If you think the federal government is leaky these days, it's got nothing on the biotech industry.
Ever since Amgen (AMGN) bid $10 billion for up-and-coming Onyx Pharmaceuticals (ONXX) back in June, the drama has dribbled out to Wall Street largely through news reports citing unnamed sources.
Over the last couple of weeks, the news has shaken investor confidence in the deal, and in biotech stocks in general.
Onyx announced June 30 it had rejected Amgen's offer as too low. True, Onyx is losing money — at the moment — but analysts polled by Thomson Reuters expect skyrocketing profits next year as its blood-cancer drug Kyprolis ramps up following last year's U.S. approval.
That is just the kind of hot drug the solid but slower-growing Amgen is looking for to fill out its pipeline, particularly in its oncology franchise.
Large drugmakers are increasingly on the hunt for biotechs. Investors often value biotech stocks for their buyout potential more than for profits, say analysts.
Onyx was no exception. In spite of the rejection, its stock vaulted more than 50% after the news of Amgen's bid. Speculation about other suitors also flew around Wall Street. Big pharmas Bayer (BAYRY) and Pfizer (PFE) were on the list. Both were already developing drugs in partnership with Onyx. Other large-cap biotechs, such as Gilead Sciences (GILD) and Celgene (CELG), also were mentioned.
By early August, the grapevine buzzed that Amgen had raised its bid by about 8%. Reports also said Amgen was the only buyer still interested. On Aug. 15, another anonymous report claimed Amgen had demanded specific data from one of Onyx's ongoing drug trials before it would finalize a deal.
This rattled Wall Street's confidence, according to analyst Mark Schoenebaum of ISI Group.
"What's going on with Onyx now indicates that the pharma industry may think that a lot of these stocks are expensive," Schoenebaum told IBD. "So we've seen underperformance in biotech in the last week.
By Thursday, Onyx reportedly had capitulated, handing over the requested data to Amgen.
If true, Schoenebaum wrote in an email, this should lead to a rapid resolution of the issue "and a deal should be near.
His expectation: "We wake up this coming Monday morning to a deal announcement at about $130 (per share).
Divining Cost Of Blockbusters
Biotech stocks have been on a bull run for a couple of years now. The 261-stock biotech group seems permanently lodged in the top 10 among the 197 industries tracked by IBD. Rallying since October 2008, the group this month climbed to less than 10% from its frothy March 2000 peak before easing up.
Are the valuations justified? Schoenebaum admits that, for those using a discount cash-flow analysis, many of the stocks seem overpriced. At the same time, he avers that "fundamentals are stronger than they've ever been.
To prove the point he charts out the number of new drugs approved in the drug industry per every inflation-adjusted billion dollars spent on research and development. Conclusion: industry productivity is at its highest level since 2000.
Of course, not every new drug that makes it to the market is a hit. But a number of recent launches from the larger-cap biotechs have been very strong.
Last month, for instance, Biogen Idec (BIIB) smashed analysts' estimates when it reported the first quarter of sales for Tecfidera, its new multiple-sclerosis pill. Some other drugs in late-stage development also have sky-high expectations. Consensus estimates for Gilead's hepatitis C drug sofosbuvir, which is currently awaiting FDA approval, have crept upward steadily over the last year. Many analysts are discussing peak annual sales of $8 billion. Also hotly anticipated: Biogen's long-acting blood product for hemophiliacs and Vertex Pharmaceuticals' (VRTX) cystic-fibrosis cocktail.
Morningstar analyst Karen Andersen says her valuation analyses for large-cap biotechs are "all over the map," but agrees that fundamentals are excellent. What worries her more is that the excitement is extending to smaller-cap biotechs that may be less deserving.
"If I had to predict a source of disappointment, it's in seeing the trial data coming out of the companies that are IPO-ing," Andersen said.
Buyout Hopes Float IPOs
Indeed, biotechs have been storming the initial public offering calendar lately. Exhibit A is Intrexon (XON), a player in synthetic biology — programming DNA for use in medicine and food production.
The stock nearly doubled its $16 IPO price in its first two days of trading earlier this month. Shares pulled back, but remained 43% above their initial offering price on Friday.
Cancer-drug developers Onconova Therapeutics (ONTX) and Agios Pharmaceuticals (AGIO) are up 70% and 35% respectively from their July debuts. Muscular-dystrophy specialist Prosensa (RNA), which came out in June, is up more than 100%.
Besides all being recent IPOs, these companies have something else in common: none of them actually has a product on the market yet. While it's not unusual for biotechs to go public early as a way to raise R&D capital, it is unusual that investors are so excited about them.
John Pennett, who heads the life-sciences division of accounting and advisory firm EisnerAmper, says that buyout speculation may be a factor in driving these stocks' prices well above what the underwriters think the market will bear. But he also attributes some of the interest to improving prospects for new drugs getting through the FDA approval process.
Pennett told IBD that among the companies garnering the most investor interest are makers of orphan drugs, a designation created by the FDA to speed approval of treatments for rare diseases that lack existing therapies.
Alexion Pharmaceuticals (ALXN) rode its orphan drug Soliris to a $20 billion market cap. It has also been the subject of buyout rumors this summer as giant pharma firm Roche (RHHBY) was reportedly exploring a deal.
Making The FDA A BFF
More recently the FDA created a "breakthrough therapy" designation, which expedites review for drugs that "may have substantial improvement on at least one clinically significant endpoint over available therapy" for serious medical conditions.
Last month, Pharmacyclics' (PCYC) stock shot up after it said it had filed for approval of its leukemia drug ibrutinib using this designation, which allowed it to file after only two phases of clinical trials instead of the usual three.
"The tone and tenor that the FDA sets drives an awful lot of the process," Pennett told IBD.
"I do think that companies are talking to the FDA earlier, trying to be upfront about getting buy-off and sign-off early in the process as opposed to waiting and seeing what happens down the road," he said.
As a result of this friendly environment and pipeline strength, none of IBD's sources expect a dramatic crash anytime soon.
Schoenebaum reckons that the market is in "the third or fourth inning of a bubble." Andersen sees too many near-term catalysts among the leading biotechs to be seriously worried.
"There's still room for an extended period of positive news," she said. "We're not anticipating that the bottom is about to fall out."