2007 Financial Markets Preview: M&A upside

Last year was a banner year for financing in the biotech sector. A total of $29.6 billion was raised worldwide, including $23.9 billion in the public space. But that doesn't mean investors will be fatigued going into 2007, because many had big returns from the M&A frenzy that cashed out companies from their portfolios.

Indeed, the 2006 surge in biotech M&A meant even more money was returned to public and private shareholders via takeouts - about $30 billion - than was raised in the private and public capital markets combined. As a result, many public equity funds, while not giving out specific performance numbers, are chalking up 2006 as a strong year.

These investors are likely to continue to make money via M&A this year, as the disconnect between what public investors are willing to pay for companies versus what a strategic buyer (big biotech or pharma) will pay might narrow but certainly will not vanish. Indeed, 2007 kicks off with $19.6 billion worth of acquisitions waiting to close.

On average, corporate buyers in 2006 paid higher premiums for their takeouts than in years past. Indeed, it was not uncommon for a buyer to pay a premium of more than 50% for a public biotech. There are multiple reasons for the sweeter payouts, but two stick out. Equity assets were cheap, especially in the fall. The other can be summed up in two words: rational panic. Several pharma companies have new CEOs who are facing the worst of all worlds: major drugs coming off patent and a dearth of internal productivity.

The result, said Kai Bruening of DEKA Investments, is that "consolidation and M&A will be the major theme for 2007."

But despite the consensus that M&A will be a key way to make money on public companies this year, industry watchers don't think that will change how investments are made. Some buysiders had fast exits via M&A, while others saw long-time portfolio companies get taken out, and all find it impossible to predict which companies will get acquired.

As a result, the buysiders see M&A as a bonus, rather than a key factor in the decision to invest. Consequently, the prognosis for 2007 is a continuation of the past few years: measured investing in fundamentally sound companies with much less boom and bust in the sector(see BioCentury, Jan. 2,

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