MorningWord 12/22/14: We Represent the Biotech $GILD

by Dan December 22, 2014 10:07 am • Commentary

Adam Feuerstein of had a good post this morning on the potential for a re-rating in Biotechs as they are one of the cheapest sectors in the market relative to expected growth.  (Read here –Express Scripts and AbbVie Drug-Pricing Deal Might Devastate Biotech Bull Market).  Here’s an excerpt, relating to Friday’s news of Abbvie’s pricing of their new Hep C drug and its effects on Gilead’s existing dominant drug in the space:

The exclusive hepatitis C pharmacy deal struck between Express Scripts (ESRX) and AbbVie (ABBV) is a serious, perhaps permanent, blow to the multi-year biotech stock bull market.

The power to control drug prices in the U.S. now has shifted firmly to cost-cutting insurance carriers and pharmacy benefit managers. This means biotech companies, especially those facing competition, can’t guarantee the outsized profits investors have come to expect and crave.

After today, investors are no longer going to ask biotech executives, “What will you charge for your new drug?” Instead, the new question becomes: “What will Express Scripts — or any other pharmacy benefit manager — allow you to charge for your new drug?”

That’s a huge, fundamental change which is likely to put downward pressure on lofty biotech stock valuations.

The deal between AbbVie and Express Scripts focuses only on the price of hepatitis C drugs, but expect future cost concessions to be wrung from other high-priced diseases, including cancer


It may take some time to sink in, but the Express Scripts-AbbVie deal is a tectonic shift in the control of drug prices which is going to have far-reaching ramifications on the profitability and valuations of biotech stocks

We took a look at GILD a month ago (Name That Trade – $GILD’s Turf War) as we had gotten a lot of questions about the stock’s inability to keep pace with other large cap Biotechs given the apparent cheap valuation (less than 10x expected 2015 earnings.)  In hindsight, it turned out it was the potential pricing news keeping the stock back and options prices elevated.  We detailed a couple strategies for those looking to play for a move back to prior highs, with some room to the downside, targeting $90 as a sort of line in the sand, but allowing for leverage for an upside move.

This morning GILD’s shares were down 15% at one point, as low as $93.36, but has since bounced to about $97.  As identified in our prior note, the stock could be range bound between $90 (just below the 200 day moving average in yellow) and $110 as investors digest the new drug pricing world order:

GILD ytd chart from Bloomberg
GILD ytd chart from Bloomberg

Options prices have not surprisingly seen a massive ramp, with 30 day at the money implied vol reaching the low 40s, a massive level for a $150 billion market cap company trading at only 10x earnings:

GILD 1yr chart 30 day at the money IV from Bloomberg
GILD 1yr chart 30 day at the money IV from Bloomberg

The set up could be interesting for longs looking to add yield in a range bound stock by overwriting shares with call or strangle sales, but the structure that we outlined last month to play for upside also remain attractive compared to outright long premium directional trades. We’ll keep an eye on it and start looking at structures.