2 Stocks to Buy on Merger Speculation

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Large healthcare companies are facing revenue declines due to expiring patents. These cash rich giants are increasingly investing in small biotechnology companies with promising candidates. Solta Medical (NASDAQ: SLTM) and Keryx Pharmaceuticals (NASDAQ: KERX) are good targets for Big Pharma players looking to diversify or expand patent portfolios.

Solta’s board is resisting an acquisition but it seems highly likely that activist shareholders will succeed. The shareholders have already rejected the Board’s attempts to double outstanding shares and reduce chances of acquisition. Keryx is getting ready to submit its first NDA next month and there is a high probability that it will get FDA approval for Zerenex.

Medical Equipment

Solta Medical is involved in design, development and commercialization of energy-based medical appliance and equipment. Its target market expands to Middle East, North America, Europe and Asia Pacific. Solta brands include Fraxel, Thermage, Liposonix, Isolaz and CLARO. Over the years it has developed its own distribution network but also utilizes independent distributors and retail networks. Solta’s customers include gynecologists, dermatologists, plastics surgeons and ophthalmologists.

The valuations of Solta have been pretty stagnant in the last few years. During the last few quarters shares have fluctuated between $2 and $3. While the valuations have remained stagnant, Solta has shown a significant revenue growth. The company revenues have increased from $110 million (2010) to $144 million (2012), growing by nearly 31%. Despite the revenue growth, gross margins have remained stable at around 62%. However, this growth has not been reflected in the bottom-line due to an approximately 100% increase in SG&A expenses to $104 million.

In the recent past Solta has become an attractive acquisition target. The stagnant price and lack of dividends indicate that a profitable acquisition should be the right option. However, the board of Solta has been resisting any such attempts. According to Voce Capital, the company has been actively trying to thwart acquisition attempts by interested parties. In its last week’s letter to the board, Voce has demanded that the board should formulate a special committee to evaluate M&A. The firm has also criticized the board for shareholder dissatisfaction and intentionally refusing good bids for Solta. The board is already low on investor confidence as the shareholders have rejected the Board’s proposal to double the shares outstanding to 200 million.

There are a number of parties interested in Solta Medical. There have been rumors that Valeant Pharmaceuticals (NYSE: VRX) is interested in acquiring Solta. The company has already acquired a number of companies in the last year. These acquisitions include Bausch & Lomb, Obagi and Medicis Pharmaceuticals. Medicis was primarily bought for its facial aesthetic portfolio and Solta has a pretty significant presence in this space, making it an interesting target for Valeant.

The board has already lost trust of shareholders and Voce Capital has a pretty good record of convincing boards which are not focusing on shareholder interests. In case of successful acquisition, the valuations of Solta will soar and provide significant upside for investors.

Healthcare

Keryx Biopharmaceuticals is a biotechnology company involved in acquiring, developing and commercializing treatments for the renal diseases. Its primary candidate is Zerenex, which has completed Phase III trials. Zerenex is an oral compound with the ability to bind phosphate in the gastrointestinal tract, which helps in treatment of renal diseases. The drug is also in Phase II trials for the treatment of anemic patients with serum phosphorus and iron deficiency.

In January, Keryx released data from Phase III trials of Zerenex. The market reacted positively to the released information and valuations of Keryx soared from approximately $3.5 to above $9. The released data showed that Zerenex had met all the primary endpoints of the study. The trials measured the Serum Phosphate levels in subject taking Zerenex and the results shows that they had well maintained levels with 4.90 mg/dL at the end of the 4-week efficacy period and 5.1 mg/dL at baseline. As compared to other competitors already available on the market, Zerenex requires less intravenous iron supplementation and ESAs (erythropoietin stimulators).

The valuations of Keryx have already appreciated by a mammoth 344% in the last 52-weeks. In the last six months institutions have increased their Keryx holdings by a mammoth 35%, adding 30 million shares to their portfolios. Despite the recent appreciations, the company is still trading at a 36% discount to the mean sell side target price of $13.2. 10 sell side analysts have a buy recommendation for Keryx.

The patent cliff has increased the attractiveness of companies like Keryx. Big pharmaceuticals are acquiring promising biotechnology companies to supplement their expiring patents. Keryx will submit its NDA by August and there is a high probability that Zerenex will get FDA approval. Despite the January valuations hike, there is still more juice in Keryx. The company is an attractive acquisition target for healthcare giant suffering from the patent cliff.

Bottom line

Solta Medical’s board is trying to stop any attempts at the acquiring the company. However, Voce Capital is fighting the board to put interests of the shareholders first. It seems highly likely that the board will have to give in to pressure from shareholders. Keryx has already appreciated over 300%, but there is still a significant upside for investors. There is a highly probability that Zerenex will get FDA approval, which will have a positive impact on valuations. 

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Mohsin Saeed has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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