Biotech is hot. A number of sizeable deals — and expectations of more — keep the sector in the headlines and in the minds of investors. 

Just a few days ago, on June 17, Pfizer (NYSE: PFE), which had not made a major acquisition for a couple of years, announced an agreement to buy Array BioPharma (Nasdaq: ARRY) for $10.6 billion (a 62% premium). 

And PFE is not alone in its attempts to beef up its drug pipeline. 

Novartis (NYSE: NVS) is planning to spend as much as $10 billion per year on acquisitions. GlaxoSmithKline (NYSE: GSK) — which, just six months ago bought oncology-focused Tesaro for $4.1 billion in cash and a 62% premium to the company’s market price — said it plans to spend more on its cancer-related research. Merck (NYSE: MRK), too, over the past two months has spent more than $3 billion on two acquisitions: the first was Peloton Therapeutics just a day before Peloton was scheduled to go public, and then Tilos Therapeutics, a company working on cancer, fibrosis and autoimmune diseases. 

If you are looking for a pattern, there is one. These acquisitions and spending plans have a focus: investing in fast-growing markets — primarily cancer, but also the developing area of gene therapies. The worldwide market for cancer drugs alone is set to grow by more than 70% in just five years, to $237 billion in 2024 from $138 billion this year, according to research firm EvaluatePharma. 

No wonder companies with promising cancer-focus research and early-stage drugs demand the spotlight. 

Two distinct ways to approach an acquisition can be seen in these examples. 

GlaxoSmithKline, for one, was hunting for a cancer-related bargain — and it got it with Tesaro, whose shares declined from a high of $190 in 2017 to a low of $26 in November 2018 before GSK swooped in at $73.50 a share in December. The reasons for the share price decline are related to the same drug that was likely GSK’s target: Zejula, Tesaro’s only approved ovarian cancer drug, faces significant competition. Clearly, just as with the stock market, everyone loves a sale. This also shows that the market often punishes perfectly good stocks more severely than a misstep or two might justify. 

But the opposite is also true. In many cases, big pharma pays large premiums for companies whose shares have rallied strongly in a short period of time. Let’s take Array BioPharma — for which PFE is paying a hefty premium — as an example. 

This stock was rewarding its shareholders way before PFE’s bid. In 2018, for example, it returned 11% compared with the market’s 4% decline. That’s respectable enough, but at mid-year, ARRY investors were sitting on a 56%-plus gain before selling off with its peers and the broader market in the fourth quarter. Of course, because of PFE’s bid, anyone who bought ARRY at that midyear high and held on through the sell-off would be sitting on a gain of about 132% today (versus 6.7% for the S&P 500). 

But ARRY was strong even prior to 2018. From a five-year low in February 2016 through June 14 (the Friday before the Pfizer’s bid was announced), ARRY posted a 950% return (versus the S&P 500’s 52%). Unlike GSK — which was looking for a bargain — PFE was buying a success story. Both approaches are equally valid. 

PFE’s strategy also goes to show that, if a biotech’s share price goes up for a good reason (strong clinical study results or a new drug approval), there is a strong-enough chance that this company will deliver value to the acquirer. 

Let’s Identify Some Potential Biotech Takeover Targets
Of course, it’s impossible to predict if a company will become a takeover — many factors go into this calculation, including whether the target’s pipeline complements the existing portfolio for the acquirer. 
Price is just one component — but it’s an important one: companies hate to overpay. But they also understand that their ideal match might become more expensive still. 

It’s often not too late to jump on a bandwagon in motion.

I believe the same to be true for the three stocks below. Each presents a compelling story, and for each, a strong rally is yet another indication of future promise. 

1. ArQule (Nasdaq: ARQL), public since 1996, is having its day in the sun, with its share price at a 12-year high. This year alone the stock has rallied more than 270%. 

After a few setbacks in the past decade (which included pulling the plug on its cancer drug tivantinib in 2012, reviving the drug in 2013, and seeing it subsequently fail in several studies), ARQL has seemingly hit a jackpot with ARQ 531 — its cancer drug candidate. While only the results of a stage one study have been released so far, the drug has shown a strong safety profile and it has shown success in shrinking tumors. The early success of ARQ 531, which is part of the new class of drugs that promise relief to many patients not helped by the existing drugs for a variety of reasons, also proves that ARQL’s proprietary approach works. 

ARQ 531, which is fully owned by ARQL, has a blockbuster-market size opportunity, given the malignancy of blood cancers. And the company has more drugs in development. While the share price appreciation might give some investors pause, remember that ARQL is hitting its stride after years of disappointing results. While up multifold this year and more than double compared with a year ago, shares are still lagging the S&P 500 on a 10-year basis. 

Just as with any biotech, there is a danger that ARQL might disappoint in the future — but the chances of a disappointment have gone down significantly over this year. 

2. Stemline Therapeutics (Nasdaq: STML) is another small-cap biotech that has rallied this year. 

The reason for STML’s 68% year-to-date gain is the FDA’s December 2018 approval of its cancer drug Elzonris for the treatment of Blastic plasmacytoid dendritic cell neoplasm (BPDCN), a rare and aggressive hematologic malignancy of the bone marrow and blood that can affect other organs — and a cancer for which there are no approved therapies on the market.

Just as with ARQL, Stemline utilizes a unique proprietary approach to treating cancer. In this case, the company targets cancer stem cells. While this does not seem to work for every type of cancer, this is the approach that created Elzonris — and so it’s been proved as feasible (Elzonris serves as a proof of concept for Stemline). 

And Elzonris has the potential to help — and to be approved — for a host of other cancers. According to the company, Elzonris could be used in many blood-cancer areas; other indications, beyond blood cancers, are possible — STML anticipates eventually expanding Elzonris to solid tumors and even to autoimmune diseases. The potential is significant. 

Plus, STML has four more drug candidates in early stages of development in its pipeline. The company’s future has never been brighter. 

3. Up more than 180% year-to-date, gene-therapy company uniQure (Nasdaq: QURE) is my third pick. In this case, there are two distinct reasons for investor optimism. 

For one, uniQure’s primary focus is on hemophilia. Its lead candidate, gene-therapy AMT-061, is showing strong results that are similar or better than the competition and could become an attractive takeover candidate for large pharmaceuticals from Novo Nordisk (NYSE: NVO) to Pfizer to Sanofi (NYSE: SNY). 

In mid-June, Bloomberg reported that uniQure has put itself on the market and that the company is working with advisers for a possible partnership or even a sale. 

It’s important to assess all the possibilities here. While there is no guarantee that a takeover or a new partnership will happen, QURE is an attractive company on its own. A near-term risk of owning the shares at this time is related to the somewhat inflated takeover expectations: if no offer comes in the near future, QURE’s share price is likely to decline. On the other hand, this is an interesting stock that has progressed more than many on the way to presenting a functioning gene therapy for hemophilia. So, if no suitor appears and the stock declines (all else equal), I would view that as a buying opportunity.

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