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Biotechs' Fusion Fever

By Arlene Weintraub From Wall Street's initial reaction to the latest big-biotech marriage, it might seem the future of such mergers is cloudy. On Aug. 21, OSI Pharmaceuticals (OSIP) announced it would buy Eyetech Pharmaceuticals (EYET) for $935 million in stock and cash -- a whopping 43% premium over Eyetech's most recent closing price of $14 a share. Eyetech investors were thrilled, pushing its shares up 29.6%, to $18.13 on Aug. 22.

But OSI shareholders balked, stomping its stock down 21.7%, to $31.92, and raising questions among analysts about whether the deal can be consummated at the new valuations. OSI investors seem to be questioning whether any synergy exists between the two companies: OSI focuses on cancer and diabetes, while Eyetech's strength is treatments for eye diseases.

UNDER-THE-RADAR BARGAINS? Still, the volatile reaction to the deal isn't likely to dampen the growing appetite for biotech mergers. More than eight biotech acquisitions were announced in the second quarter of 2005 alone, valued at more than $5 billion. Leading the pack were Pfizer's (PFE) $1.9 billion buyout of Vicuron Pharmaceuticals (MICU) and the $1.6 billion merger of Shire Pharmaceuticals (SHPGF) and Transkaryotic Therapies (TKTX).

Analysts expect the merger mania to continue, driven by two important catalysts. First, despite a rebound in the biotech indices this year, many companies are still trading at relatively low valuations.

True, the Amex Biotech Index has gained 20.5% in the last three months, but much of that runup has been driven by giants Amgen (AMGN) and Genentech (DNA), both of which have seen their stocks fly on positive earnings news. Take both these leaders out of the index, however, and the index is up just 13% -- a sure sign there are smaller, under-the-radar players, whose valuations potential acquirers might deem attractive.

ONCOLOGY TARGETS. The second trend fueling consolidation: The American Job Creation Act, which is allowing some large companies to repatriate foreign earnings at a reduced tax rate. In the Big-Pharma space, that repatriation could free up a lot of cash for deals. Pfizer alone has repatriated $36 billion this year, and with the Vicuron deal, it demonstrated its hankering to spend the money by beefing up its pipeline with biotech drugs. Vicuron has a number of promising candidates to treat infectious disease.

As for which biotech concerns might get scooped up next, analysts are keeping a close eye on the oncology sector. Andrew McDonald, a biotech research analyst for Think Equity Partners in San Francisco, says BioCryst Pharmaceuticals (BCRX) is a likely takeover target in the cancer space. The Birmingham (Ala.)-based biotech is testing a leukemia remedy.

"The drug is showing potential for expanded indications," McDonald says, and at $7.20 a share, the stock "is fairly undervalued." Christopher Raymond, an analyst for R.W. Baird & Co. in Chicago, names MGI Pharma (MOGN) and NeoPharm (NEOL) as other attractive targets in oncology.

LITTLE IPO ACTION. So who is likely to be shopping for biotech? Most analysts are betting the biggest moves will be made by well-capitalized drugmakers seeking to improve their pipelines. McDonald names Bristol-Myers Squibb (BMY) as a likely acquirer in the oncology arena. And biotech giant Amgen -- which acquired Tularik last year as part of its effort to boost its research in cancer, inflammatory disease, and metabolic disorders -- could go hunting for more worthy candidates.

These takeover artists might also find their targets in the large list of biotech outfits hoping to go public. Despite the rebound in biotech stocks, the appetite for initial public offerings in the sector is virtually nonexistent. In the second quarter, only two biotechs went public, raising just $74 million -- the lowest sum mustered by the sector since 2003, according to life-sciences merchant bank Burrill & Co.

Since that year, the biotechs that have IPO'd have seen their stock prices fall by an average of 5%, making it even less likely investors will smile on such outfits that try to go public in the near future. Earlier this year, Peninsula Pharmaceuticals cancelled its IPO and instead opted to be bought out by Johnson & Johnson (JNJ) for $245 million. Analysts expect to see more such deals this year.

STAMPEDING TO FUNDS. If investors continue to flock to biotechs that are already public, as they have in recent weeks, it will only fuel the merger trend. In the week ended Aug. 3, investors poured $2.1 million into dedicated health-care and biotech mutual funds -- the ninth week in a row that such funds enjoyed a large influx of dollars.

"This is one of the largest inflows into dedicated biotech funds I've ever seen," says Baird's Raymond. "That money has to go somewhere." Investors likely realize sure bets in biotech don't exist, but this sector may offer better opportunities than elsewhere in the near term.

Weintraub is BusinessWeek's science department editor

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