Investments in small capitalization biotechnology companies are fraught with risks. Most bio-techs rely on a single or a few trial candidates to determine their entire valuations. With little or no revenues, the downside to these stocks is immense. A major chuck of the bio-tech investment risk is due to the uncertainty surrounding the outcome of drug trails. The outcome of these drug trials is detrimental to valuations, and results are very hard to predict.
A way around this uncertainty is to invest in big pharmaceutical giants or large capitalization generics. Generic drug manufacturers bypass the uncertainty associated with drug trails and only manufacturer already approved products. While the margins in this segment are relatively lower, the risk associated is also significantly lower. Actavis (ACT +0.00%) is a pharmaceutical giant which focuses on generics and is a good investment for those weary of high risk associated with bio-techs.
Biosimilars
The company is also focused on developing biosimilars, under collaboration with Amgen to develop and commercialize Bio-similar versions of Avastin, Erbitux, Rituxan/Mab Thera and Herceptin. The company, however, expects to launch the first biosimilar product with Amgen somewhere in 2017. The primary aim of bio-similars is to reduce the drug price by providing a similar treatment with a different compound (somewhat like small-molecule generics, although these drugs are merely 'similar' instead of the same).
While the opportunity in this market is huge, there are a number of unanswered questions. The new compounds might be able to reduce the drug price but the actual reduction remains uncertain. An even bigger problem is the type and magnitude of testing the FDA will demand for the bio-similars. Drug testing is one of the primary costs behind developing a new drug and is in many cases a pretty lengthy process.
Fundamentals and potential risks
The primary factor behind the recent popularity of Actavis has been a steady increase in company revenues. During the last financial year revenues have increased a whopping 47% year over year. The company has cash and equivalents of approximately $340 million as of March 2014 and positive cash flow.
Actavis is involved in a number of lawsuits, as are many pharmas. A court ruling against Actavis in any of these cases is bound to cause a share drop and adversely affect the operations of the company. The company also has expanded operations worldwide and is subjected to risk of foreign currency fluctuations, interest rate changes, and market risks associated with the area of operations. These risks can have a damaging effect on the cash flows and operations.
Bottom line
Actavis is a good investment for market players weary of the high risk associated with bio-tech companies. Actavis' shares are currently trading at a lower than market forward P/E of 12.6x, which looks pretty cheap to me given the revenue growth. Comparatively most biotech companies have no earnings and greater risk because they are usually trading on the assumed potential of their trial candidates.
The company recently completed the acquisition of Warner Chilcott, an Irish drug maker, for $8.5 billion stock-for-stock. This acquisition has expanded the pipeline of the company and is expected to increase the company's earnings per share by 30% in the year 2014. Following the acquisition, the U.S. Specialty Brands sales organization was restructured with a 350-person cut in sales positions. All in all, this acquisition provides major benefits to the company and will help it to grow further, not only through pipeline expansion but also financially. The primary financial benefit of this deal comes from the reduction in Acatvis' effective tax rate. Additionally, Actavis is currently in the process of acquiring Forest Labs, and investors will want to watch closely to see what additional benefits are wrung out of that acquisition.
Overall, the company is well positioned for further growth, with a strong pipeline, vast portfolio of products and rights collaborations and acquisitions. The company is also performing well financially with increased revenue and cash flow. I think it's a worthy addition to any Fool's watchlist.
