Controversy has clouded the brief presidency of Donald Trump, especially after he fired FBI Director James Comey. If for some reason Trump doesn't finish out his term in office, pharmaceutical stocks could get walloped going forward. 

The long and short of it is that the biopharmaceutical industry has been soaring since Trump took office -- that is, until this week, when the ramifications of Comey's dismissal began to play out. Specifically, the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB) had risen by as much 12% year to date, but it has since given up nearly half of those gains in fairly short order. In fact, the IBB ended Wednesday down 2.27% on higher-than-normal volume. 

Why Trump is key to biopharma's near-term fortunes

The underlying reason for biopharma's broad-based rally this year has been the promise of corporate-tax reform -- Trump's second major priority behind the repeal and replacement of Obamacare. In a nutshell, most major drug manufacturers and blue-chip biotechs have a tidy sum of overseas cash that they'd love to put to work to create shareholder value, but they're reluctant to do so because of the potential tax implications associated with repatriation.

The words "Trump's Tax Plan" appear on a stack of papers on a desk, next to a pair of reading glasses.

Image source: Getty Images.

Pfizer (NYSE:PFE), for example, had a staggering $86 billion in unremitted foreign earnings at last count. And Gilead Sciences (NASDAQ:GILD) exited 2016 with approximately $37.6 billion in cash permanently earmarked for its foreign subsidiaries. To repatriate these cash reserves, Gilead would have to fork over as much as $13 billion to Uncle Sam, and Pfizer a possible $30 billion, under the current tax code. 

However, Trump's plan, as originally envisioned, would have slashed rates on foreign profits to a mere 10%, down from 35%. Best of all, companies would have been allowed to pay the balance of their taxes on repatriated cash over the course of a decade. Putting these figures into more concrete terms, Gilead's tax liability would drop to only $3.76 billion, and Pfizer's to $8.6 billion. That's a sizable cost savings and illustrates nicely why these two companies in particular have shied away from shipping cash back home. 

The dual incentives of a lower tax rate and an extended payment period might have sparked an unprecedented influx of overseas cash into the U.S. operations of industry titans such as Pfizer and Gilead. However, Congress appears to have lost its appetite for entertaining Trump's campaign promises, and that includes corporate tax reform. 

With the M&A machine stuck in neutral, pharma stocks could plunge

The biopharma industry is begging for a massive wave of consolidation. Top dogs such as Pfizer and Gilead, after all, have mountains of cash stored overseas, and both companies desperately need to address their faltering top lines through mergers and acquisitions. And that's just two examples out of many.

That's also arguably why the market has clearly been anticipating an M&A bonanza sometime in the near future. As proof, the price-to-sales ratios of several small to mid-sized pharma companies -- such as Incyte Corp. and Vertex Pharmaceuticals -- have absolutely ballooned simply because of their prospects as buyout targets.  

Getting to the point, the market appears to have gotten carried away regarding the real-world potential for corporate-tax reform, and the subsequent flurry of pharmaceutical M&A activity. And if Trump doesn't somehow pull a rabbit out his hat to revive the dying prospects of corporate-tax reform, valuations across the pharma space might start regressing to the mean in a hurry.

In fact, a return to fundamentals -- and a shift away from buyout-fueled speculation -- may mean a drop of 50% or more in the share prices of some pharma companies that have obviously benefited from rampant buyout speculation. That's a terrifying prospect, especially since it could trigger a wider bout of panic-selling across the pharma space.

 

George Budwell owns shares of Allergan, iShares NASDAQ Biotechnology Index, and Pfizer. The Motley Fool owns shares of and recommends Gilead Sciences. The Motley Fool has the following options: short June 2017 $70 calls on Gilead Sciences. The Motley Fool recommends Vertex Pharmaceuticals. The Motley Fool has a disclosure policy.