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Top Biotech Takeout Targets in 2011

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Investors can expect another impressive year of M&A activity in 2011. Here, the biotechnology companies most likely to be bought.

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Mergers and acquisitions in biotechnology saw a strong year in 2010 with 91 acquisitions of firms with market capitalizations exceeding $100 million. Morningstar research analysts, in their recently released annual report on the health care M&A landscape, say investors can expect another impressive year of M&A activity in 2011, and highlight the biotech companies that they believe are most likely to be bought.

Biotech, in particular, remains an attractive investment for Big Pharma, which as a group has not fully seized the opportunity to put cash balances to work through acquisitions, but still faces pressure from the rapidly approaching patent cliff, says Damien Conover, Morningstar's associate director of health care.

"There is a strong group of acquirers in Big Pharma that remain very motivated to do these acquisitions," he says. "They have a huge patent cliff coming up and they just don't have products in their own pipelines to offset that. Also, they have very strong balance sheets and cash flow generation so they have the means to acquire growth."

Despite increasing buyback activity, the 20 largest health-care firms held 15% of their total assets, on average, in cash and equivalents versus 12% of total assets held, on average, for the rest of Morningstar's stock universe.

Conover and his team of analysts, after surveying the entire biotech space, came up with 15 companies that are the most likely takeout targets this year. To assess the odds of a takeout for each small- and mid-cap biotech name, the analysts developed a methodology that took into account the company's drug portfolio strength, collaborative fit with potential partners, profit-boosting power and financial health.

Topping the 2011 list: Biogen Idec (BIIB), which secured the No. 1 ranking given its renewed focus on its core strength in neurology, large late-stage pipeline, and growing foundation of profitability.

"There are certain areas that Big Pharma really wants to move into such as neurology and oncology," says Conover. "It's easier to get drugs in these therapeutic classes through the regulatory process because there aren't many treatment options out there. Those are both areas of focus for Biogen Idec."

Specifically, Conover thinks Biogen could be a logical target for Roche. The two companies already partner on cancer blockbuster Rituxan, and acquiring Biogen would bring full rights to Rituxan, next-generation cancer products, as well as Bio-gen's growing neurology portfolio.

Rounding out the takeout list: Seattle Genetics (SGEN), which has an innovative antibody-drug conjugate technology allowing for a more targeted attack on cancer cells. There's also Human Genome Sciences (HGSI), which scored highly due to its expected approval for lupus drug Benlysta in March and several collaborations with GlaxoSmithKline (GSK).

"It could happen that GlaxoSmithKline is actually the one to pull the trigger there," says Conover. "Often, in these kinds of partnerships, as the drug gets closer to market, the economics look strong or it just makes sense to bring the company in-house."

He also thinks Dendreon (DNDN) could look attractive to Big Pharma as the approval of its drug, Provenge, illustrates the promise of the company's cutting-edge platform, which might seem appealing to companies trying to expand into immunotherapy.

And he highlights Actelion (ATLN), which dominates an orphan drug niche. [Orphan drugs serve patient populations that are very small.] The company has four products on the market: Tracleer, Ventavis, and Veletri treat various stages of pulmonary arterial hypertension and Zavesca treats Gaucher disease.

"Not too many people might be impacted by orphan drugs but, on the flip side, if the company has a drug that works for these diseases then they can charge a lot of money," says Conover. "So you can still have a drug that's a blockbuster."

The other candidates on this list of 15 takeout targets, in chronological order: Exelixis (EXEL), BioMarin (BMRN), Vertex (VRTX), Celgene (CELG), Alexion (ALXN), InterMune (ITMN), Lexicon (LXRX), Savient (SVNT), Merck KGaA, and Shire (SHPGY).

Finally, there were some important changes to the annual takeover target list. For instance, InterMune fell from No. 4 in 2010 to No. 11 due to a lower Drug Portfolio Strength score.

While the Morningstar team still considers InterMune's pirfenidone a promising orphan drug, the firm's decision to sell rights to its hepatitis C drug candidate to Roche removes diversification and novelty from its portfolio, they argue.

Also, Vertex fell from No. 1 in 2010 to No. 8, due to changes in its scores for Financial Health and Profit-Boosting Power. The firm monetized its royalties for telaprevir and has raised substantial amounts of cash over the past 18 months, reducing future profits from the drug and pushing out the time to reach Morningstar's highest category of profitability. This monetization boosted Vertex's cash balance to roughly $1 billion today, which reduces its need for a buyer, says Conover.


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