3 Takeover Candidates in the Drug Space

 | Jan 08, 2017 | 2:00 PM EST
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This commentary originally appeared on Real Money Pro at 7 a.m. ET Friday, Jan. 6. Click here to learn about this dynamic market information service for active traders.

We expect quite a number of M&A deals in the health-care sector in 2017. In particular, the pharmaceutical and biotechnology space will see heightened levels of activity as major industry players such as Gilead Sciences (GILD) , Johnson & Johnson (JNJ) , Pfizer (PFE) , Merck (MRK) and Novartis (NVS) look to restock their portfolios.

The pathway has likely been further cleared with the recent election of Donald Trump and a Republican Congress, as deals will accelerate after years of regulatory roadblocks under the prior administration.

While we expect much of the activity in the small- and mid-sized names, many of their valuations are pretty rich, and the value lies in betting on their pipelines, which is tougher to handicap.

Our focus today is on some of the larger companies that we also think are vulnerable to takeover activity in the upcoming year.

Three names that we find particularly interesting are Eli Lilly (LLY) , Bristol-Myers Squibb (BMY) and Biogen (BIIB) . These are big companies in their own right. LLY generates $21 billion in revenues and has a market cap of $82 billion. BMY generates $20 billion in revenues and has a market cap of $98 billion. BIIB generates $12 billion in revenues and has a market cap of $64 billion.

Nevertheless, these could be attractive to some of the largest players like Johnson & Johnson, Pfizer, Merck and Novartis, who need bigger acquisition targets to really move the needle.

Investors are bullish on Lilly as several new product launches have recently hit the market, including Trulicity for diabetes, Taltz for psoriasis and new indications for cardiovascular risk in its diabetes drug Jardiance.

Following up these launches is an already strong set of core existing drugs in diabetes, oncology and animal health that are expected to report solid growth in the upcoming years. Lastly, one shouldn't count out Lilly's programs in Alzheimer's, even though they did have a major setback in one of their programs late last year.

The shares aren't cheap at 18.4x earnings. However, Lilly sells at this premium for the high likelihood of a larger company looking to acquire its first-rate cabinet of medicines and for hopes of a big hit in its pipeline.

Bristol-Myers Squibb is also at the top of the takeover heap and selling at an even larger premium at 20x earnings. The big attraction of BMY is its extensive portfolio of immune-oncology (I/O) drugs, led by Opdivo and an Opdivo/Yervoy combination therapy.

Opdivo surprised investors this year by not hitting its lung cancer endpoints. Nevertheless, analysts believe this product will come to market and be a major drug in the space. Furthermore, the Opdivo/Yervoy combination therapy should also be a success. This is in addition to several other key I/O patents, drugs and clinical trials.

To any of the larger players looking to be a key player in the next revolution in oncology via the I/O drugs, Bristol-Meyers Squibb is the most logical acquisition candidate.

Last on the list, Biogen keeps popping up in the rumor mill. The company is the smallest in the group and is best known for its multiple sclerosis drugs, such as Tysabri, Tecfidera and Avonex. The company trades at the lowest valuation of the three discussed at just 14x earnings as key franchises continue to mature and are expected to go generic over the next several years.

Although less dynamic that some of its peers, we think there is real value to their stable product set and emerging pipeline of products in multiple sclerosis and Alzheimer's. The smaller size and attractive valuation level make it a top-of-the-list candidate.

While much is already being priced into potential deals for any of these three potential takeover candidates already occurring, an acquirer will still have to pay a 15% to 20% premium to get a deal done -- so there is still some upside in these names if transactions occur.



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