Biotech Giving Best Returns as Drugs Fuel Deal Frenzy

Biotechnology shares are generating the best risk-adjusted returns among U.S. industries, gaining as drugs to treat cancer and rare diseases boost sales and spur takeover interest from the biggest pharmaceutical companies.

The BLOOMBERG RISKLESS RETURN RANKING shows biotechnology stocks beat the other 67 groups in the Standard & Poor’s 1500 Index during the three years through June. The gauge, which includes Gilead Sciences Inc. and Celgene Corp., returned 7.67 percent after adjusting for price swings, more than double the gain in the broad equity measure.

Products such as Gilead’s drugs for HIV and Celgene’s Revlimid cancer treatment have driven a revenue expansion that’s more than double the pace for the S&P 1500. With government approvals reaching a 15-year high and takeovers outpacing the rest of the market, biotechnology companies will continue to reward investors, according to Marshall Gordon, a New York-based health-care analyst at ClearBridge Investments LLC.

“The big biotechs have clean, visible growth for the next five years and at a relatively high rate,” Gordon said in a phone interview last week. His firm oversees about $70 billion, including Biogen Idec Inc. shares. “Those types of trajectories are not available anywhere else with high certainty and visibility. So there has been a rotation to those stocks.”

Once seen as prone to volatility and too dependent on just a few drugs, biotechnology companies have evolved into a business with stable growth. The industry’s sales rose 7.2 percent in 2009 even as companies in the S&P 1500 experienced a 9.7 percent decline amid the financial crisis.

Accelerating Sales

Revenue from the 14 biotechnology companies in the S&P gauge surged 48 percent over the last three years, compared with a 21 percent increase for the broad equity measure. While growth in the S&P 1500 is projected to stall near 4 percent over the next three years, analysts forecast the industry’s sales expansion will accelerate to 15 percent in 2015 from 9.9 percent this year, estimates compiled by Bloomberg show.

Including reinvested dividends, the biotechnology gauge returned 158 percent over the three years through June on an absolute basis, compared with a 67 percent gain in the S&P 1500. Regeneron Pharmaceuticals Inc., the maker of eye medicine Eylea, soared more than 10-fold.

The industry’s risk-adjusted return over the period was 0.64 percentage point more than the next best performer, cigarette makers, and 1.36 percentage points more than the No. 3 industry, auto and pool supply distributors.

Risk-Adjusted Returns

Risk-adjusted returns, which aren’t annualized, are calculated by dividing total gains or losses by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. Higher volatility means the price of an asset can swing dramatically in a short period of time, increasing the potential for unexpected losses compared with a security whose price moves at a steady rate.

Biotechnology’s volatility score was 20.5, about 12 percent lower than the average. While Internet retailers produced the only higher total return over the three years, their volatility was 45 percent greater.

“Biotech is one of those few industries where you are seeing real change happening,” Les Funtleyder, a New York-based health-care strategist at Poliwogg, said by telephone on July 12. “That’s one of the areas that we are really seeing innovation, and innovation with respect to new products is generally what drives stock returns.”

Best-Selling Drugs

Biotechnology involves the manipulation of proteins that form the building blocks of living organisms to develop drugs and vaccines. Since the Food and Drug Administration approved Humulin, Eli Lilly & Co.’s diabetes treatment, as the first genetically engineered drug product in 1982, the industry has developed some of the world’s best-selling drugs to treat cancer, arthritis and AIDS.

Celgene jumped to a record on July 11 after its Revlimid cancer drug met the goal of a study aimed at showing the medicine could be an initial treatment for patients with multiple myeloma. Shares of the Summit, New Jersey-based company rallied 130 percent during the three years through June.

Gilead, the world’s largest biggest maker of AIDS medicines, tripled during the period. The company, based in Foster City, California, is expanding into hepatitis C research, one of the fastest-growing areas of medicine. On June 7, Gilead said its experimental pill, sofosbuvir, will receive a priority marketing review by U.S. regulators.

Biogen Surges

Biogen surged 52 percent this year after the Weston, Massachusetts-based drugmaker in March won U.S. approval for its first pill for multiple sclerosis, Tecfidera.

“You’re getting approvals that are leading to top line growth,” Jon Loth, a Minneapolis-based money manager for Nuveen Asset Management, said in a phone interview on July 15. His firm manages more than $125 billion and owns shares of Biogen, Celgene and Gilead. “Over the past three to four years, they’ve done what investors have postulated the group couldn’t do over the past 20 years. It’s rather remarkable.”

Fast-growing biotechnology companies have become takeover targets as big drugmakers try to fill revenue holes left by expired patents. About $85 billion worth of mergers and acquisitions took place in the industry during the last three years, data compiled by Bloomberg show. The largest acquisition was Sanofi’s $20.1 billion takeover in 2011 of Genzyme Corp., a developer for rare illnesses such as Gaucher and Pompe diseases.

Biggest Deal

In 2012, the biggest biotechnology deal was Bristol-Myers Squibb Co.’s $5.3 billion purchase of Amylin Pharmaceuticals Inc. to gain diabetes drugs. New York-based Bristol-Myers faced generic competition last year to Plavix, its best-seller with more than $7 billion in peak revenue.

“You have these large pharmaceuticals, and to a certain extent some of the mega-cap biotechs, that have excess cash flow and don’t have a lot of growth,” Walter Todd, who helps oversee $950 million as the chief investment officer of Greenwood Capital Inc. in Greenwood, South Carolina, said by phone on July 11. “So you’ve seen a lot of M&A activity, and that’s played into the return you’ve seen in biotech.”

Speculation over new drugs and takeovers has driven the industry to the highest valuation in almost seven years, with stocks in the S&P Supercomposite Biotechnology Index trading at 30 times reported earnings. That’s 79 percent higher than the multiple of 16.8 for the S&P 1500.

‘M&A Premium’

“There is probably a fair amount of M&A premium in biotech stocks,” Michael Sjostrom, who helps manage $4.5 billion as the chief investment officer at Sectoral Asset Management Inc., said in a July 12 phone interview from Montreal. “Premiums will probably go away, not all these companies will be acquired.”

“Biotech in and of itself is a fairly risky business,” he said. “Most of these companies are involved in developing drugs, and drug development is a lengthy and expensive undertaking and does not always result in success.”

Bulls aren’t discouraged by rising valuations and the potential of product failures. The biotechnology index has climbed 9.6 percent since the end of June, after rallying seven straight quarters, the longest stretch since the measure was created in 1994.

The FDA cleared 39 novel medicines in 2012, including 11 new cancer therapies such as Ariad Pharmaceuticals Inc.’s Iclusig, aimed at forms of leukemia, agency data show. That’s nine more approvals than 2011 and the most since 1997.

Speeding Approval

Regulators may be able to speed the approval of some drugs under a new proposal that was part of legislation that became law in July last year. Pharmaceutical companies can request the agency designate their experimental treatments for serious or life-threatening diseases as breakthrough therapies.

Takeovers among biotechnology companies are already exceeding last year’s levels. Mergers and acquisitions reached $21.5 billion this year, or 12 percent higher than all the combined deals in 2012, data compiled by Bloomberg show. Total U.S. transactions were worth $432 billion, or half of last year’s value, the data show.

Roche Holding AG, the largest maker of cancer drugs, is seeking billions of dollars in financing for a potential takeover of Alexion Pharmaceuticals Inc., people with knowledge of the situation said last week. Alexion, with a market value of about $21 billion, has a single approved drug: Soliris, which is used to treat rare blood diseases. Shares of Cheshire, Connecticut-based Alexion jumped 13 percent on July 12 and more than tripled in the past three years ended June.

“Biotech has undergone a renaissance period of significant pipeline successes and blockbuster new product stories,” Michael Yee, a San Francisco-based analyst with RBC Capital Markets, said in a July 12 interview. “Combined with the recent M&A flurry, it has created a perfect backdrop for a biotech bull market.”

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