Biotech Stock Bubble Talk Deflated By Cost-Conscious Buyers

NEW YORK ( TheStreet) -- Amgen's ( AMGN) recent acquisition of Onyx Pharmaceuticals ( ONXX) sparked a lot of takeover speculation in the biotech sector. Which company would be the next M&A target? Naturally, the rumor mill was busy. Roche ( RHHBY) was said to be interested in Alexion Pharmaceuticals ( ALXN) and then BioMarin ( BMRN) a few weeks later. Clovis Oncology ( CLVS) shares jumped on an unconfirmed media report that the company was actively seeking a buyer. Soon after, Clovis shares fell when reports surfaced about a lack of interest from prospective suitors forced the company to call off the auction.

The problem with Clovis? Its drug pipeline was too immature and its valuation too rich, reportedly.

Assuming the media reports were accurate, Clovis' unsuccessful attempt to sell itself dovetails nicely into the ongoing debate investors are having about biotech stock valuations. With biotech stocks soaring to 52-week highs (all-time highs in many cases) plus the huge number of successful biotech IPOs, the "bubble" word is being thrown around a lot.

Are we currently experiencing a biotech stock bubble?

I say no bubble. Are biotech stock valuations stretched and in need of a healthy dose of consolidation? Yes, but that's a different and less worrisome condition than a biotech stock bubble.

A financial bubble occurs when the price of an asset rises significantly higher than its intrinsic value. The trouble with this definition is intrinsic value is not known, so bubbles are often only identified in retrospect. Bubbles do, however, generate identifiable behaviors: Greater fool theory, extrapolation of previous price action and increased risk taking.

We're not seeing any of those behaviors exhibited by the strategic buyers of biotech assets during the recent spike in M&A activity -- real and rumored.

When Amgen's $120 bid for Onyx was first reported, Onyx shares rose quickly above the offer price because investors expected other suitors with higher, competing offers to roll in. Amgen eventually raised its offer for Onyx to $125 per share but there was no bidding war for the company. Strategic buyers were quite cost conscious, in fact.

An unwillingness to overspend on biotech assets also affected Clovis, apparently. While we don't know any of the details of the Clovis auction process, it appears that Clovis' valuation and the price the company set for itself turned off strategic buyers.

So is the willingness of strategic buyers to walk away from these valuations a sign of a bubble? Some might say yes, I believe the opposite is true. Speculative bubbles occur when insiders chase returns and investors extrapolate short-term returns too far into the future. This leads to unsustainable price hikes which inevitably causes a bust and ensuing years of meager returns. That strategic buyers exercised restraint seems the exact opposite of bubble mentality.

This is not to say a biotech stock bubble won't happen ever. Some of the conditions which make bubbles grow are present today. Money is flooding into the biotech sector chasing fewer investable options (even with new IPOs), which brings higher prices. When investors assume the higher returns they're seeing today will remain in place (or grow even more) far into the future, the bubble grows.

Markets move from undervalued to fairly valued to overvalued all the time, so nothing I'm arguing here is groundbreaking. The point I'm trying to make mainly is that the only bubble in biotech today is in the calling of the biotech bubble. I'll worry more about a real bubble when strategic buyers give up their cost-conscious ways and start to believe in the higher valuations attached to companies or drugs still the earliest stages of clinical development.

Until then, what we're experiencing today in the biotech sector is the normal valuation cycle that will work itself out eventually with a correction.

Sobek has no positions in stocks mentioned.

David Sobek has been writing on biotech for a number of years through various outlets with a general focus on small cap oncology and antibiotics companies. He received his PhD in political science from Pennsylvnia State Univeristy in 2003 and a BA in international relations from The College of William and Mary in 1997.

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