Health care is rife with deal activity, but is the biotech group being shunted aside? The $41 billion merger between Merck ( MRK) and Schering-Plough ( SGP) announced Monday is a story investors have seen before: Two large pharmaceuticals firm consolidate in order to cut costs, diversify and stave off looming competition from cheap, generic copies of their most successful products. Six weeks ago, Pfizer ( PFE) acted similarly when it decided to acquire Wyeth ( WYE) for $68 billion. Biotech investors are probably feeling a bit slighted by all the Big Pharma-buying-Big Pharma wheeling and dealing. After all, Merck was supposed to be buying Biogen Idec ( BIIB) and Pfizer was going to buy Amgen ( AMGN), or at least that was part of the Street's conventional wisdom this year. Biotech companies, with their cutting-edge drugs and high growth rates, were supposed to be the belles of the deal-making ball. Roche is getting closer to buying Genentech ( DNA), but so far, that deal seems more like the exception than the rule. Why is the rest of biotech, more specifically large-cap biotech, being treated like an ugly step sister? "One of reasons we may not be seeing Big Pharma buy big biotech is that there remains a significant valuation difference between the two groups," says Les Funtleyder, a health care sector strategist at Miller Tabak & Co. By that, Funtleyder means that even in this bear market, biotech still remains relatively expensive. Celgene ( CELG), for example, is growing a lot faster than Schering-Plough, but the former is much more expensive than the latter from a valuation perspective.
"Celgene's market cap is roughly half that of Schering-Plough's, but Schering-Plough generates a lot more revenue," says Funtleyder. There is anecdotal evidence that high prices for biotech, or at least the perception of high prices, is scaring off would-be buyers. Biogen was put up for sale in late 2007 without any bidders; and when ImClone Systems was similarly offered for sale in 2008, Bristol-Myers Squibb ( BMY) offered $60 a share, a bid considered low by many on the Street. Later, Eli Lilly ( LLY) came in with a successful $70-a-share price for ImClone. Summer Street Research Partners analyst Carol Werther thinks Big Pharma talks about wanting to become more involved in biotech but can't seem to pull the trigger. "Merck's CEO
Richard Clark had been out there talking publicly about wanting to buy biotech, but instead he buys Schering-Plough, which is another Big Pharma company albeit one with a small amount of biotech exposure," she says. Schering-Plough co-developed the rheumatoid arthritis drug Remicade and owns partial rights to a successor drug golimumab. Johnson & Johnson ( JNJ) is Schering's partner on both drugs. Funtleyder says Pfizer, in buying Wyeth, also expanded its biotech capabilities without getting into an unfamiliar situation of having to buy a real biotech company. "Drug companies and biotech companies have slightly different business models, which may make Big Pharma uncomfortable about jumping in with both feet," he says. With consolidation accelerating within the drug sector, the number of buyers capable of swallowing large-cap biotech firms is getting smaller. That may leave Big Biotech to buy its smaller brethren in the group.
"There are a lot of biotech companies in the mid tiers - companies like BioMarin Pharmaceuticals ( BMRN), Alexion ( ALXN), United Therapeutics ( UTHR) or AMAG Pharmaceuticals ( AMAG) - that are either undervalued or would make a good fit inside a larger company. If Big Pharma won't buy them, perhaps a larger biotech firm will."