Biotech Poised to Disappoint

A month ago, following a cue from some big pharma mergers that united the likes of Merck (NYSE:MRK) with Schering-Plough (NYSE:SGP) and Pfizer (NYSE:PFE) with Wyeth (NYSE:WYE), I was standing in the same line most of you were to join the "bullish on biotech" camp. Unfortunately, I think we may have erred.

The line between the two industries is blurred a little every day, as big pharma realizes biotechnology is likely to be at the core of new drug designs. As such, the assumption was made that the less prominent biotech outfits would get snatched up by the remaining (and desperate) pharmaceutical makers. But biotech stocks continued to stink. And, I think they could continue to stink for a while, unable to meet the market's elevated expectations. Why? Here are three possible reasons.

1. Where Are These Deals?
If so much deal-making is in the works, where are the deals? Since Roche Holding (OTC:RHHBY) announced its purchase of the remainder of Genentech, the acquisition activity has dried up.

A few strategic partnerships were signed, however - one of them being a deal between Bayer and Genzyme (Nasdaq:GENZ). But, that was only a transfer of resale rights from Bayer to Genzyme, which is hardly a merger, even if mutually beneficial. Gilead Sciences (Nasdaq:GILD) also snagged CV Therapeutics (Nasdaq:CVTX) in a fairly small $1.4 billion deal. Since then? Nada.

Granted, it's only been about a month since the wave of big pharma mergers began. Those big three acquisitions happened one right after the other so that the companies could prevent competitors from beating them to the bargaining table. But that sense of urgency has faded already.

2. Money Not Arriving By The Truckload
Somewhere in the back of our heads, many of us may justify holding a biotech stock not only because it's a buyout candidate, but because it's a solid, profitable company, too. Those profits are rarer than you might think, though.

Nine of the top (by market cap) biotech companies are profitable; the remaining majority - smaller companies that are seen as acquisition targets - have not been not profitable for the last twelve months. Even one of the top 10, Celgen (Nasdaq:CELG), recently warned that Q1 earnings will not meet expectations.

One has to wonder if the other top nine names will come up short, too. If the smaller brethren are struggling, the others also must question their survival capabilities. Savient Pharmaceuticals (Nasdaq:SVNT) was able to raise $31 million in an equity deal, but the odds of raising funds through equity, let alone debt, may be out of reach for the small biotech firms that can't otherwise attract suitors.

3. Sector Still Pointed Lower
The final arbiter is results. Despite a few bursts of bullishness lately, most of the biotech sector remains in a long-term downtrend.

The S&P 500's biotech stocks were down about 7% this past week, and down about 15% year-to-date. The S&P 500, by comparison for the same time periods, was up about 5% this past week, and is down only about 8% for the year. That's a little more disparity than we can chalk up top volatility alone.

You can talk about value and potential all you want, but a sinking stock is losing you money. Investor patience based on the hope of a buyout is awfully close to simple stubbornness. (This type of strategy demands controlled decision-making, requiring a continual refinement of entry and exit techniques. Read Momentum Trading with Discipline to learn more.)

Last Word
Aside from my opinion being a minority one, it's going to make me pretty unpopular as well. But just let me add one more thought before you begin the flogging.

Michael Becker, formerly the CEO of Cytogen and VioQuest, put this idea into stark terms in late March by suggesting that 120 biotech companies would run out of cash within three months. Barring a miracle, most would not be rejuvenated through M&A, either. (Read more in The Wonderful World Of Mergers.)

Big pharma may truly need some new drugs in the pipeline, but the lack of new deals over the last three weeks - or even hints of new deals - doesn't quite send the same message. Hence, the M&A party already may be winding down. Factoring that in with the industry's already-struggling stocks, biotech doesn't seem to be as widely compelling as it was assumed to be just a mere few weeks ago.

I'm not saying there won't be any more deals made in 2009. And I'm not saying every stock in the biotech industry is doomed. But a combination of factors most likely will greatly limit M&A in the biotech arena for the remainder of the year. Investors who were counting on a buyout will be disappointed. So take this lesson: Don't fall for the hype.