Buy Now! It Might Get Bought!

Wow. Johnson & Johnson (NYSE:JNJ) decides to take out Cougar Biotechnology, and suddenly everyone is rushing to invest in development-stage drugmakers again. Just look at these price moves from Friday.

Source: CAPS and Yahoo! Finance.

I can't find any news to suggest that these companies were really worth more Friday afternoon than they were Thursday night, so it seems that investors were buying them in hopes of a takeout offer.

Not so fast
Sometimes it's rational for news from one company to move the stock prices of an entire industry. When Wal-Mart Stores (NYSE:WMT) reports good earnings, for instance, it's reasonable to expect that other discount retailers will have similar results. It doesn't always happen, but at least it's a sensible bet.

But to expect that Johnson & Johnson's purchase will set off a flurry of additional acquisitions is just ridiculous. In fact, that outcome is somewhat less likely, because there's $1 billion less available for acquisitions, now that Johnson & Johnson has agreed to spend it.

Wyeth and Schering-Plough are almost certainly out of the acquisition market, and their acquirers, Pfizer (NYSE:PFE) and Merck (NYSE:MRK), are probably a bit too distracted to make offers right now. Bristol-Myers Squibb (NYSE:BMY) has plenty of cash, but it seems more interested in licensing drugs than buying companies outright -- a good move, in my opinion.

That's not to say further acquisitions couldn't happen. Heck, all four of the companies in the above table could get bought in the near- or medium-term future. I'm just not convinced that such a possibility is more likely today than it was last Thursday.

Buyer beware
Even when companies put a for-sale sign on their front lawn, it doesn't guarantee a price premium: Remember Biogen Idec (NASDAQ:BIIB)? Investors who bought around $75, on news that the bidding process had begun, have seen pretty much all red since then. A bid failed to materialize, and other problems have hampered the company.

PDL BioPharma also put itself on the block, and while it was able to find buyers for some of its assets (and returned that cash to shareholders), it was never able to monetize its largest asset: the royalties it receives on humanized monoclonal antibodies. Instead, it spun off its pipeline into Facet Biotech, and it's running PDL as a holding company, distributing the royalties as dividends to investors. That's not exactly what investors who bought in late 2007 were expecting.

Granted, PDL and Biogen Idec are larger than the companies above, and Biogen Idec has some complex partnerships that made an acquisition rather difficult. But it's still a reminder that a deal isn't guaranteed, and that the prospects of an acquisition premium aren't the best reason to hit the "buy" button.

That said …
Investors who bought into those companies on Friday may not be making a huge mistake, even if they're investing for the wrong reasons. Many development-stage drugmakers are down 50% or more, without any substantial negative news.

It all comes down to risk. Wall Street seems to fear that the development-stage companies won't be able to get additional financing, and investors aren't willing to take on that additional risk. After losing so much, many investors clearly feel safer sitting on the sidelines.

Longer-term investors who are willing to take on risk now could make a killing from here. As investors become less risk-averse, money will flow back to development-stage drugmakers, and secondary offerings will be more feasible, allowing them to continue operations without selling themselves.

Still, clinical trial results and FDA approvals ultimately drive any increase in drugmakers' value. That's what investors should focus on. The potential for an acquisition should be nothing more than icing on the cake.