Gene Marcial's Stock Picks

Marcial: Pharma Firms May Vie for Vertex


Expect merger-and-acquisition activity to heat up in the biotechnology sector. That's the prognostication of many analysts who have become more upbeat about the industry, with share prices now outpacing most other small-to-mid-cap stock groups.

The Nasdaq biotech stock index gained 3.15% in the week of Sept. 14, vs. the broader Nasdaq composite index's 2.50%, notes Simos Simeonides, senior biotech analyst at investment firm Rodman & Renshaw (RODM), who believes the biotech rally will likely persist this year. Both the profitable biotech companies as well as those that are still trying to develop and produce drugs for approval by the Food & Drug Administration have been gaining ground, he adds.

Analysts note that the young biotechs that have yet to earn a penny are again attracting accelerated interest from large pharmaceutical companies. Health-care analysts at Credit Suisse (CS) believe there is a higher likelihood of large drugmakers pursuing smaller biotech outfits to augment their drug pipelines. They believe there will be less likelihood of megamerger deals occurring among the major drugmakers.

One of the biotechs the Credit Suisse analysts believe will be a target of major drug firms: Vertex Pharmaceuticals (VRTX), which focuses on the discovery and development of small-molecule drugs to treat viral infections, inflammation, and cancer. Its chief product is telaprevir for the treatment of hepatitis C (HCV).

Expiring Patent Pressure Vertex's name emerges whenever the subject of merger deals in the biotech sector pops up, says Steven Silver, biotech analyst at Standard & Poor's. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).) He notes that a number of the major pharmaceuticals, particularly those likely to lose huge revenues because of drugs facing patent expiration, are eager to buy biotechs with drugs that could replace those medicines.

Vertex's attraction: Telaprevir is a potential blockbuster drug with a multibillion-dollar market that could get approval next year, notes Silver. The product, he says, is "likely to emerge as a leader in treating hepatitis C (HCV), which afflicts more than three million people in the U.S."

He rates Vertex a buy with a 12-month target of 43. However, "My price objective of 43 doesn't include a takeover premium," he adds.

Vertex spokesman Cach Barber declined comment, saying the company doesn't respond to market speculation.

Analyst Rachel McMinn of Bank of America Merrill Lynch (BAC), who rates Vertex a buy, projects a higher price target of 48, mainly based on her "high expectations" for telaprevir. Vertex is "well positioned," she says, to be the first to bring to market a "novel, highly potent oral medicine to treat a broad range of patients with HCV." She forecasts telaprevir sales of $3.6 billion in 2013, which she says would make it "one of the highest-profile biotech product launches in the next 18 months." (Bank of America Merrill Lynch has done business with Vertex.)

Embraced by J&J Who could be the potential suitors? Credit Suisse believes Vertex could well be a takeover target of Johnson & Johnson (JNJ), Bristol-Myers Squibb (BMY), or Gilead (GILD). Other biotechs the Credit Suisse analysts believe could also be targets of big drugmakers: Alexion (ALXN), Amylin (AMNL), Biomarin (BMRN), Rigel (RIGL), and Salix (SLXP).

But some analysts believe Vertex may be the more attractive target as it is already in a close embrace with Johnson & Johnson. Vertex partnered with J&J in 2006 to develop and commercialize telaprevir in Europe and several other regions. Vertex received an upfront payment of $165 million from J&J and could potentially "receive a total of $545 million in license and milestone payments," says S&P's Silver.

Shares of Vertex have been on a roll, hitting a 52-week high of 38.50 a share on Sept. 21 from a 52-week low of 18.43 on Oct. 28, 2008. The stock's advance is in part ascribed to the takeover speculation. It climbed as high as 45 in 2006 when the deal with Johnson & Johnson was announced. The stock closed on Sept. 25 at 36.39.

Analyst Maged Shenouda of investment bank UBS (UBS), who met with senior executives of Vertex on Sept. 21 for an update on telaprevir, says that while numerous compounds to treat hepatitis C are in development, telaprevir "possesses the most competitive efficacy, safety, and treatment duration profile."

"Superior Efficacy," Shorter Treatment Rating Vertex a buy, Shenouda says the drug is a "major advance in the treatment of HCV." The company, he adds, is studying more competitive dosing regimens for telaprevir. It has completed three phase III clinical studies on dosing. Vertex on Sept. 24 disclosed that it will announce data results on the twice-daily dosing of telaprevir at the 60th annual meeting of the American Association for the Study of Liver Diseases in Boston on Oct. 30 through Nov. 3, 2009. Drugs in existence have a three-dose regimen,

"We believe the drug has shown superior efficacy to rivals," says S&P's Silver, and notes that telaprevir's treatment duration of 24 weeks vs. the 48 weeks in current standard-of-care drugs would be a big advantage.

Vertex is expected to file a new-drug application for telaprevir in the second half of next year, and could launch the product in 2011 if it's approved.

Besides telaprevir, Vertex has also begun clinical studies on next-generation hepatitis C protease inhibitors. It also is studying novel small molecules for the treatment of cystic fibrosis in partnership with the Cystic Fibrosis Foundation.

On Wall Street, Vertex has been attracting significant support, with 16 of 24 analysts who follow it recommending a buy for its stock, with 8 others rating it a hold. Big shareholders include Fidelity Management, which holds an 11.7% stake, Capital World Investors with 5.3%, and Barclays Global Investors with 4.9%.

Those institutions—and lots of smaller shareholders—should not be too surprised if a takeover bid emerges as drug companies discover the virtues of Vertex.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.
Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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