How to Survive this
Credit Crunch
By Dr. George Huang, editor, S&A FDA Report
October 17, 2008
Cash is tight.
What's true for the American consumer is true of the nation's biggest blue chips. If General Electric and Goldman Sachs are struggling to raise money, then a small, cash-hemorrhaging biotech has an impossible time trying to refill its coffers.
The biotech industry depends on the public markets to keep the lights on. And with hedge funds closing shop daily and private-equity investors balking, biotech funding options have dwindled considerably. This year, through the end of September, the biotech sector managed to raise only about $12 billion, the lowest level since 2002.
So I expect a slew of biotech companies to go bankrupt or get acquired at fire-sale prices – as low as 30 cents on the dollar.
Just last Tuesday, Atlanta-based AtheroGenics (AGIX) became the first victim. The company filed for bankruptcy after defaulting on its convertible debt earlier in the year. Micro-cap biotech Pharmacopeia (PCOP) recently sold itself to slightly larger Ligand (LGND) in an all-stock transaction. Pharmacopeia shareholders are essentially exchanging their shares to own a company that has the cash to survive a prolonged crisis.
We'll see dozens of other small biotechs go under... even if the credit crunch reverses by the end of the year. But that doesn't mean we can't find rich opportunities...
Biotech's cash-rich sugar daddies, Big Pharma companies, are weathering the crunch just fine:
Company |
Cash Hoard |
Pfizer |
$26 billion |
Novartis |
$16 billion |
Roche |
$15 billion |
Wyeth |
$14 billion |
Bristol-Myers Squibb |
$6 billion |
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Pfizer, with $26 billion on its balance sheet, is currently the cash king. And the company is set to generate another $17 billion in operating cash flow over the next 12 months. Even after accounting for its $8.5 billion dividend payment, Pfizer will grow its cash hoard to a whopping $35 billion by next summer.
The other Big Pharma players are in a similar situation. According to business intelligence outfit Datamonitor, the top 20 pharmaceutical companies in the world each has an average $7 billion cash balance. That's a cumulative $140 billion war chest!
When we include pharma-like biotech companies Amgen and Genentech as potential acquirers, this group has enough money to buy up every biotech in the world many times over.
The only way for Big Pharma to rebuild its pipeline, while earning a reasonable return on its investments, is to buy biotech assets at distressed prices. Plan on seeing the world's biggest drugmakers gobble up at least five to 10 biotech players across the next few quarters.
It may seem like the best way to play it is to simply buy likely acquisition candidates – companies with lucrative products on the market, a stable of late-stage candidates, and a productive drug-discovery team – and wait. But waiting in this market can be painful. If we experience more panic selling, we could end up sitting on major paper losses.
I'd much rather lower my risk and get paid to wait for the trend to fully play out. We'll look for the highest quality names selling at the biggest discounts. That will keep our downside to a minimum. Then we'll continue to take advantage of recent market volatility by selling options.
First, we can sell covered calls on the positions we already own. Someone else pays us for the right to buy our stock at a higher price. With option premiums as large as they are now, it's free money. Second, we can sell puts on stocks we'd like to own at a lower price. If the price falls, we buy the stock cheap. If it doesn't, we keep the cash.
Cash is tight right now. And biotech companies are hurting. But with the right strategies, biotech investors can generate plenty of income while we wait for better times.
Good investing,
George Huang
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