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Our Top Five Biotech Takeout Picks

Karen Andersen, CFA

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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Anderson: So now that we have an idea of the four factors that go into the takeout target rankings, what were some of the top scorers in 2010?

Migliore: Well, our top takeout candidate for 2010 is Vertex Pharmaceuticals. Vertex scored very highly from a drug portfolio perspective because its late stage protease inhibitor, Telaprevir, has the potential to revolutionize the way Hepatitis C is treated. And it also scored very highly from a profit-boosting power perspective because if the drug makes it to market, we think it could garner several billion dollars in sales.

After Vertex we have Auxilium Pharma, whose drug Xiaflex is nearing the market for two rare conditions; Human Genome that saw very positive data for its lupus drug Benlysta this past year; InterMune, which is focused on the popular therapeutic indications of rare and infectious diseases; and then finally Celgene rounds out our top five due to its blockbuster drug REVLIMID, and extensive pipeline that gives it a leadership position in the blood cancer market.

Anderson: All right. Great! Thanks, Lauren.

Migliore: My pleasure.

Anderson: For our full list of biotech takeout targets for 2010 as well as our M&A outlook for other industries within the healthcare space go to healthcare.morningstar.com and download our February issue of The Morningstar Healthcare Observer.