Interesting pharma M&A stat….

From this Bloomberg article: recent pharma acquisitions of >$500M have been at an average 71% premium to their pre-deal market price.

The article suggests that this is driven by the large number of Big Pharma's products going off-patent and therefore needing to be replaced. This is true, but I think there's also the partial explanation of a cost of capital arbitrage.

Pharma companies tend to have a cost of capital just a few points more than the borrowing from the Fed. This figure can be calculated for each pharma company, but let's just assume 8% over the long run, but with today's low interest rate QE2 environment, that might be more like 6%.

Biotechs, - even public biotech's - have a MUCH higher cost of capital. This too varies based on company, disease-focus, maturity, etc., but probably somewhere in the range of 12-18% today, or 2-3X big pharm.'s cost of capital.

Big Pharma companies (generally) trade based on earnings multiples, while biotech's tend to trade on the value of growth, which is risk-adjusted by the biotech firm's MUCH higher cost of capital.

Consider the forward and trailing P/E ratios of the first 7 pharmas that came to mind:

So let's say that you've got a blockbuster ($1B in revenue) at typical pharma margins (27% operating margin - we'll use that as a stand-in for EPS.)

That suggests that on a forward basis, the blockbuster is worth $3.25B (forward P/E of 12 x ($1B x .27)) to the pharma.

But if the blockbuster has sales of only ~$250M at this point, and $1B in revenue is still years off, the discounted (risk-adjusted)  value is much less perhaps half the value of its' forward value under the wings of a pharma company.

This example is pretty much a reflection of the setting of the HGSI-GSK merger talks. HGSI had $130M in revenue (JV revenue) and a market value of <$1.3B immediately before GSK launched their $2.6B takeover offer.

What I've described above - pharma's lower cost of capital relative to biotech driving M&A activities - is nothing new, but with interest rates today low enough that borrowing costs are almost negative for big pharma, it should really only be news if Big Pharma WASN'T buying, irregardless of the oncoming patent cliff.

Thanks to FierceBiotech for pointing out the article.

HGSI in play, an era comes to a close

It's been a long, long, long road for Human Genome Sciences, but congratulations are due for their $2.6B buyout offer from GSK at a roughly 50% premium to their previous trading price of $7 per share. HGSI rejected the offer, but it is widely expected that HGSI and GSK close a deal at a slightly higher price ($3B?), though it would be fun to see GSK hold firm on the pricing of their offer - I don't think HGSI is likely to attract higher bids from any other companies.

By way of comparison, over its' history, HGSI raised ~$3.8B in capital.

The buyout is driven by HGSI-developed Benlysta (for Lupus, partnered with GSK) and it's near term pipeline which includes a pretty exciting atherosclerosis drug. Once again, we see big pharma buying a partner who has been substantially de-risked, something to consider as Vertex, Onyx, and others approach this stage.

But HGSI will forever be to me a lesson in buzzword-investing.

Rewind to very late 1999-2000 - the peak of the internet investing bubble and the dawn of the genomic age. Tech investor fervor and the news of the success of the Human Genome Project ran up the stock prices of all things genomic. HGSI peaked at a split-adjusted price of 103 in 2000. (Reminder: GSK's current offer is ~$13 per share.) Here's a crazy chart of HGSI's stock price over the last 13 years:

(Live link to chart)

But genomics shares (including Celera, Incyte, etc.) cratered quickly once the hot money cooled and once the realization hit that genomics products seriously lagged, for a variety of reasons. What followed was a lonely decade for genomics stocks, and I can't help but wonder if the 2000-era fervor was a net negative for genomics. (Did the investing bubble distract management from building a successful long term tech platform? Did the unreasonable expectations of the market poison the well for future genomics companies?)

The genomics bubble was nothing new - remember the gene therapy bubble or the angiogenesis bubble before that? Since the genomics bubble we've seen a stem cell bubble and an RNAi bubble, so clearly the investment community hasn't learned the lesson to ignore or at least devalue hype, but HGSI's sale to GSK shows that post-hype, post-bubble companies can still generate value. 

Big speed bump on the way to the stem cell revolution

A report this week indicates that induced pluripotent stem cells (IPS), the technology whereby adult stem cells (ASCs) are used to create novel stem cell lines may be inherently flawed, as the resulting cells and cell lines have been found to have important mutations.

Adult stem cells in this case are more appealing than embryonic stem cells (ESCs), which come with ethical/moral challenges. So - assuming the research is confirmed - we're back to the core conflict with stem cells - do we use morally complicated ESC technology, or potentially flawed ASCs.

The news this week will be used to aggressively promote the still controversial ESC research over ASC, but I suspect that with research we will become very comfortable with the known mutations in certain applications, but not without time and additional research.

I mention all of this because - like most emergent life science technologies - stem cells have been substantially hyped and oversold.

I just took a look at the timeline of some of the hype involved. Christopher Reeve led a big PR campaign in 2001, and California passed Proposition 71 in 2004, which raised $3B to be spent by CIRM over 10 years on stem cell research in California.

We're in year 7 of CIRM, and presumably 70% of the bond proceeds ($2.1B) have been allocated and spent. Along with annual Federal (NIH) spending - estimated at $1.1B in 2010, state funding (estimated at $400M/year) other academic basic research, and billions by pharma (hard to track) we may be spending $2B/year on stem cell research, and likely >$15B since 2001. Funding doesn't seem to be the problem.

What does this tell us:

-we should be EXTREMELY cynical in evaluating expectations for new life science technologies. It is not unreasonable to double estimated costs and timelines.

-technologies should be measured and advanced on the basis of their disease impact. The stem cell crusade in the 2000's was an effort to advance basic research as a whole. The better basis would be on a more accountable disease-basis, which would emphasize that stem cells would be one therapeutic tool among many.

-we should do whatever we can to keep technology development from being a political issue. I still believe that the kerfuffel over embryonic stem cells in the early 2000's was as much about a tug of war for $$$ (and pushback against the notion that politicians should have a voice in research agendas) as it was a morality debate. Ultimately, I do not know conclusively if the debate helped or hurt stem cell research (my guess is helped with funding, net), but it certainly drew a great deal of intellectually dishonest speculation.

-just plain don't invest in public companies at the front of a technology wave. Stem cells will ultimately have a commercial impact, but as anyone who bought Geron shares in 2000 at a price >$60 per share, investing too early represents dumb money. (10 years later, Geron is now trading for one 12th of the price ten years earlier.)

Of course, one might have been able to say the same thing about genomics (take a look at the HGSI valuation over time (peak of ~$25B in value, now worth $5B, after the approval Benylista), so let's hope that the billions spent on stem cell research have brought research to the tipping point.