Investors Just Doubled Their Money on This Stock

With biotech research on the rise, Alexion Pharmaceuticals (ALXN) sure seems to have the market covered. The rarest of diseases are being treated with some of the most expensive, and most effective drugs on the market.

As Alexion has purchased Synageva (NASDAQ: GEVA) with a price tag of $8.4 billion, some investors might think this is a great buy. But with $0 in sales for upcoming miracle drugs, not everyone is convinced the cost of the deal was worth it. Join Michael Douglass and Todd Campbell in today's Healthcare edition of Industry Focus to see how they think it will all pan out.

A full transcript follows the video.

Michael Douglass: How investors just doubled their money in this stock. This is Industry Focus.

Hi, Fools! Healthcare analyst Michael Douglass here for the health care edition of Industry Focus. Today is Wednesday, May 6^th and I have on the phone with me Todd Campbell from New Hampshire.

Todd, how's it going?

Todd Campbell: Everything's in bloom up here in New Hampshire which means we're full-fledged into allergy season.

Douglass: Which means that things are getting hot and humid down here in Virginia. Thanks for rubbing it in though. So, it goes.

All right. Interesting news in the market today, actually. Alexion Pharmaceuticals -- that's ticker ALXN -- reported today that it had agreed to buy Synageva BioPharma Corp or $8.4 billion, which was about twice what Synageva's market cap had been the day before. Which is really an incredible premium as you can imagine.

A nice windfall, so congratulations to any Synageva BioPharma investors out there. You seem to have picked quite the winner. What I wanted to do today was talk through the deal a little bit, and then let's talk about rare diseases, buyouts and how to think about this kind of thing in health care.

I think first off, the most important thing for any investor to know is, here at The Motley Fool -- and I would say certainly for me, personally, when I'm investing -- and Todd, you can speak to your experience -- but really discourage people from buying a company because they think it's going to get bought out because all to often that doesn't happen.

Shire plc (NASDAQ: SHPG) last year -- that's ticker SHPG, I believe -- AbbVie (ABBV 0.89%) had indicated it was going to buy up Shire, Shire soared enormously on the news, and then AbbVie ended up backing out of the deal when tax inversions were made more difficult by the U.S. federal government and Shire lost 20% in a single day.

So, I think the first -- the key thing, even though we're talking about a buyout and what a great thing it was for Synageva BioPharma shareholders -- one of the key things to remember is that you really shouldn't buy a stock based on the fact that you think it could get bought out. Look at the underlying business.

Hopefully that means that somebody else wants it because you're willing to put your money into it, and hopefully other companies will want to as well. But it's important to pay attention to those underlying business operations and to use that as the crux of you investment thesis.

Campbell: Yeah. Merger-mania is not a good strategy. You absolutely don't want to just blindly go out and buy any bio-tech that you could come across thinking "Wow! There's 100% premium deal coming down the road." It just doesn't work that way.

In this case the acquisition, there were some real reasons that it was attractive to Alexion and I think, sure, maybe we can draw some broad brush stroke conclusions at what that might mean for some other, ultra-rare disease players in the space, but like you said, always better to start with "Are there drugs currently approved by this company on the market? How much are they generating in sales? Are those sales growing?"

Douglass: Right.

Campbell: What does the balance sheet look like? What's coming in the pipeline? What are they working on that's going to fuel growth going forward? Those are the three things that biotech investors really need to be focused on. If people that thought that biotechnology stocks were overvalued heading into today, then they really think they're overvalued now.

This deal -- $8.4 billion for a company with $0 in sales.

Douglass: Yeah. As often happens with biotech buyouts, there's immediate-- a lot of commentary from folks saying "Well, is that really a fair price for the company?" I've got to say, personally, it's hard to say right now because so much has been done in that pipeline. But the fact of the matter is that Alexion has been a really, really good at one thing.

That one thing is Soliris. What they've just done with this drug is expanded it in rare disease after rare disease, after rare disease. It's got a price tag of over half a million dollars a year for patients. It's just for these ultra-rare diseases. You don't really see insurers complain too much about the cost because they've only got a handful of people who have whatever disease it is that Soliris is treating in whatever individual case.

Synageva works in that same space. So, it makes sense for Alexion whether or not the price tag makes sense again. We'll know further on, but it's definitely consistent with our current strategy.

Campbell: Yeah. I don't think any company in biotech has done a better job, if you will, of discovering, or increasing the patient populations that their drug can treat. You look at what they've done with Soliris and it's really amazing. They've taken a drug that at one point they thought "Well, maybe this will treat 1,000 people or less." Now they're generating -- I think they're on pace now to do $2.4 billion in sales from that one drug alone.

That's come from expanding the label to other indications, but it's also come from discovering more patients that are afflicted with these conditions. I think that's one of the reasons they're so interested in buying Synageva, because they're looking at Synageva's most advanced product, which is Kanuma. That's in front of the FDA and the EU regulators for approval.

Those approvals theoretically should come this year. I think the FDA one's expected in September. The thing that Synageva's been saying over and over again is "This is an underdiagnosed condition." Basically what it is -- what this drug treats -- is very rare enzyme deficiency. So, this is an enzyme replacement therapy. This is an inherited disease, there's no --it's called LAL D -- there's no approved therapies for it and what they're thinking is "If we can get this approval, and we've just bought this company, and we already know how to expand patient populations thanks to our experience with Soliris. I but we can get sales of this to go even higher than people are expecting."

Some people think the disease, LAL D, is responsible for things like fatty liver disease that can actually cause liver failure, etcetera. A lot of people think that people who are diagnosed with ultrahigh levels of cholesterol may be being misdiagnosed. They're actually suffering from LAL D. So, there's a lot of ways theoretically they could expand and get some extra value out of this.

That being said, by Synageva's own admission, they're targeting-- they pulled out and said "Look at all the other enzyme replacement therapies that are out there." They typically do in the $300 million to $600 million a year range. So, if we assume that's going to be the case with this drug -- assumptions are always a little shaky -- then you're still talking about a pretty remarkable valuation that Alexion's paying.

Nonetheless they think it's worth it. They think that's going to be a credo to their earnings within three years. I think they said '2018'. So, they see the value in it. Time will tell whether or not that's true.

Douglass: Yeah. The 2018 number, I'm sure a lot of folks -- particularly if you're familiar with Valeant Pharmaceuticals (BHC -2.76%) that is usually try not to have earnings of creative deals very, very quickly. The 2018 number, I'm sure, seems kind of like a red flag. But to my mind, when you've got a drug that isn't yet on the market, and it's going to take a lot of marking build out, you're going to have to expand your sales force -- or at least cross train them -- that makes sense.

Campbell: Yeah. When Sanofi (SNY 1.84%) stepped up and bought Genzyme -- again, another company that made its notoriety from treating rare diseases. They also said it's going to take two or three years before this [...] of turning. I think that you're right. Where you're talking about a brand new drug that hasn't even hit the market yet, you have to expect that here's going to be some cost associated with getting that up to speed and that it will take a little bit of time.

The other thing is that they think they're going to be able to save about $150 million in overlapping, by cutting costs here and there from overlapping Synageva and all that fun stuff.

Douglass: Yeah. And frankly, you just look at this and you've got to think "Alexion" -- my suspicion, for what it's worth -- is that Alexion knows what it's doing here. Again, they've turned Soliris -- it has two indications -- and they've been able to turn it into a multibillion dollar drug. I personally wouldn't bet against them.

I know the market is today. I think they're down 10%, or something like that as of last time I checked. I would be very interested to watch. I think that September 2015 PDUFA date for Kanuma will definitely be a date for investors to circle on their calendars.

Campbell: I think the other thing investors should be keeping an eye on -- or paying attention to here -- is that these companies and these deals and the drugs that are coming up through there -- this is all really fascinating because you're talking about what's going on in health care overall. You've got ultra-rare diseases, very small populations, with huge price tags associated to them.

You've got BioMarin, who's another one in this space and they've got drugs that are selling for $450 thousand a year. This is going to be high priced, too. Orphan drugs are attractive and as a result they do deserve somewhat of a premium in the market. They get a little bit extra exclusivity, they get a faster review period, there are benefits, tax credits that they can take advantage of.

So, there's a lot of moving pieces that go into why they're paying as much as they are for this company versus what another biotech may pay for somebody else. I think that's something that investors ought to remember.

Douglass: Yeah, and the fact of the matter is, in a lot of the market -- I think particularly in financials, utilities, energy, industrials; you get a lot -- you can value companies pretty reasonably based on the growth curve.

What they're doing in terms of earnings, free cash load, perhaps what they've been doing for the last few years, what it looks like the next couple years. In health care, and I'd say in tech, it's just difficult, frankly. You just have so much uncertainty about what the future could hold, both to the upside, and to the downside.

But Alexion, definitely a generally good company, and one that I would be hesitant to bet against, as I've said. I think a point that you made, Todd, that I want to highlight again; rare diseases is a growing market. It's a big market. It's one that you've got a lot of folks pretty excited to get involved in.

Shire PLC, which I mentioned earlier in the show, also plays in rare diseases. You mentioned Sanofi's Genzyme unit, and you've got some other players as well. It's definitely an area where there's an opportunity to really serve a small niche of the population and also do very well by your shareholders at the same time.

Campbell: Yeah. EvaluatePharma did a study last year and they're saying that the compounded annual growth for orphan drugs is probably going to run around 11% a year through 2020. By 2020 that market will be worth about $176 billion. So, this is not small by any measure. That growth rate is definitely going to be faster than the typical prescription drug market. They'd double it.

Douglass: Yeah. That's -- yeah. Lots to think about. Definitely, one of the big growth areas in health care that, frankly, one of those big trends in health care that folks are going to want to watch over the next few years, along with diabetes -- here in the United States, of course -- the increase in health insurance, biosimilars; you've just got a number of really big drivers for health care over the next years and decades that we'll want to watch closely.

Todd, we could probably do a show on each of them. Maybe that's something for us to do as things settle down a bit in the summer. Something to think about. Todd, as always, thanks for your time and your commentary here. It's always greatly appreciated by me, and I' sure by our listeners.

Folks, as always, if you have any questions, or something on your mind, shoot us an email. [email protected]. That's "H-C -- health care -- @fool.com", we'll be happy to feature your question on the show, talk about it.

I love getting mail. We're happy to do anything --ask us a question and we will do our level best to answer. As always, one of the things we're all about here at The Motley Fool is making sure that everyone is empowered, and that everyone does their own due diligence. Never, ever, ever buy or sell a stock based on just what you hear on the radio, or in a podcast.

Always do your own due diligence. Of course, the companies that we mention -- either Todd, or I could own them, or have options on them, as well The Motley Fool could have an active recommendation, or could own shares.

With that said, folks, thank you for listening to Industry Focus today. We'll look forward to seeing you on Friday. Until then, check back at Fool.com for all your investment needs, and Fool on!