Merger mania could mean big gains

Recent acquisitions in the biotech sector show capital is now available for the right deals. And with a wave of consolidation a distinct posibility, it's a sector for investors to keep an eye on.

Talk about a winter of discontent... Over the past seven weeks, we've seen quite possibly one of the best examples of stock market fear in history. Actually, it's not fear. It's panic, as top-quality stocks have been spanked down to bargain-basement levels.

But business is still booming in one sector...

Over that time, we've seen three huge buyouts occur in the Big Pharma/biotech area. It started in January, with the news that Pfizer (NYSE:PFE) would shell out $68bn to buy Wyeth (NYSE:WYE).

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

And things really got rolling last week, with the announcement that Merck (NYSE:MRK) will acquire Schering-Plough (NYSE:SGP) for $48bn and that Roche and Genentech (NYSE:DNA) finally concluded protracted negotiations that will see Roche buy the biotech superpower for $47bn.

Total value of done deals: $163bn. And in a market where access to capital has supposedly dried up.

The question is: Could these Big Pharma mergers signal a shift in sentiment and a bottom for the broader stock market?

If you're looking for a simple, one-word answer... no. But if you don't take your lead from features as the Lightning Round, I invite you to keep reading...

The money is there... but only for the right deal

There's no doubt that it's tough to get credit these days. But as the mergers above show, capital is clearly available for the right deals.

For example, in order to finance its acqusitiion of Genentech, Roche issued nearly $33bn in notes. In addition, Pfizer received over $22bn in loan commitments from various banks to complete its transaction. And similarly, JP Morgan (NYSE:JPM) slapped down $8.5bn so Merck could fund its deal with Schering-Plough.

Again, this has occurred during one of the most fear and panic-ridden periods in stock market history. And it's come despite frequent comparisons of the Depression era. Listen to the media too much and you'd expect to see the world in a grainy, brown hue every time you look out the window, while Brother, Can you Spare a Dime? plays in the background.

Don't get me wrong here: I'm keenly aware that the economy is in bad shape. No one has ever accused me of being a Polyanna. But my point is that it's not necessarily all doom-and-gloom (as some would like you to believe).

These healthcare/biotech mergers indicate the beginning of a thaw in credit markets and hopefully the start of a healing process for the markets. Notice that I'm not calling it a "bottoming process" because as I said last week, I do believe we'll see new stock market lows.

But as more deals get done, investor and lender confidence will slowly return to the market. And I do think more acquisitions are imminent - particularly within the biotech sector...

On deck... biotech

Biotech is likely in store for a wave of consolidation. While the above-mentioned Big Pharma companies have plugged some holes in their businesses and created massive biopharma companies with their acquisitions, there are still many pharmaceutical companies that desperately need to fill their pipelines.

And that bodes well for biotech - particularly when you consider that the largest biotech company after Genentech is Amgen (Nasdaq:AMGN), which boasts a market cap of $48bn.

After that, Gilead Sciences (Nasdaq:GILD), which just announced a $1.4bn takeover of CV Therapeutics (Nasdaq:CVTX), is next at $40bn. Then the numbers drop off considerably, with only three companies that have market caps over $10bn and 11 other companies with market caps of $1bn or more.

For example, Merck could buy Biogen (Nasdaq:BIIB) and Genzyme (Nasdaq:GENZ) for less than it cost the firm to buy Schering-Plough.

The point is: Even though the biotech sector has outperformed the S&P 500 during the bear market, many biotech stocks have become cheap.

In fact, pharmaceutical companies wouldn't even need to raise capital to buy a BioMarin (Nasdaq:BMRN), or Xcelerated Profits Report portfolio member Medivation (Nasdaq:MDVN) and many others like them.

Our two favourite emotional friends: fear and greed

When managements are scared they hunker down and hang on to capital. But when opportunistic executives add to their businesses - even during downturns - that kind of optimism and action is healthy. They're essentially expressing their confidence that conditions will improve.

Remember... emotions control the stock market as much as fundamentals. And as we've mentioned in previous columns, fear and greed are the two main players. So when investors see this kind of activity, they start to think about their own opportunities, rather than cowering in the corner in the foetal position like so many have for the past few months.

Snowball effect

As we've seen recently, Big Pharma has already fallen for some of the most attractive biotech names. And as some more choice companies begin to get snapped up, you might see a rush into the sector by other Big Pharma firms to grab the existing quality companies before someone else does.

Mix in this momentum with some speculation and that could kick prices higher, causing Big Pharma executives to pull the trigger before valuations get too expensive.

The economy is still bleeding, but these recent acquisitions indicate that the patient is no longer spurting blood all over the emergency room floor. Eventually, it will stabilise and walk on its own again.

When it does, the strongest drug companies will be the ones that took advantage of this unique opportunity to fill their pipelines with products from inexpensive biotech companies.

This article was written by Marc Lichtenfeld for the Smart Profits Report