Saturday, February 5, 2011

Are M&A's a Signal to Buy Stock in a Biotech Company?

We all knew this would be coming as we approached the patent cliffs of 2011 and 2012.  Big pharmaceutical and biotechnology companies would start buying smaller companies to access their drug and biologic candidates.  Recently, we have seen Johnson & Johnson buy Crucell, and Pfizer buy Seattle Genetics.  Then there is Sanofi-Aventis trying to buy Genzyme and Pfizer reaching a deal to buy Theraclone.  

It is interesting to notice that all these acquisitions concern antibody technology.  Antibodies have become the fad in biotech drugs making some believe that they are the silver bullets for cure of various ailments.  Antibodies are proteins manufactured and secreted by the plasma cells (a type of white blood cell derived from B cells) in response to an antigen (typically an exogenous substance).  Each antibody has specificity for only one antigen.  The purpose of antibody-antigen binding is to destroy the antigen either directly or by recruiting other white blood cells to do the dirty work.  Therefore, antibody therapy aims to either have the antibody kill the tumor or stimulate the patient's immune system to kill the tumor. 

We also know that antibody therapies are expensive and can rake in huge revenues for companies especially if the antibody is for relatively common disease states such as cancers.  Another advantage of pursuing antibody technology is to make generic versions difficult and expensive to design and manufacture.  Small molecules are the most common forms of drugs, and they are much simpler to copy than biologics.  As a result, the patent life is in essence extended and less expensive generics or biosimilars do not reach to the market as quickly.

According to a recent Wall Street Journal article, several biological drugs with $60 billion in annual sales will be off-patent by 2015.  Spectrum Pharmaceuticals ($SPPI), Sandoz, and Teva Pharmaceuticals ($TEVA) have all begun designing and testing generic versions of Roche's Rituxan, which is a very complex antibody.  Due to the nature in which biologics are made, generic versions are not carbon copies of the brand drug.  Biologics are designed and manufactured using live cells and not following a chemical recipe that is used to make small molecule drugs. 

This slight difference in chemical structure and possibly function raises issues on how the FDA will review applications for biosimilars.  It would be expected that there will be a need for a modified Abbreviated New Drug Application (ANDA). 

Currently, it may be worth the risk to invest in small biotechs working on biologics and with a possibility of being acquired by bigger companies.  This of course requires a lot of research into the financials and scientific publications of the companies and the ability to evaluate if there will be interest in acquiring the technology.  Investing in small start-ups can be lucrative for investors willing to take the risk.

Longer term investments may be better in those companies that are acquiring these start-ups and technologies.  Larger companies such as $JNJ. $MRK, and $PFE are cutting their R&D costs, decreasing their payrolls and trying to be in better financial position as many of the executives will soon be retiring and want to be compensated nicely.  Investors should decide whether the companies are overpaying for drug candidates and technology.  It takes around $800 million to bring a drug to market.  A company is saving costs if they acquire a drug and complete clinical trials for less than that amount.  An article by EJ Emanuel et al. published in the Journal of Clinical Oncology calculated that the average cost of a phase III trial was around $6,000 per subject enrolled.  It is difficult to predict the correct price for acquiring a drug.  The seller will stress the potential of the candidate, which can be much higher that the $800 million average of bringing a drug to market.  It is good news for investors that larger companies typically buy the smaller biotech firms and thus not only acquiring the main drug target, but other drug candidates and technologies being developed.  These larger companies typically pay dividends and are safer investments (beta < 1).  An investor can diversify by simply buying some shares in smaller, riskier companies, and also buying shares in larger companies.      

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