This is the investment environment we live in. Celgene (CELG), a $98 billion market cap company that had $7.7 billion in sales in 2014, agrees to pay $7.3 billion for Receptos (RCPT), a biotech company with NO sales (but an immunology drug that is in phase 3 trials) and CELG is up 9% in the pre-market, gaining the market cap of the purchase price. The price action reinforces this sort of behavior. But what’s interesting about this deal is that rather than use their stock as a currency, CELG has decided to use its entire cash hoard of $7.3 billion. That is greater than the $6.8 billion in debt on their balance sheet. CELG is levering up and I suspect they will look to raise more cash in the debt markets in order to buy a company with a drug that won’t add any revenue contribution until at least 2019.
I am not a biotech analyst. Heck, I am not even a financial analyst. But I can tell you this all of these biotech deals will NOT be home runs. And some will open a gaping hole in the acquirer’s balance sheet in less rosey times. But for now, these are the deals that are expected from shareholders, and when the acquirer’s stock is rewarded like CELG’s is this morning, managements would be foolish not to pull the trigger.
As I wrote the other morning, large cap biotech/pharma, still looks fairly constructive from a technical standpoint, and options prices remain relatively cheap for directional players (read here on the XLV). But make no mistake, this sector’s performance has been fueled by very cheap money. And it’s resulted in bull market deal after bull market deal which have been easy to justify during a raging bull market.
But parties end. I have no idea when this one does. But when it does it will be one of the most crowded sectors in the entire stock market and likely be used as source of funds. And if you own any of these smaller cap biotechs (with no sales but the promise of future FDA trial approvals) and are waiting for massive take-over premiums. Remember it’s a game of musical chairs and the ones that aren’t bought will be cut in half in the next downturn.