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Gilead Is About to Disappoint Investors -- but for All the Right Reasons

By George Budwell - Oct 8, 2015 at 9:06PM

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Wall Street is hoping Gilead is gearing up for a major buyout soon. One Motley Fool thinks this scenario is both unlikely and unnecessary. Here's why.

After a brief summer spike, Gilead Sciences (GILD 0.89%) stock has given back most of its gains this year and continues to be seemingly locked into a long-term relationship with $100 a share. The problem is that Wall Street appears to be becoming increasingly convinced that the hepatitis C market has already hit its high-water mark, meaning that the biotech's top line could suffer soon.

GILD Chart

GILD data by YCharts.

According to the army of analysts covering this stock, the Street thinks Gilead's earnings and product sales will essentially flatline over the next year. A deeper dive into the numbers, though, reveals a high degree of uncertainty over the drugmaker's top and bottom lines moving forward.

Gilead's estimated 2016 earnings per share, for example, ranges from $9.73 to $14.45. This projected EPS range is several orders of magnitude wider than many of the biotech's closest peers, illustrating just how much debate there is on the Street over Gilead's future growth prospects.  

Source: Gilead.

The basic issues underlying this gigantic EPS range are fourfold:

  1. The impact of AbbVie's (ABBV 0.42%) competing hep C drug, Viekira Pak, on Gilead's hep C franchise in 2016 and beyond is a big unknown.
  2. The potential introduction of Merck's (MRK 1.37%) experimental hep C therapy could negatively impact the market as a whole via further pricing discounts.
  3. No one has a good feel for how strong Gilead's ex-U.S. sales of its hep C drugs will be moving forward. After all, generic versions of Sovaldi are already available in dozens of low-income countries, and these steeply discounted pills could very well show up illegally in other emerging markets. 
  4. Sovaldi from countries with vastly lower prices such as India is apparently starting to show up in Western countries. As many patients are reportedly being denied access to the drug in the U.S., this trend may only grow stronger with time, hurting the biotech's top line.

All these potential headwinds facing Gilead's hep C franchise have contributed to the Street's uncertain outlook, and that's typically bad news for a company's share price. Put simply, the Street desperately wants clarity on Gilead's 2016 revenue before it allows the stock to finally leave $100 a share in the rearview mirror. 

Can we get an acquisition, please?
If you've been listening to the Q&A portions of Gilead's conference calls and investor presentations recently, then you're probably well aware that analysts have been constantly peppering management about a potential acquisition -- one so large it could immediately put these lingering revenue questions to rest. So, when Gilead took out a noteworthy $10 billion in new debt a few weeks ago, everyone seemed convinced that this was the lead-up to a major buyout. 

While I hate to dash the hopes of Gilead's shareholders, I find it highly doubtful that a major-league acquisition is on the horizon for this biotech. There are a couple of reasons.

First off, Gilead has dramatically increased its share buyback program and instituted a dividend this year. You don't start upping shareholder rewards when you're gearing up for a huge acquisition. That's plain bad business management, as it would tempt the credit agencies to slash your rating.

Next up, I think investors need to understand that a big buyout would be a massive departure from Gilead's playbook. The biotech's usual strategy is to buy smaller drugmakers with early-stage assets. So it's hard to see why Gilead would suddenly forget what got it here and take on a larger company with products already on the market. 

Perhaps the final nail in the coffin, though, is that there aren't really any good midsized biotechs or biopharmas that would immediately add to Gilead's earnings. Indeed, peers have faced the exact same problem. Nearly every acquisition this year is expected to be a drag on earnings in the short term. Put simply, a mid- to large-sized acquisition probably wouldn't solve Gilead's short-term earnings conundrum.

What's next?
My gut feeling is that Gilead's real game plan is to continue to develop its own clinical pipeline and perhaps add a few choice pieces via much smaller buyouts than the Street is hoping for right now. In this way, the biotech can use its healthy financial position to buoy its near-term earnings through share buybacks and grow its revenues organically, for the most part. 

While that's not as exciting a move as many investors are hoping for, I think it's a prudent one. After all, what investors see right now is a public tug-of-war between the Street's desire for short-term gains, and management's fiscal duty to guide the company to long-term profitability. 

Although a multibillion-dollar acquisition might help to juice Gilead's share price in the short term, the right conditions simply don't appear to be in place to make this a wise strategy over the long haul (i.e., there's no good buyout target for a compelling price).

Investors therefore might want to lower their expectations regarding Gilead's M&A aspirations and instead focus on the biotech's robust clinical pipeline, which sports numerous product candidates with blockbuster potential.

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Stocks Mentioned

Gilead Sciences, Inc. Stock Quote
Gilead Sciences, Inc.
$62.36 (0.89%) $0.55
Merck & Co., Inc. Stock Quote
Merck & Co., Inc.
$92.42 (1.37%) $1.25
AbbVie Inc. Stock Quote
AbbVie Inc.
$153.80 (0.42%) $0.64

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