Five Firms Big Pharma Should Buy Next

Pharmaceutical companies still see riches in biotechnology.  AstraZeneca's (AZN) $15.6 billion deal to acquire  MedImmune  is only the latest example of their continuing willingness to pay high premiums (in this case, a 53% premium to where MedImmune was trading before it put itself up for sale) for future growth.

At Morningstar, we've seen various themes to these drug stock take-outs over the past year. In some cases, the larger firm in a collaboration takes out the smaller partner, in an effort to claim full rights to future profits;  Amgen's (AMGN) acquisition of antibody expert Abgenix and  Lilly's (LLY) acquisition of Cialis-driven ICOS are both good examples of this behavior. Sometimes a firm looks to expand into new therapeutic areas, such as when HIV expert  Gilead (GILD) bought cardiopulmonary firm Myogen,  Merck (MRK) bought Sirna Therapeutics for its innovative new RNA interference technology, or when  Abbott (ABT) bought Kos Pharmaceuticals for its cholesterol drug pipeline. In other cases, firms attempt to ward off slowing growth by injecting new products into established businesses, like  Genzyme's  purchase of AnorMED to supplement a sluggish transplant segment, or  Shire's  purchase of New River to fend off generic competition to its attention deficit franchise.

Given the current interest in scooping up biotechs at healthy prices, we've decided to use clues from past acquisitions to provide a list of firms that represent potential future targets. To start, we've created a screen that filters out any biotechs with market capitalizations of less than $250 million (firms that tend to be extremely volatile and speculative) and greater than $15 billion (firms that are difficult for even large pharmaceutical companies to afford). We've also screened for biotechs that we don't think are overvalued by the market--that is, firms that have received a Morningstar Rating of at least 3 stars. We were left with 26 firms, which we've qualitatively culled into a list of what we see as the five most likely future targets, as shown in the table below. To see the current results of this screen, click here.

Potential Acquisition Targets
	Morningstar      Rating	Fair Value Estimate	Moat Rating	Risk Rating*	Price/ Fair Value	Market Price
Amylin Pharm.		$44	None	Above Average	0.94	$41.33
BioMarin Pharm. (BMRN)		$18	Narrow	Above Average	0.91	$16.31
Lexicon Genetics		$6	None	Speculative	0.60	$3.62
MannKind (MNKD)		$23	None	Speculative	0.62	$14.31
Vertex Pharm. (VRTX)		$44	None	Above Average	0.72	$31.88
All data as of 04-20-07 market close

As we discussed in our most recent quarterly review of the health-care sector, we don't typically factor acquisition speculation into our fair value estimates, but instead focus on what we think the firm's products and pipeline are really worth in the long run. Below, we've highlighted why we think these five firms could create value for prospective buyers, including excerpts from company reports.

 Amylin Pharmaceuticals 
While we think Amylin shares are now trading at prices closer to their fair value than in the recent past, one could argue that Amylin's partner Lilly would still stand to gain by taking out its 50/50 partner for novel diabetes drug Byetta (exenatide). The drug leads to a rare combination of diabetes control and weight loss, and a once-weekly version could reach the market within two years. Add in an ambitious obesity development pipeline, and the firm's growth potential increases further. As I discuss in my Analyst Report, "If pipeline development is fruitful and Amylin proves that its competitive advantage extends beyond the exenatide molecule, we believe this biotech would warrant a narrow economic moat."  

 BioMarin Pharmaceutical (BMRN)
BioMarin's rare disease expertise has earned it a narrow economic moat, and strong prospects for current products and its late-stage pipeline could make it a desirable target for partner Genzyme or other firms looking to gain exposure to this niche. While share prices fell in February due to poor hypertension data for lead pipeline candidate Phenoptin, we still think the drug has excellent prospects to treat the rare disease phenylketonuria, and it could be on the market by the end of the year. As I mention in my analysis, "BioMarin should enjoy steady sales growth from its innovative, life-saving treatments, and we expect it is just a matter of time before this biotech turns a profit."

 Lexicon Pharmaceuticals  (LXRX)
Of all of the companies on our list, Lexicon has the earliest-stage pipeline--which makes it a more speculative investment than many other biotechs. However, a productive collaboration with  Genentech  is starting to yield new pipeline candidates, and Lexicon's comprehensive research platform has provided a wealth of informative from knockout mice. From my Analyst Report: "Lexicon's two lead drug candidates could serve large markets if approved, and several other programs are about to push into clinical development; all told, the firm's technology could generate up to 150 promising drug candidates."

 MannKind (MNKD)
Given the mediocre launch of  Pfizer's (PFE) inhaled insulin Exubera, prospects for MannKind's own inhaled insulin have come into question. The firm's only pipeline candidate, Technosphere insulin, is still in Phase III trials, and the firm has not yet formed the marketing partnership it would need to bring the product to the market--all of which contributes to MannKind's speculative risk rating. However, we're bullish on the prospects for Technosphere insulin, which could actually work better than injected insulin, and without the side effects of Exubera. As I discuss in my report, "Technosphere insulin has the potential to significantly improve upon Exubera if it enters the market on schedule by 2010, which puts MannKind in a position to negotiate generous terms in a partnership. However, given the nascent market and substantial competition among such products, we see MannKind as a speculative investment."

 Vertex Pharmaceuticals (VRTX)
Although this firm has several products in development--as well as a history of generating successful HIV therapeutics--all eyes are focused on the potential of telaprevir (VX-950) to treat patients with hepatitis C. The drug candidate has shown impressive efficacy to date, and while shares fallen from their peaks due to concerns over the drug's side effects, we think its efficacy and market position outweigh any safety problems that have arisen to date. As I discuss in the valuation section of my Analyst Report, I've assigned VX-950 a 60% probability of approval in 2009, and "we still believe that the drug will garner 30% of hepatitis C drug sales by 2015, and that the global market could be larger than $10 billion by that time."