Get ready for a biotech buyout boom

The future outlook for the biotech sector is looking more positive than ever. Marc Lichtenfeld reveals why biotech could be a rich addition to your portfolio.

Next week, I'm giving a speech at the 13th Annual Pharmaceutical and Biotech Licensing and Deal Making Summit.

To prepare for my presentation, I spoke to many of my hedge fund contacts. Given that I'm already a biotech bull, I wanted to know what they expect from the mergers and acquisition landscape regarding the biotech sector.

And what I heard from my sources made me more positive than ever on the future outlook for the sector. So if you'll pardon the pun, here's the deal...

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The sugar daddies of the healthcare sector

Big pharmaceutical companies are analogous to Sugar Daddies. You know, the rich, older guys who want some pretty young girl to spice up their lives. (Of course, this analogy works both ways. Just substitute rich, older women - or 'Cougars' as they're known these days - for Sugar Daddies).

In the healthcare world, the Sugar Daddies are the large-cap pharma companies, who are loaded with cash, but their patents are getting quite gray. And their pipelines (drugs in development that haven't yet been approved) are, shall we say, not quite as robust as they used to be.

But just as it means nothing to the Daddy to lavish his new object of affection with cars, diamonds and apartments in the city, a large-cap pharma can easily drop $800 million for a biotech company.

For example, GlaxoSmithKline (NYSE:GSK) has nearly $7 billion in cash, while Novartis (NYSE:NVS) boasts more than $10 billion. And Pfizer's (NYSE:PFE) coffers are bursting with $25.4 billion in cash.

And some have already splashed their fat wads of cash in a big way...

Two reasons for an imminent biotech buyout boom

Take Glaxo, for example, which spent $720 million of its $7 billion horde to buy Sirtris Pharmaceuticals (Nasdaq:SIRT) last month. That was an 84% premium to SIRT's closing price the night before.

And on the other side of the world, Japanese drug giant Takeda Pharmaceuticals is buying Millennium Pharmaceuticals (Nasdaq:MLNM) for $6.6 billion - a 53% premium. That's also one-third of Takeda's $18 billion of cash and securities.

My sources tell me this type of activity is going to continue - and for a couple of key reasons:

Patent problems: Many of Big Pharma's blockbuster drugs are set to lose their patent exclusivity in the near future. This means the door opens for more generic competition and eats into a Big Pharma company's previously exclusive revenues from the drug.

Poor pipeline: Surprisingly, the large-cap companies don't have particularly full pipelines. Since a pipeline is the lifeblood of these corporations - it's easy to see why they go after smaller rivals who do boast stronger pipelines and/or cutting-edge technology. Some consider it less risky to buy a drug midway through development (or even in the latter stages) than to develop it from the start.

And this is why I think biotech will become a rich addition to your portfolio...

Big pharma wants drugs at any price

The bottom line is this: Big Pharma companies have cash and want drugs. And for the right price, biotech firms will be happy to sell to them.

Moreover, based on the recent M&A activity within the healthcare sector and laws of supply and demand, the prices may stay high or go higher.

For example, imagine you're the CEO of a promising biotech firm and you're seeing the 50% to 80% premiums that Big Pharma companies are paying for your fellow biotechs - many of which have unproven technologies. You can be sure that if a potential buyer comes sniffing around your firm, you're going to try to extract as much money from them for your shareholders as possible.

With drug patents expiring and sparse pipelines, Big Pharma will continue to pay up for smaller biotechs because it has to. And it's these small-cap biotechs that will reap the benefits. So although the big Sugar Daddy pharma firms have all the cash, it will really be the small biotechs that will be asking, 'Who's Your Daddy?'

Hoping your longs go up and your shorts go down.

By By Marc Lichtenfeld, Senior Analyst, Mt. Vernon Research for the Smart Profits e-Report,