Is Gilead Sciences (GILD -0.74%) backing away from its plans to acquire a smaller biotech focusing on oncology? That could be the case. Gilead CEO John Milligan reportedly told Leerink analyst Geoffrey Porges that the company "might end up doing nothing in oncology."

Just a few months ago, Milligan and other Gilead executives were openly talking about the possibility of an acquisition to bolster its oncology portfolio. What's changed? And what could this mean for Gilead?

Notepad with M&A and drawing of big fish about to eat small fish

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Small pool of bigger fish

It's not that Gilead Sciences doesn't want to make a deal. CFO Robin Washington stated in the company's second-quarter conference call that Gilead is still prioritizing its use of capital for partnerships and acquisitions to grow the business over the long term.

According to Geoffrey Porges, the problem seems to be that Gilead wants to make a "transformative" acquisition -- but can't find the right candidate in oncology. Milligan doesn't want to buy a smaller biotech that won't be able to contribute significantly to growth until several years from now.

There aren't many smaller biotechs that have a solid oncology portfolio that would be big enough to move the needle for Gilead. Incyte (INCY -0.24%) is probably the best fit. Jakafi is already a winner in treating myelofibrosis and polycythemia vera. Late-stage pipeline candidate epacadostat is one of the most eagerly anticipated immunotherapies in development.

Milligan also told Porges that Gilead is looking for a company with "substantial data, value, and scale." Incyte arguably has the data, with promising clinical results for epacadostat and Jakafi. It also has scale, with a pipeline that includes several other experimental cancer drugs. Value is another matter altogether. Incyte's market cap currently stands at close to $26.5 billion, but the biotech only posted revenue of $1.1 billion last year.

It's a big gap between Incyte and the next tier of smaller biotechs focused on oncology. Exelixis (EXEL 0.78%) also has a solid cancer lineup with Cabometyx, Cometriq, and Cotellic. Its market cap is around $8 billion. There should be a lot for Gilead to like about Exelixis, but the big biotech might not think an acquisition of the company would be transformative enough. Buying any of the many cancer-focused biotechs smaller than Exelixis wouldn't be all that transformative, either.

Looking elsewhere

Milligan's comments to Porges could indicate that Gilead is seriously looking at making an acquisition outside of oncology. That wouldn't be a huge surprise. Milligan has said several times that Gilead is interested in inflammation and non-alcoholic steatohepatitis (NASH) in addition to oncology. However, the reality is that there aren't many acquisition targets with current products or late-stage pipelines that seem to fit Gilead's criteria in those areas, either.

Incyte has rheumatoid arthritis drug baricitinib in addition to its cancer portfolio. But the drug failed to win approval from the Food and Drug Administration (FDA) earlier this year and probably will have to undergo another clinical study. Gilead probably isn't very interested in baricitib, anyway, since Lilly licensed the drug from Incyte in 2009.

Hand holding jigsaw puzzle piece with question mark on it

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Perhaps the best bet for Gilead would be to target a smaller biotech focused on rare diseases. Two solid prospects stand out: Vertex Pharmaceuticals (VRTX 1.36%) and BioMarin (BMRN -0.50%). Vertex specializes in developing drugs to treat cystic fibrosis (CF), while BioMarin has six drugs on the market that treat rare genetic diseases.

BioMarin would be the least costly deal for Gilead, with its current market cap of less than $15 billion. However, Vertex would arguably be the more tranformative acquisition. Despite its market cap of around $39 billion, Vertex's sizzling growth prospects make it a reasonable value, as well.

Doing nothing not an option

Incyte would be a great match for Gilead. If Gilead is open to going in a totally different direction, Vertex would be a nice pickup. I can understand reluctance to pull the trigger on such large deals, though. However, if Gilead wants to do something transformative, it will take spending a lot.

It's possible that Milligan's remarks are something of a head fake. Maybe Gilead is pursuing Incyte after all. Or perhaps the company is looking at making multiple acquisitions of smaller biotechs -- the so-called "string of pearls" strategy. 

Whatever happens, Gilead Sciences must do something to reignite growth. With its falling hepatitis C sales, Gilead's other drugs and current pipeline simply won't be enough to turn things around for the once high-flying biotech. The company might end up doing nothing in oncology, but doing nothing at all isn't an option that Gilead's investors will accept.