No Sign of Slowdown in Biotech M&A

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Six Morningstar equity analysts were recently named by the Wall Street Journal as Best on the Street. I'm here with Lauren Migliore. She was named as one of the best biotech analysts, and we are going to talk a little bit about the biotech industry and her favorite pick in that field right now.

Lauren, thanks for joining me.

Lauren Migliore: Happy to be here.

Glaser: Well, first off congratulations.

Migliore: Thank you.

Glaser: I just want to talk a little bit about some of the big themes that you're seeing in biotech. Can you walk us through what are some of the major things you are seeing right now?

Migliore: Sure. Well, we are noticing three dominant trends in biotech right now. First, we are seeing increased cost-cutting at big biotech. This has long been a trend among big pharma firms, but we're increasingly seeing big biotech, especially firms like Roche and Biogen Idec, take the lead and move toward more specialized and leaner salesforce and pipelines.

Next, we're also seeing tightening FDA approval standards that are putting pressure on first filings for new drugs. So, going forward we expect this to lead to longer regulatory times for reviews and request for more additional data. We also expect more safety data in broad indications like diabetes and strategies to mitigate side effects for drugs like oncology drugs that have the potential for harsh side effects. We think this could also accelerate the trend toward personalized medicine, which has the potential to show stronger efficacy in more targeted patient populations.

Lastly, M&A is always a theme among biotech. We expect especially 2011 with the abundance of cash at big pharma firms and impending patent cliffs to really keep a strong pipeline of activity among the M&A field right now, especially in popular therapeutic areas like cancer, infectious disease, and multiple sclerosis.

Glaser: Let's take a closer look at the M&A trend, I know, it's one like you said we've been looking at for a while. What do you think are some of the top targets to be taken out, and why do you think that they look so attractive?

Migliore: We think firms that in popular therapeutic areas that have really cutting-edge technologies are going to be key targets this year. So, Morningstar's proprietary biotech takeout methodology actually identified our top five picks for this year, and they are Biogen Idec, Seattle Genetics, Human Genome Sciences, Dendreon, and Actelion.

Glaser: Do you think that the acquirer would probably be another big pharma firm or another biotech firm, I mean, who is really making the plays in this space?

Migliore: We see both big biotech and big pharma as likely acquirers due to all the cash on the balance sheets, the challenges for approval filings, and the impending patent cliffs. So these are firms like Amgen, which has many billion dollars on the balance sheet, as well as Johnson & Johnson. Both big biotech and big pharma firms are going to be players, we think.

Glaser: Health-care reform is a topic that's affected really all the health-care industry. We are talking a lot the last couple years. How do you think that reform has affected the biotech industry? Do you see any companies deemed to make big strategic changes because of it?

Migliore: We think overall that health-care reform has a net-neutral impact on the sector. We are seeing a few percentage-point hits to some of the big biotech firms as industry fees start to ramp up, but overall we think increased coverage will make this a net-neutral impact on the valuation of the companies.

Glaser: And looking at valuations today, do you think the whole sector looks pretty overvalued, undervalued, about fairly valued?

Migliore: Overall, the sector looks approximately fairly valued, but there still are some names in biotech for opportunistic investors. A lot of company-specific events have put pressure on stocks. We think there are some opportunities out there.

Glaser: What's your favorite name right now?

Migliore: One company that we think is pretty interesting for investors that have a stomach for risk is Vanda Pharmaceuticals. This company has an antipsychotic, Fanapt, on the market that's partnered with Novartis. We think the drug could see $500 million in peak sales potential, and also the firm has an orphan pipeline drug in the works, as well. The company is currently trading at cash levels. So, we think this puts a floor on the valuation and limits the downside, while the upside remains substantial.

Glaser: Lauren, congratulations again, and thanks for taking the time today.

Migliore: Thank you.

Glaser: From Morningstar, I am Jeremy Glaser.