyte's sky-high price to sales ratio of 23.1 and Vertex's similarly unappealing 17 price to sales ratio are flat-out deal killers, in my opinion.
Now, if Gilead had $45 billion instead of $34 billion, it could possibly go after bigger game with more attractive valuations. Regeneron Pharmaceuticals (REGN 0.80%), for instance, sports a market cap right around $45 billion, and a somewhat more palatable price to sales ratio of 9.4. Regeneron is also forecast to grow its top line by a stately 24% over the next two years.
Likewise, Shire plc (NASDAQ: SHPG) would probably be part of this conversation based on its market cap of $52.3 billion, double-digit growth prospects, and diversified product portfolio. Shire would also provide an entry into the highly coveted orphan drug space, which has proven to be less vulnerable to push back from payers compared to Gilead's bread and butter infectious diseases.
Gilead's share repurchases have been a poor use of capital
As I've discussed previously, Gilead's current forays into anti-inflammatory conditions, oncology, and non-hepatitis liver diseases are not going to turn the tide anytime soon. In fact, the biotech's HIV franchise may start to falter due to the entry of generic competitors well before these clinical assets even have the chance to reach their peak earning power. So Gilead is going to have to make a major acquisition to truly transform itself into a multi-therapeutic company with a sustainable revenue stream.
Unfortunately, the only "big" acquisition targets that are within realistic striking distance -- Incyte and Vertex -- sport rather bloated valuations, to put it mildly. And Gilead arguably shot itself in the foot by squandering $11.5 billion on share repurchases over the last five quarters, putting far more attractive targets, such as Regeneron and Shire, out of reach, at least without risking a credit downgrade.
All things considered, I think Gilead's only real option is to start picking off multiple small-to-mid-sized companies with one or more products on the market, and some compelling clinical candidates in their respective pipelines. Although this path probably won't improve Gilead's fundamentals overnight, the fact of the matter is that the large acquisition route no longer appears viable for the reasons discussed above. So investors may want to temper their expectations about M&A being a rapid fire solution to Gilead's woes going forward.
