Warning: Good Biotechs Get Acquired; The Rest Don't

Published in Investing on 26 April 2012

Buy because they're good, not because they'll get acquired.

A version of this article originally appeared on our US site, Fool.com.

It's happening. Again. String together a few biotech acquisitions or threats thereof, and suddenly every biotech is a takeout target.

Yesterday it was AstraZeneca (LSE: AZN) taking out Ardea Biosciences, and last week it was Human Genome Sciences (NASDAQ: HGSI.US) rebuffing a lowball bid from GlaxoSmithKline (LSE: GSK). An unconfirmed report that Bristol-Myers Squibb (NYSE: BMY.US) was making an unsolicited bid on Amylin Pharmaceuticals (NASDAQ: AMLN.US) caused the biotech to shoot up higher, and an unconfirmed report that it was putting itself on the auction block sent it even higher.

But the names don't even matter. Put enough of them together, and investors will suddenly think they can buy any drugmaker and see an overnight double as the drugmaker gets taken out.

Sorry, Fools: it doesn't work that way. Good biotechs are in scarce supply, for sure, but pharma's cash isn't burning a hole it its pocket. Contrary to popular belief, they have more wherewithal than a five-year-old in a candy store. In addition to just waiting for deals, share buybacks and dividends are viable options for using excess cash.

About the only place where the M&A-begets-M&A mantra made any sense is in the hepatitis C space. When a combination product is the only thing that's going to get you on the market, it's logical to snap up assets to round out the portfolio. Even so, there are still some hepatitis C biotechs that haven't been purchased -- Idenix Pharmaceuticals (NASDAQ: IDIX.US) and Achillion Pharmaceuticals -- and they're trading well off their 52-week highs.

But Ardea gets taken out, and suddenly you hear everyone talking about gout drugs. Sorry, but pharmas don't need a gout drug to fill their pipelines; they need any promising drug to fill the pipelines. And if Ardea is the best it gets, drugmakers playing second fiddle aren't going to have an advantage now that Ardea is out of the running.

The buy-your-partner rumours make even less sense. How does Glaxo's interest in its partner have any relevance over whether Bayer buys Onyx Pharmaceuticals (NASDAQ: ONXX.US) or Eisai buys Arena Pharmaceuticals (NASDAQ: ARNA.US)? It's always been easier for drugmakers to buy their partners, but that happens only if it makes financial sense.

The reason pharma companies buy biotechs is the same reason you should buy biotechs. Either, like Human Genome Sciences and Amylin, they've been overly punished for their struggles, or, like Ardea, they have some upcoming catalyst that's worthy of holding over. Buying in the hopes that this string of M&A transaction will continue is a bad investment thesis.

We cover these types of biotech investments – and make specific share recommendations – in Motley Fool Share Advisor, a premium investing service designed to help you preserve and grow your wealth. If you'd like to see for yourself how we can help, start your 30-day free trial today. There's no obligation to subscribe.

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