What GlaxoSmithKline's Latest Move Means for You
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
GlaxoSmithKline (NYSE: GSK) recently announced the completion of its acquisition of Human Genome Sciences (NASDAQ: HGSI) for approximately $3 billion. The acquisition will be completed at $14.25 a share, including cash and debt, valuing the target at $3.6 billion, a nearly 100% premium over Human Genome Science's stock price on April 18 when GlaxoSmithKline's intention was first announced. Aside from the obvious implications for the two companies (discussed in more detail below), a careful analysis of this deal can give an investor a peek inside both the pharmaceutical and genomics industries. Understanding the increasingly important interplay between these two industries can provide an additional basis for analysis of several market-driving companies.
Why the Deal is a Catalyst
The analysis of a merger or acquisition can be complicated because the specific composition of the new company can be hard to piece together. While many individual investors do not have the training or access to data to quickly process this information, there is an informal indicator that can be a great first step - how the market reacts to the news. In most case, the stock of the target company will go up on the news of the deal because most acquisitions are done at a premium to the stock's prevailing market price. In contrast, the stock of the acquiring company will often fall. The reason for the decline is that while the deal may lead to a long-term benefit to the acquirer, the acquiring company is spending cash - and hence earnings - to complete the transactions. In some cases, however, the stock of the acquirer will appreciate on the news. This may indicate a variety of things, but the most common reason is that the market believes that the acquisition will immediately increase the company's earnings sufficiently to more than offset the purchase price. As stated, this is an informal indicator, but the market has an uncanny ability to assimilate information quickly. On the news of the acquisition, Human Genome Science's stock rose by nearly 4.5% and GlaxoSmithKline's stock price rose by 0.67%. The rise is particularly noteworthy given the higher price that GlaxoSmithKline paid after Celgene (CELG) announced it might be willing to bid against GlaxoSmithKline for the company. The bottom line is that the market likes this deal and, therefore, the transaction can act as a catalyst for GlaxoSmithKline's stock.
One of the most attractive parts of this deal for GlaxoSmithKline is the $200 million in cost savings it expects to achieve by 2015; the company also expects an appreciable contribution to core earnings by 2013. In light of the market's reaction to the news, one can conclude that while earnings may not immediately spike, any negative impact will be minimal. This view is bolstered by the wide distance between the market capitalizations of the two companies. GlaxoSmithKline has a market cap of $112 billion relative to the $3 billion paid for Human Genome Sciences.
In addition to the pure numbers, the partnership will yield exclusive control over three critical drugs, each of which have the potential to have a dramatic impact on earnings. The first, a lupus treatment called Benlysta, has already been approved by the Food and Drug Administration (FDA). While initial sales have been less than spectacular, many insiders believe that there is still significant upside potential. The second drug, called Darapladib, is designed to counteract the effects of plaque buildup and inflammation in the arteries - conditions that can lead to heart attacks and strokes. The third drug, called Albiglutide, is a modified GLP-1 peptide that uses an albumin-based technology. This drug is similar to a drug created by Amylin Pharmaceuticals (NASDAQ: AMLN), recently bought by Bristol-Myers Squibb for $7 billion, and is generating interest from both AstraZeneca (NYSE: AZN) and Bristol-Myers Squibb (NYSE: BMY). Amylin's Exenatide (Byetta), was the first drug in this class. AstraZeneca also formed an alliance with Bristol-Myers Squibb, offering to pay $3.5 billion of the total $7 billion cost for Amylin. Each of these drugs represents important areas of research and development for the industry and have great potential for GlaxoSmithKline.
Given the above analysis, GlaxoSmithKline is well positioned to be added to one's core portfolio at current levels. With that part of the analysis complete, the implications for the industry can be more thoroughly considered. In a recent Forbes article, Matthew Herper suggests that the three lessons to be gained from this acquisition are that partnerships lead to mergers, that most pharmaceutical companies abandoned genomics too soon, and that big risks force even bigger bets. It is the second of these "lessons" that provides the greatest insight into how each of these industries will interact in the future.
Mr. Herper explains how, frustrated with early failure to procure usable genetic data, many of the major pharmaceutical companies exited the industry in favor of more immediately profitable projects. Now, as these companies begin to make significant and potentially lucrative advances, the major players have all become interested again. The likely result is that this is not the last acquisition that will take place over the coming months and years. As the pharma companies are forced to compete, acquisition is likely to be the cleaner approach. The most obvious result of this information is that holding a portfolio of the leading genomics companies should have dramatic upside potential, particularly if one is able to select those companies with leading technologies. The other strategic advantage that can be gained from this information is that it may provide a new basis of analysis to determine where the holes are in the pipelines of the biggest players.
In the interim, GlaxoSmithKline looks like a good bet coming off of this news. More conservative investors may wish to wait for a pullback and to see how the market digests the news over the next several days, but the overall impression is positive.
jordobivona has no positions in the stocks mentioned above. The Motley Fool owns shares of AstraZeneca plc (ADR) and GlaxoSmithKline. Motley Fool newsletter services recommend GlaxoSmithKline. 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.If you have questions about this post or the Fool’s blog network, click here for information.