(Published this am in Seeking Alpha)

Onyx Pharmaceuticals (ONXX) $10.4B Buy-Out Fuels Speculative Deal Lists

We have written extensively on the life science bull market and its underpinnings: cheap money, scientific breakthroughs, sales growth and of course, M&A. The recent acquisition of Onyx Pharmaceuticals, Inc. by Amgen, Inc. has triggered analysis and commentary on the economics between big pharma and emerging growth biotech as well as a target list of potential acquisitions. On August 27,  the Wall Street Journal provided analytics on the ‘No Drama” AMGN/ONXX deal and other “Biotech Buys” saying that it was notable for ” …what didn’t occur: a bidding war among multiple suitors…”  The article points out that there may be a ceiling to buy-out valuations and a more disciplined approach. The M&A trend is bound to continue as not all mid-cap biopharmaceutical companies have the resources to invest heavily in both marketing and R&D as they ramp up the commercial phase. The sweet spot for buy-outs continues to be the upper mid-cap range where pipelines are robust and sales growth can be more easily forecasted. The market also perceived the deal to be synergistic because the Amgen stock price went up after the announcement.  Big pharma has wisely balanced their R&D investments with biotech partnerships and increasingly have their own pipelines focused in biologicals.

One cautionary note may be that the raging biotech bull market (up ~40% YTD) has stretched valuations to the point where valuation and risk needs more careful consideration. Caveat emptor to MBAs and analyst types: deep financial analysis of biopharmaceutical valuations are only one parameter of a Company’s value. Pipeline is critical as we saw in the Onyx deal because their track record for approval was excellent and there are 9 drugs in the Phase 2/3 pipeline for thyroid, liver and breast cancer as well as multiple myeloma.

This bull market is more about top down and momentum investing and not value driven. Biotech is a hot sector driven by news, sentiment and fund buying. Funds of all types need to be in the sector because growth companies are in short supply and M&A just adds another catalyst.

Many pundits and analysts have come up with a “hit list” of acquisitions and CNBC’s Cramer recently suggested on August 27 BioMarin (BMRN), Medivation (MDVN) and Seattle Genetics (SGEN $42.85). Seattle Genetics has been on the Rayno focus list since 2/2/09 at a price of $9.50.

Here is a list of selective well known, “mid-cap” companies that have strong pipelines, unique technology and growth potential. Now we have an excellent benchmark in the Amgen/Onyxx deal to compare valuations going forward. Note that the peak value of Onyx (ONXX) stock prior to the Amgen (AMGN) news was $100, so the buyout had a 25% premium over average 2013 stock prices.

Company Ticker Price $ Market 2013/’14 Est P/S* SE DiseaseFocus Ph.2/3
Cap $B Revs  $B $B Pipeline
Onyx ONXX 123.6 9B (10.4) 0.634/0.876 17.5 1.14 Oncology 9
Alexion ALXN 107.8 21 1.53/1.91 15.9 2.2 ultra-rare diseases 6
BioMarin BMRN 65.5 9.13 0.55/0.67 17.8 1.26 orphan drugs,oncology 4
Incyte INCY 33.9 4.82 0.35/0.512 13.9 -0.3 oncology,inflammation 12
Medivation MDVN 56.5 4.24 0.243/0.404 19.4 0.61 oncology 5
Pharmacyclics PCYC 111.5 8.13 0.170/0.327 37.3 0.21 oncology,autoimmune 6
Regeneron REGN 242.3 23.67 1.94/2.49 13.6 1.5 ophthalmology,RA,etc 5
Seattle Genet SGEN 42.4 5.14 0.243/0.278 21 0.24 oncology 9

*Price to Sales needs to be recalculated for 2014 estimates.

Here are some preliminary comments on this chart:

  • Price to Sales: with ONXX as an M&A standard and using their 2014 analysts revenue forecast the P/S would be around 12. BioMarin (BMRN) has a current market cap of $9.13B and 2014 forecasted revenues of $670M giving it  a premium P/S of 13.6. For example, one should look at the BioMarin pipeline and market niche to justify the premium.
  • Shareholder Equity (SE) : normally we do not think of balance sheets in reviewing biotech companies but it is a measure of capital allocation, debt and cash reserves. Incyte (INCY) has good cash reserves but is leveraged with $223.8M of debt and negative shareholder equity.
  • Disease focus and Pipeline: Both Alexion and Biomarin are focused in orphan drugs or “ultra-rare” diseases a unique niche first developed by Genzyme which was sold for $24.2B to Sanofi-Aventis in in 2010. Many large drug companies are not focused in this area.  Seattle Genetics (SGEN) as well as Immunogen (IMGN) are in a unique niche of oncology drugs called ADCs or antibody-drug conjugates with broad applications. A financial analysis of pipeline drugs  post Phase 2 can still be a difficult undertaking.
  • Momentum investing: Pharmacyclics (PCYC) stock has soared 93% YTD as funds seek new names and identify product breakthroughs that elude financial analysis. The stock chart tells the story here.
  • A few larger biotech growth companies such as Regeneron (REGN) may actually become acquirers as their revenues, pipeline  and financial strength can attest.

Deals such as AMGN/ONXX provide a new benchmark for the difficult task of analyzing biopharmaceutical valuations. Unlike many other sectors of the stock market, financial metrics such as sales growth are hard to forecast beyond one year and looking at valuations can be misleading. A deeper knowledge of product pipelines combined with stock chart analysis can help complete the picture for investors and traders. But a momentum market requires a different mentality and at times you must trade without a complete analytical framework.

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