Will This Orphan Drug Maker Find a New Home?

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Alexion Pharmaceuticals (NASDAQ: ALXN), already quite expensive, spiked higher since takeover rumors surfaced in early July. But can a deal give the stock another boost? I’m doubtful. Even if there is a buyout, which is not a certainty, I think it's probable that the company won’t command a much higher valuation than the current price. Saying that, there are also very good reasons I could be wrong and the chances for a strong bid are real. Why the contradictory assessment? Here are the reasons:

Questions about what an acquirer would be getting

It’s not exactly clear what value Alexion's assets would be to an acquirer. The current prize is a drug called Soliris. It is a complement C5 inhibitor and the company’s only revenue source. The first therapy approved for the treatment of paroxysmal nocturnal hemoglobinuria (PNH) and atypical hemolytic uremic syndrome (aHUS), it is also classified as an orphan drug. One that has been developed specifically to treat a rare medical condition and has an extended exclusivity period and generous financial incentives.

Though the drug is extremely lucrative, there are questions related to its European patent, which expires in May 2015. Not a significantly long life for an acquirer. The patent is also being challenged by large pharma-company Novartis. Since Alexion relies on Europe for a large percentage of the drug's sales, over 36% in 2012, any adverse ruling would seem to weaken the company's position in a critical market. Especially as increased attention already looks to be directed at the C5 therapeutic mechanism.

Both Novartis and Opthotech, a privately held biotech firm, are looking at C5 and though their attention is toward eye-related issues, the increased research may aid developments closer to Alexion’s purview. On the other hand, Alnylam Pharmaceuticals (NASDAQ: ALNY), a cutting-edge RNAi therapeutics biotech company, recently announced pre-clinical data for a developmental C5 targeting drug called ALN-CC5, which specifically addresses PNH and aHUS related issues.

Analysts believe that this firm also has an exciting pipeline beyond ALN-CC5. One that looks to address dangerous excessive protein related diseases and rare bleeding disorders like hemophilia that may justify the company’s $3 billion market cap. The possibility of a buyout and Novartis’ 6.5% stake has also given Alnylam shares a boost.

There might also be questions as to Alexion's overall research & development capability given an unsettling history of legal settlements related to the development of Soliris. In 2008, the company settled with the Oklahoma Medical Research Foundation to acquire all rights to certain patents related to complement-inhibition technology, which had been used for the development of Soliris. In 2009, they settled with PDL BioPharma to resolve a legal dispute relating to Soliris and PDL's Queen et al patents. In October 2012, Alexion reportedly reached a settlement and non-exclusive license agreement with a non-disclosed third party where the company issued an upfront payment and agreed to pay royalties on sales of Soliris.

Of course, patent issues and legal wrangling aren't unusual in the pharmaceutical industry but they might get a closer look in light of the firm’s premium valuation.

Questions about what the acquirer would be paying

There is little doubt that Alexion is already optimistically priced. Based on expected peak sales of as high as $6 billion, near quadruple the current run rate, its market cap is around 3.8 times those revenues. As a general rule of thumb, 3 to 4 times is often considered generous.

Onyx Pharmaceuticals (NASDAQ: ONXX) is a good comparison. The company has an attractive product portfolio with drugs Nexavar and Stivarga on the market and Kyprolis, a highly regarded cancer drug, in development. Onyx also has a respected pipeline including palbociclib, with partner Pfizer, and anti-tumor drug oprozomib. All considered, the company is thought to have peak sales in the $4 billion area. Its shares now trade at a generally reasonable 2.5 times peak sales. If they get to a $150 a share, a 25% premium to Amgen's reported initial takeover offer; it would trade at only 2.8 times.

However, there is a belief that Roche, a rumored suitor, may be willing to pay a much larger premium for Alexion. Roche's $46.8 billion acquisition of Genentech is often used as an example, but that comparison might not be corroborative. At the time of purchase, Genentech had substantial assets such as a stable of blockbuster cancer treatments including Avastin, Herceptin, and Rituxan. Considered a world leader in oncology, it also had sales of over $13 billion.

But why I might be wrong

As much as the evidence might suggest a lack of upside for Alexion shares, I realize that my conclusion might be totally off for two main reasons.

The first is the amazingly dynamic nature of biotechnology. Terrific drugs are frequently discovered. Alexion may come up with a blockbuster through its own research or an extremely wise acquisition, which would obviously increase the value of the company. A second, more compelling reason is that companies have been known to spend incredible amounts for purchases in hot sectors. Biotech is certainly in demand at the moment and orphan drug makers are especially in vogue, so the possibility of a large bid is very real.

I've been caught in such a scenario before. In early 2007, starting to prepare for a slowing economy and housing difficulties, I began shorting Hilton Hotels having noticed hotel stocks do not perform well in recessionary times. Not long after, in the heat of the property boom, Blackstone Group took out Hilton in a $26 billion deal, about a 40% premium. Though the economic downturn eventually vindicated my assessment, a seemingly imprudent takeover bid still put a hurt on my net worth.

Conclusion

Alexion’s shares have recently been quite explosive. Though some of the evidence might suggest that further meaningful upside is unlikely, there are also legitimate reasons why a large takeover bid could happen. An interesting situation, however it turns out, the stock is likely to remain extremely volatile.

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Bob Chandler has a short position in Alexion Pharmaceuticals. The Motley Fool recommends Alnylam Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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