The biotech pharmaceutical business is all about clinical trials, FDA approvals and the potential market its addresses. Most of the biotech companies experienced rising stock market prices despite the fact that it had consistently generated negative earnings over time. The negative earnings were due to the high R&D expenses it occurred during the testing and clinical trials phase. Normally, those biotech companies would be acquired by larger, established pharmaceutical firms at a huge premium to its stock price. They got acquired not because of their earnings they have generated in the past, but because of the current drug pipelines, which could create a lot of cash flow in the future.
The intrinsic value of GILD
Pharmasset is an example of a successful biotech company, which got acquired by Gilead Sciences (GILD) in November 2011. Pharmasset was founded by two scientists and professors targeting three main diseases: HIV, Hepatitis B Virus (HBV) and Hepatitis C Virus (HCV). Indeed, the two professors have achieved success in biotech business field in the past. They were also the founder of Triangle Pharmaceuticals in 1996. Triangle Pharmaceuticals focused its efforts on HIV and chronic HBV. In its pipeline, it had antiviral Coviracil, a pill taken once daily for HIV treatment. Triangle went public one year after it was founded and later got acquired by Gilead Sciences in 2001 for $482 million.
A big successful buyout
Pharmasset, before it got acquired, had only 80 employees with no commercial products yet available. At first, Gilead offered $100 per share. However, Pharmasset considered it inadequate, and Pharmasset's CEO revealed to Gilead that it would deliver important information about its positive development at the American Association for the Study of Liver Diseases. If the positive product development information would be released to the market, Pharmasset's share price would surge higher, making the acquisition more expensive for Gilead. At last, the final price tag was as high as $137 per share, making the total acquisition price of $11 billion. Fast-forward four years later, this acquisition seems to be quite successful. Pharmasset's acquisition has brought Gilead the foundation for Sovaldi and Harvoni. Both Sovaldi and Harvoni have significantly increased the business performance of Gilead. In 2014 alone, Sovaldi generated nearly $10.3 billion in revenue, accounting for nearly 45.9% of Gilead's total revenue. For the full year 2015, Gilead expected to generate $32.1 billion in sales, a 31.4% year-over-year growth. Interestingly, Dr. Raymond Schinazi, a big shareholder in Pharmasset, mentioned that Gilead would have the company for only $300 million or less in 2004. Of course, Gilead has paid the big premium, but the risks were also reduced significantly.
Schinazi was also the founder of Idenix Pharmaceuticals, which also got acquired by Merck & Co (MRK) in 2014 for $3.85 billion, or $24.50 per share, more than triple Idenix's stock market price of $7.23 per share. Prior to acquisition, Idenix also had only 85 employees, with no product presence in the market. It had only less than $1 million in revenue. However, Idenix had a huge potential for Hepatitis C virus treatment, with its IDX21437, a nucleotide prodrug in Phase 2 clinical development. Value investor Seth Klarman (Trades, Portfolio) has benefited from this acquisition, as he was one of the largest shareholders in the company. At the time of acquisition, Klarman owned 53.3 million shares, accounting for 35.4% of the company.
Early investors in biotech can realize huge gains. However, the difficulty lies in identifying which biotech could be the next big acquisition target. Although it's hard to identify correct drug trends and successful names, I think investors would be better off following the founders and management teams that are already experienced in the biotech field. Investors should keep an eye on the two successful Pharmasset's founders, Dr. Raymond Schinazi and Dr. Dennis Liotta, for the upcoming companies they may create in the future.
This article first appeared on GuruFocus.
The intrinsic value of GILD