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By Karen Andersen, CFA | 02-25-2010 01:29 PM

Our Top Five Biotech Takeout Picks

Health-care analyst Lauren Migliore looks at what makes a biotech firm a likely takeout candidate and reveals our top five biotech M&A picks for 2010.

Karen Anderson: I'm Karen Anderson, senior biotechnology analyst at Morningstar. With me today to discuss the 2010 mergers and acquisitions environment in biotech is our biotech analyst, Lauren Migliore. Thanks for joining us, Lauren.

Lauren Migliore: Good to be here, Karen.

Anderson: So I know in 2009 M&A activity was a little bit lighter than we thought it was going to be. The big pharma companies got really wrapped up in mega mergers, but we did see a few events in M&A.

We saw Roche take out the rest of Genentech that it didn't already own. We saw some Japanese pharma firms kind of stay involved with oncology acquisitions in the U.S., and we also saw J&J take a couple of equity stakes and a couple of firms, Elan and Crucell.

But in 2010 I think we really expect M&A to kind of pick up again. Could you talk about the factors that we look at when trying to figure out which companies might make the most likely takeout targets?

Migliore: We really looked at four main criteria when we were trying to develop which firms would be most likely to be acquired in 2010. First we looked at drug portfolio strength. So we looked at the popularity of a company's therapeutic focus and also gave it extra points if it had a novel technology or exciting platform.

And then a company that scored very highly here was small-cap biotech Exelixis, which is a company that has over a dozen targeted oncology drugs in development and really advanced its portfolio in 2009.

Second, we looked at profit-boosting power, which took into account the timing and the overall size of the profit boost to a potential acquirer. So here we would see biotech giants like Gilead and Amgen really rank very highly.

Next, which played a slightly lower role in our analysis, was collaborative fit, and we took into account the strategic sense for an acquisition from both the buyer and the seller's perspective. Here Biomarin was a top scorer because we think that its portfolio of rare diseases would make a nice addition to a larger firm like Shire or Genzyme.

And then lastly we looked at the financial health of firms, and we took into account the cash balance of a biotech and its burn rate. So Lexicon scored very highly for a need of an acquisition from a financial health standpoint because the firm has a very high burn rate, and we think it might need a larger company to help it bring its drugs to market.

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