Gilead Sciences (GILD - Get Report) should solve the long-term revenue cliff problem some investors and analysts believe the company faces by acquiring Vertex Pharmaceuticals (VRTX - Get Report) and its growing cystic fibrosis drug franchise for $45 billion, says Bernstein analyst Geoff Porges.
Writing to clients Tuesday morning, Porges says Gilead "needs the promise or high probability of an incremental $5-7 billion of revenue to reassure investors about their future outlook, and ideally any investment would add optionality for even higher revenue should upside scenarios play out."
Buying Vertex, Porges adds, "makes the most sense, because its future is wholly dependent on CF [cystic fibrosis], where Gilead already has a product (Cayston) and commercial infrastructure."
Gilead's stock price has significantly underperformed the broader biotech market over the past six months, in part because investors are concerned about increasing competition eroding its most important HIV and hepatitis C drug franchises.
Porges estimates Gilead will lose 30-40% of its revenue between 2017 and 2021. But Gilead also has an enormous stockpile of cash and access to cheap debt with which it can make another transformative acquisition, just like the company did twice before.
"Given Merck's (MRK) timeline for entering the HCV market (we think early to mid-2016), and the disruption they may cause from aggressive contracting, we think the time for Gilead to move on such transactions is this year," Porges writes. "Our conversations with investors suggest that many of them feel the same way, and wonder why Gilead is taking so long to make such moves given their strong balance sheet, prodigious cash flow, unmistakable need (and mediocre multiple)."
Porges' proposed deal looks like this: Gilead buys Vertex at a 50% premium, or about $180 per share, using 20% cash and 80% debt. Such a deal would be 7-8% dilutive to Gilead earnings in 2015 and 2-3% dilutive in 2016 before being accretive in 2017 and beyond, he says.
Normally, the stock price of the acquiring company, Gilead in this case, falls on a large acquisition. Porges argues Gilead's stock price would go up, however, because investors would re-rate the company with a higher earnings multiple on par with other profitable biotech and drug companies.
Gilled shares closed Monday at $100.65. Vertex shares closed Monday at $125.55.