In the early innings of 2024, there was a flurry of consolidation in the biotech industry. It stoked hopes that this would finally be the year in which well-heeled blue-chip pharmaceutical companies would spend some of their cash on faster-growing biotech firms.
That mergers and acquisitions activity has waned in recent months, but there’s still hope that biotech exchange traded funds such as the ALPS Medical Breakthroughs ETF (SBIO) could benefit from an uptick in takeover activity. One of the potential catalysts is often mentioned and omnipresent. Many pharmaceutical companies have thin product pipelines and/or are contending with patent expirations over the next several years. Buyouts are an efficient way to solve those issues.
Additionally, large-cap pharmaceutical companies are sitting on mounds of cash that could be used to acquire smaller biotech firms. Many of which currently sport unusually depressed multiples. That’s pertinent to investors considering SBIO. Why? Because the ETF has a track record of being home to takeover targets, both realized and rumored. Also, some of the fund’s holdings are inexpensive on valuation.
Speaking of Cash …
There’s no denying that large pharma firms have the ammunition with which to affect buyouts. In a recent report, EY analysts Rich Ramko, Ashwin Singhania, and Arda Ural noted such companies were hoarding $1 trillion in cash and cash equivalents at the end of the first quarter.
High interest rates are part of the problem for biotech stocks and ETFs like SBIO. Those elevated borrowing costs weigh on capital-intensive biotech firms. Additionally, those high rates make it more attractive for prudent pharmaceutical companies to be picky when it comes to deal-making. Their cash stockpiles can sit around accumulating high levels of no-risk interest, generating more cash in the process.
Of course, that situation isn’t tenable over the long term. Interest rates will eventually decline, making cash instruments less appealing and pharma corporations will still need to replenish product pipelines. Those are among the reasons why some traditional drug makers could opt to strike while biotech valuations are low and most of the stocks in the industry are dithering.
“As shifts in macro policy potentially infuse more confidence into financial markets both public and private, we can expect to see accelerating activity in biotech in terms of partnerships, acquisitions, financing rounds, follow-ons, IPOs, and more,” concluded EY.
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