Biotech cos: Are they just paper tigers?

Biotech cos: Are they just paper tigers?

Big pharma has long regarded the biotech sector as its supermarket. When drug pipelines grew thin, drug giants could just do a bit of shopping. But what happens when bigger biotechs start wheeling their own trolleys?

Take Celgene’s $2.9 billion (Rs11,397 crore) acquisition of Pharmion. Strategically, it makes a lot of sense for the biotech company to buy its smaller rival. Both have new, and complementary, drugs for the treatment of cancers of the blood. And they know each other through partnership arrangements. Still, all the strategic rationale in the world means little if one can’t pay the market price for something. Here’s where it gets interesting. Subtract the cash on Pharmion’s books, and the price is $2.6 billion. Moreover, Celgene already owns around 5% of Pharmion. Add it all up and Celgene could have bought its rival from its $2.5 billion of cash on hand.

Big pharma has plenty of cash, too. But Celgene was able to pay up thanks to a more valuable currency—its stock—which it used for the bulk of the purchase. Its paper trades at more than 40 times estimated 2008 earnings according to JCF FactSet. In contrast, the world’s three biggest drugmakers, Pfizer Inc., GlaxoSmithKline Plc. and Sanofi-Aventis, trade at an average of 11 times estimated earnings.

The idea that biotech companies trade at higher multiples isn’t novel. However, the size of the gap continues to widen. Big drugs makers may have gobs of cash, but biotechs can reach for higher prices by using their highly valued paper. Moreover, biotech companies have growing ambitions as they become larger. Celgene’s market capitalization has now swollen to $25 billion. Pharmion is, by far, the biggest purchase it has ever made.

Of course, big pharma is hardly going to stop shopping. Pfizer, for example, has more than $14 billion in net cash on its books and desperately needs new drugs. It will just need to pay more when it decides to stock up its larder. Celgene has agreed to acquire Pharmion for $2.9 billion, or $72 per share, in cash and stock. The biotech group will pay $25 in cash and $47 in stock. Both companies develop and sell drugs that treat cancers of the blood. The stock component is collared. If Celgene shares are worth between $56.15 and $72.93 at the time of the merger, then Pharmion holders will receive for each share $47 divided by the Celgene stock price. If Celgene stock is above $72.93, the exchange ratio is 0.6445. If Celgene stock is below $56.15, the ratio is 0.837.

JPMorgan Chase & Co. and Merrill Lynch & Co. Inc. advised Celgene. Bank of America Corp. advised Pharmion.