Innovation in biotech will continue to be rewarded. Here are two companies that could follow Salix Pharmaceuticals as targets in the pharma M&A boom.
Already this month, we’ve seen two multi-billion-dollar pharma buyouts. February started off with Pfizer (NYSE: PFE) buying up Hospira (NYSE: HSP) for $15 billion.
Then, after a failed attempt to buy Allergan (NYSE: AGN) last year, Valeant Pharmaceuticals (NYSE: VRX) announced plans to buy Salix Pharmaceuticals (NASDAQ: SLXP) for $10 billion.
So why the sudden interest in buying up smaller pharma companies?
That’s because their growth is declining as major drug patents expire; they need to turn to acquisitions to help jump-start growth.
There are a number of big pharma companies that are expected to grow earnings at an annualized rate of less than 2% for the next five years. This includes Pfizer, Eli Lilly (NYSE: LLY) and AstraZeneca (NYSE: AZN).
Meanwhile, Teva Pharmaceutical Industries (NYSE: TEVA), a drug maker with a $55 billion market cap, has noted that it’s actively looking for deals in the $10 billion to $15 billion range.
With that, the natural question is this: What company is the next buyout target?
Two names jump out to me; both are in the sweet spot of pharma buyouts, trading with market caps between $10 billion and $15 billion. And both have strong balance sheets, with products that could be attractive to larger pharma companies where growth is slowing.
Watch these two pharma companies with big buyout potential:
No. 1 Potential Buyout Candidate: Endo International (NASDAQ: ENDP)
Endo just completed the $2.6 billion buyout of Auxilium Pharmaceuticals, which has two branded testosterone products. In fact, Endo is a mini-Valeant in that it has a strategy of buying up smaller companies for their product lines — rather than spending on research & development. In fact, Endo’s CEO, Rajiv De Silva, was previously the COO of Valeant.
In 2013, industry-watchers speculated that Endo could be a Valeant buyout target. And despite the Salix buy, Valeant still has plenty of firepower. Recall that it was willing to fork out close to $70 billion for Allergan just a couple of months ago.
Interestingly enough, despite the fact that Valeant is paying $10 billion for Salix, which generated just $1.4 billion in revenue over the last years, it has nearly $750 million in receivables.
Its receivables-to-revenue ratio is one of the top in the industry. Endo reminds me a lot of Salix in that respect. It has over $1.5 billion in receivables, versus its $2.6 billion in annual revenues.
So a prospective buyer would be pursuing Endo not only for the growth potential, but for the money it could still collect from past sales.
No. 2 Potential Buyout Candidate: Jazz Pharmaceuticals (NASDAQ: JAZZ)
Next is Jazz, which has one of the most effective narcolepsy treatments in the market, Xyrem. Narcolepsy is the condition responsible for excessive daytime sleeping. Jazz bought the Xyrem brand back in 2005 when it bought Orphan Medical. Jazz also has a strong balance sheet, with less than $800 million in net debt (debt less cash).
When you look at the fact that Jazz is expected to grow earnings at a near-25% annualized rate over the next half decade, it’s hard not to like the pharma company’s prospects.
The Jazz product pipeline is strong, despite the current reliance on Xyrem. This includes its focus on next-generation narcolepsy treatments. And it’s also planning to expand into oncology products.
The company has remained resilient during the M&A boom in pharma, refraining from making “reckless”acquisitions. Rather, it is choosing to wait for the right opportunity. And in the meantime, buying back its own shares — something that’s unusual for smaller pharma companies — but not a negative in this case.
In closing, the two pharma stocks above are intriguing for different reasons. And although the talk of tax inversions has cooled, it’s worth noting that both these pharma companies are located in the tax-friendly country of Ireland. Their prospects for a buyout are strong, but look for both to continue innovating whether a suitor comes or not.
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