In the second quarter of 2015, the value of takeovers in the pharmaceutical and biotech sector topped US$1 trillion. And now Montreal-based drug giant Valeant Pharmaceuticals is offering US$1 billion in cash for the maker of Addyi, popularly thought of as women’s Viagra. This prompts portfolio manager Elvis Picardo, vice president, research, at Global Securities Corp. in Vancouver, to wonder if Valeant has climbed too far, and, is the wave of mergers among top healthcare stocks ending.
I don’t claim to have a crystal ball. But back in early spring, I wrote that the ongoing wave of mergers could put the raging bull back in its pen.
Just consider what happened in the wake of two recent bouts of merger frenzy: from 1999 to 2000 and from 2007 to 2008. After both ended, stocks went into a tailspin.
In the second quarter of 2015, the value of mergers topped US$1 trillion, making it the fifth straight quarter in which they blew past the trillion-dollar mark. It was also the best streak since at least 2003.
In fact, in seven out of eight successive quarters from 2007 to 2008, the value of mergers and acquisitions exceeded US$1 trillion.
Merger frenzy among top biotechnology stocks
No other industry better represents this frenzy than the red-hot biotech sector, where companies have been falling over each other to snap up their rivals. Not only has this driven up biotechnology stocks across the board, but it has resulted in biotech indexes trouncing the S&P 500 over the past five years.
For example, from June 2009 to mid-August of this year, the NYSE Arca Biotechnology Index posted total returns of 494 per cent, or 33.5 per cent a year, while the NASDAQ Biotech Index returned 441 per cent, or 31.4 per cent a year. By contrast, the S&P 500 hit the tape at just 153 per cent, or 16.2 per cent a year.
And although it might seem otherwise, there are valid reasons for the biotechnology stocks surge. For starters, baby boomers are aging. Moreover, they have the financial clout to afford remedies for many ailments that afflicted their grandparents.
Outrageously expensive cures for chronic diseases
As a result, many companies have introduced novel treatments for a host of chronic illnesses — treatments for which they expect to get top dollar.
The poster boy for being a hot biotech stock, as well as for charging outrageous amounts of money, is California-based Gilead Sciences Inc. (NASDAQ─GLD). For instance, Gilead now charges US$94,500 for a 12-week course of Harvoni, its drug for treating hepatitis C.
Not only does Harvoni cure the majority of people with the most common type of hepatitis C in only three months, but it does so with few major side effects.
Moreover, Harvoni’s predecessor, Sovaldi, which was OK’d by the U.S. Food and Drug Administration in December 2013, was no bargain either. It cost US$84,000 for a 12-week course of treatment, or exactly $1,000 a pill.
With over three million hepatitis C victims in the U.S, as well as more than 150 million elsewhere in the world, the illness is obviously a money-maker. Sales of Gilead’s hepatitis C drug hit US$4.6 billion in the first quarter — double that of the year before. And the company now sees its revenue for 2015 ranging between US$28 and $29 billion.
Gilead’s market cap has soared six fold over the past five years, peaking at US$180 billion earlier in 2015, leaving many older health-care companies in the dust.
Gilead’s stunning success has made it the target of a growing backlash from patients who cannot afford the medication, or who are refused coverage by insurers.
But patients with chronic illnesses are clamouring for novel medications, even if they cost thousands or tens of thousands of dollars — provided, of course, that their insurers pay up. After all, what price can be put on getting cured of a severely debilitating illness, or a terminal one?
Orphan drugs for treating rare diseases
At the other end of the spectrum, outfits that specialize in orphan drugs — that is, drugs for treating rare diseases — have also been raking in the cash. That’s because insurers aren’t averse to paying for these treatments, given that rare diseases, unlike say, cancer, affect only a small part of the population.
Moreover, orphan drug makers face little, or no, competition. Besides, they often receive tax breaks, years of market exclusivity, as well as fast-tracking by the FDA. Not surprisingly, EvaluatePharma, a U.K.-based provider of market intelligence, sees global demand for prescription orphan drugs jumping to US$176 billion over the next five years — an increase of more than 60 per cent.
A recent stand alone entrant in the rare diseases market is Illinois-based Baxalta Inc. (NYSE─BXLT), which was spun off from Baxter International Inc. (NYSE─BAX) on July 1. Baxalta boasts a superb portfolio of treatments for rare diseases — treatments that are pricey.
For example, Advate, its drug for treating hemophilia A, which affects only 20,000 Americans, can cost between US$200,000 and $500,000 a year, although insurers will reimburse patients.
Shire jumped the gun
In the Aug. 14, 2015, issue of Investor’s Digest of Canada, I recommended Baxalta as a best buy at $31.19. Although Baxalta’s potential as a takeover target was a major reason for my bullishness, the takeover occurred much earlier than expected, with Shire plc (NASDAQ─SHPG) making a US$30 billion bid just days later.
In making its all-stock offer, the U.K. drug giant cited Baxalta’s three growing businesses focused on rare diseases: hematology, immunology and oncology. Shire also noted that with Baxalta likely to launch new drugs by 2020, the latter’s sales were forecast to jump to US$2.5 billion over the next five years from $200 million in 2015 — a rise of more than tenfold.
Under Shire’s offer, Baxalta stockholders would get 0.1687 Shire American Depositary Receipts for each of their shares. Not only does this imply a value of US$45.23 per Baxalta share, but it represents a premium of more than 36 per cent over the company’s share price on Aug. 3.
Although Baxalta confirmed it had received Shire’s proposal one day later, its board of directors turned it down, saying it significantly undervalued the stock. And although Baxalta traded at over US$40 a share in the days that followed, the stock has since fallen back in the face of recent market turmoil.
Some market observers now believe that to get the deal done, Shire will have to make a friendly bid at roughly US$50 a share. Still, there’s little doubt that Shire wants Baxalta, as the combined company would be the global leader in rare diseases.
New holder of ‘Canada’s biggest company’ title
Now let’s look at Valeant Pharmaceuticals Intl. Inc. (TSX─VRX), a Montreal-based outfit that has built itself into Canada’s biggest company by relentlessly hunting and swallowing up others.
Indeed, on July 24, Valeant zoomed past that titan of Bay Street, the Royal Bank of Canada, to become this country’s biggest company by market capitalization.
Valeant rose more than nine per cent that day after reporting second-quarter results that exceeded analysts’ expectations. In fact, thanks to the price surge, the company hit a peak market cap of $116 billion.
Valeant’s latest purchase is a billion-dollar wager on Addyi, a drug used to treat low libido in pre-menopausal women — in effect, a women’s version of Viagra. Just two days after Addyi received FDA approval, Valeant agreed to pay US$1 billion in cash for Sprout Pharmaceuticals, the North Carolina-based maker of the Viagra look-alike.
But Addyi reportedly has limited efficacy. It also comes with side effects so severe that it carries a “black box” warning, the strictest one mandated by the FDA. That body also requires both doctors and pharmacists to be trained and certified before administering Addyi.
Will Valeant be able to surmount these hurdles? The company has confounded critics of its growth-by-acquisition strategy by repeatedly beating analysts’ forecasts, as well as by posting rapid organic growth. During the second quarter, for example, Valeant’s organic growth topped 15 per cent for the fourth consecutive reporting period.
But can Valeant sustain its sizzling performance — one where it notched total returns of 136 per cent during the 12 months leading up to Aug. 21? If stock markets continue to shed their gains of the past six years and both biotechnology stocks and pharmaceutical stocks follow suit, it may turn out that the company paid too much for its recent acquisitions.
In any case, the biggest-company-in-Canada title comes with its own baggage, as shown by now-disgraced Nortel Networks whose top-dog status in 2000 epitomized the excesses of the high-tech bubble. And although Potash Corp. of Saskatchewan also made it to the top — in 2007, you’ll remember — it too proved to be a “bubble” stock.
Moreover, the risk of overpaying for a biotech stock because of its sky-high valuations means that stockholders may find greater returns by owning outfits like Baxalta that are being hunted, rather than owning a company like Valeant that’s a perennial hunter.
Investor’s Digest of Canada, MPL Communications Inc.
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Investor's Digest of Canada •9/24/15 •