Investors woke up Monday morning to a pleasant surprise from Gilead Sciences (GILD +0.42%). The big biotech announced plans to acquire Kite Pharma (NASDAQ: KITE) for $11.9 billion. The market applauded the deal, with Gilead stock rising more than 2% in intra-day trading.
There are several reasons to like the acquisition. Adding Kite's pipeline, particularly lead candidate axicabtagene ciloleucel (axi-cel), makes Gilead an instant leader in cell therapy for treating cancer. But buying Kite Pharma should only be the beginning of acquisitions activity for Gilead. Here are three key reasons why.
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1. Kite isn't enough by itself
The primary reason that Gilead Sciences needed an acquisition was to compensate for continued sales declines for its hepatitis C franchise. As great as buying Kite Pharma should be over the long run, buying Kite isn't enough to turn things around for Gilead by itself.
Gilead stated that the Kite acquisition is "expected to be neutral to earnings by year three and accretive thereafter." These projections assume that axi-cel wins approval in both the U.S. and Europe for treating refractory aggressive non-Hodgkin lymphoma (NHL). I don't question Gilead's estimates -- they're probably solid. However, the company clearly needs a bigger boost to its lineup to offset its hep C woes.
CEO John Milligan has stated that Gilead wanted a "transformative" deal. Buying Kite meets that qualification in terms of positioning the biotech in oncology. However, it's not transformative from a financial standpoint.
2. Gilead has hinted at more deals
In the conference call discussing the Kite Pharma acquisition, Milligan stated that Gilead would be "quite interested in things that would augment cellular therapy." He added that the company would not be "going quietly after this deal," with the business development group staying "very active" evaluating opportunities. You don't have to read between the lines to suspect that more deals could be on the way.
With cell therapy now the cornerstone of Gilead's oncology strategy, one obvious potential takeover candidate is Ziopharm Oncology (ZIOP +3.45%). Ziopharm has a solid pipeline of chimeric antigen receptor T cell (CAR T) and T cell receptor (TCR) therapies. However, Ziopharm isn't as far along with its development program as Kite is.
When Milligan has talked about potential acquisitions in the past, he has primarily discussed oncology but also mentioned inflammation and non-alcoholic steatohepatitis (NASH). It wouldn't be surprising if Gilead move forward with deals in either or both of these therapeutic categories.
Earlier this year, Gilead CFO Robin Washington stated that the company's top priority is to "focus on growth for the top line." The problem is that most of the possible acquisition targets in oncology, inflammation, and NASH wouldn't move the needle much in the near term for boosting revenue by themselves, meaning that Gilead would need multiple deals to make a significant impact.
3. There's plenty of cash to spend
Then there's Gilead's still-huge cash stockpile. The company reported cash, cash equivalents, and marketable securities totaling $36.6 billion at the end of the second quarter. Gilead plans to use a combination of cash, bank debt, and senior unsecured notes to fund the Kite Pharma buyout. Even if the biotech pulled only from its cash, Gilead would still have nearly $25 billion after acquiring Kite -- and that's before adding cash made in the second half of 2017.
John Milligan has stated in the past that "you can't buy shares back into prosperity." Gilead has done plenty of stock repurchases in the past, but don't expect the company to use much of its cash in this way going forward. And while Gilead is likely to keep its string of dividend hikes going, the company isn't likely to pour most of its money into higher dividends. The best use of Gilead's cash is in making more acquisitions that provide additional revenue relatively soon. You know it, I know it, and Gilead knows it.
Gilead could afford to buy Ziopharm Oncology at a similar premium to what it paid for Kite with its cash flow. It could buy several of the leading biotechs in NASH without making a huge dent in its cash position. The company could even afford to gobble up a couple of other mid-cap oncology biotechs without breaking a sweat.
I have thought for a while that a "string of pearls" strategy of acquiring multiple small and mid-sized biotechs could be a smart approach for Gilead Sciences. It seems that's the direction the company is heading down with the pending acquisition of Kite Pharma as the first pearl on the necklace.
