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If there was a recurrent theme in American equities in 2015-16, it was a swift, outsize return in hated, underperforming sectors. Oil, gold and mining shares prove this point since late January 2016. The biotech sector has been gutted on Wall Street since last summer, having lost almost 40 per cent from its highs on fears that the Clinton White House would crack down on drug pricing and stunt the industry's profit machine. The 2012-2015 biotech bull market had made this sector a fabulous winner, as I had pointed out a dozen times in successive strategy columns on Gilead, Biogen, Celgene, Regeneron, Roche and Amgen. The sheer scale of the biotech selloff has derated the industry's valuation metrics and growth expectations, now trading at their lowest levels since 1995.
Since I believe Hilary Clinton is destined to be the 45th President of the United States in November as Donald Trump's monstrous ego destroys the Republican Party, I concede that a political assault on aggressive drug pricing will feature in Uncle (or more accurately, Aunty!) Sam's agenda in 2017, the five point valuation multiple derating on biotechs is entirely rational.
Yet the biotech sector now trades at a 25 per cent discount to the broad market even though it can well deliver 15 per cent EPS growth in the next decade. Valuation is never an infallible timing sector in a notoriously high beta sector and I would still avoid biotech where revenue growth is hostage to aggressive, exorbitant price increases in a handful of life and death drugs. I must disclose a non-financial soft spot for immune - oncology shares since I believe these companies could well deliver a cure for humankind's ancient enemy - cancer. While I am sceptical about a S&P500 index that has soared 230 points since its February 2016 bottom, I believe compelling value now exists in some of the sector's blue chips.
Biogen (symbol BIIB) is one of the world's most innovative biotech companies and its shares have plummeted from a 52 week high of $400 to $265 now. Biogen is the world's de facto "multiple sclerosis" monopoly, with a 40 per cent market share in a $20 billion global market for MS therapies. Wall Street believes MS growth will decelerate due to fewer untreated patients and competitive therapies. True, MS therapies are no less than 80 per cent of Biogen sales and undervalues its pipeline of future neurodegenerative disease therapies notably Alzheimer's and Parkinsons disease/spinal muscular atrophy. At $265, Wall Street assigns zero value to the Biogen's drug development pipeline. Wall Street is wrong, though I concede pricing pressure will hit Biogen's existing MS drugs but three FDA approvals could create new multi-billion dollar growth markets. Alzheimers disease is the ultimate killer app in biotech and Biogen's therapy could well be the compound that wins the prize. Biogen has $6 billion in cash, a billion dollar hemophilia franchise, a lucrative agreement with Roche on the oncology drug Rituxan and innovative intellectual property in gene therapy. Drug pricing politics has led to only four per cent price increase for Tecfidera and Avonex. I expect the buy/sell range on Biogen is 230/380 in 2016.
The Wall Street biotech grapevine contends that Medivation (symbol MDVN) is in play as a takeover candidate, with Gilead, Sanofi and Amgen reputed to be among the suitors. While Medivation management has not shown any public desire to do a deal, the biotech bloodbath has made it a far cheaper acquisition candidate. The company has hired Wall Street merger and acquisition defence specialists as strategic advisors, notably J.P. Morgan. There are few more juicy takeover targets on Nasdaq than midcap biotechs. Medivation shares surged 20 per cent on takeover speculation last week.
There is no doubt that merger mania will be a major theme on Wall Street in 2016 as megacap biotechs are cash rich and looking at deals to boost revenue/pipeline growth since small cap biotechs have fallen 35-45 per cent from their highs. There is at least $180 billion in deal firepower for biotech M&A next year and small cap, early stage biotech relative valuations are, to channel Colonel Sanders of KFC, finger lickin' good. Look for earnings positive companies with potential blockbuster drugs in prostrate cancer, leukemia or gene therapy in FDA Phase Three trials.
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