Monday, March 30, 2009

The Biotech M&A Pipeline

The $46.8 billion Roche/Genentech merger is hailed as a sign of biotech's maturity--two substantial companies joining forces. But a closer look shows that this deal is much like the big pharma mergers which generate short-term balance sheet improvements and massive lay-offs. The major biotechs share big pharma's desperate need to fill their pipelines with someone else's innovations.

Biotech mergers and acquisitions typically occur when the market is in a down cycle and smaller companies are pressed for cash to complete product development and commercialization. Acquirintg companies should make their purchases when their stock price is high eneough to avoid diluting existing shares (and hurting existing shareholders).

In a down cycle, the big biotechs are seen as safe havens and remain pricey. In our opinion, they have a long way to fall before their prices look like bargains.

The way to play biotech now is to head to the 'Tier 3" players. In this group, we like Endo Pharmaceuticals (ENDP) and Techne (TECH). We recently wrote about ENDP and believe the company has a big potential. The Tier 3 players generally have lower valuations, cash, decent partners, experienced management, and a deep pipeline. ENDP is trading close to its 52 week low.

If you want to make it big is biotech, a basket of smaller companies and a lot of patience is the way to go.

Disclosure: At the time of writing, author has no financial interest in any company mentioned here.
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