The Pharmaceutical Industry – M&A

Historically pharmaceutical companies have posted double digit growth numbers and made many shareholders green. However, this decade has been tough for the drug makers.

The main reason behind the recent lackluster performance of the drug companies has been decrease in R&D productivity. R&D spending has increased many folds due to more than ever stress on safety. Clinical end-points are stricter necessitating larger and longer clinical trials. This in effect reduces the patent window when these companies can maximize their profits. To make matters worse not many innovative drugs are in the pipeline and those that are lack the market size.

Industry’s solution to deal with its dwindling organic growth has been merging within the industry and forming strategic alliances with smaller sized biotech companies that can take on the role of innovation and in the process employ big pharma’s sale/marketing force in pushing the drug in the market.

For instance, recently Eli Lilly and Company (LLY) and SGX Pharmaceuticals, Inc. (SGXP) announced a merger agreement. This merger will allow LLY to employ SGXP’s scientific resources in order to bolster its cancer fighting pipeline and allow SGXP, a San Diego based small biotechnology company, to realize its full potential with the help of LLY’s expertise in advancing drugs. Such synergic deals create great value for both companies. However, such deals often cause managerial complexities due to difference in culture between small entrepreneurial biotech firms and large too big to innovate pharmaceutical companies.

Even though there is no strong evidence that economies of scale can be achieved by pharmaceutical companies through M&A, it still remains a rewarding solution for the big players to enhance their competitive edge and maintain growth figures.

A look into the future of healthcare industry - Molecular Diagnostics

Molecular diagnostics is one of the fastest growing segments of the healthcare industry. It entails in-vitro analysis of blood, urine and other specimens to understand the molecular-level changes behind progression of medical conditions.

By screening for underlying physiological changes, the science has the potential to provide early diagnosis and optimized treatment. Firstly, molecular diagnostics can reduce healthcare wastage caused by misdiagnosis and inefficient medical management. For example, most of the blockbuster drugs work well for only a fraction of the general population. With use of pharmacogenetics, doctors can pin down the right drug, dose and time needed for effective treatment. Moreover, with increasingly educated and affluent demographics, personalized medical care will be in demand.

Currently, very few molecular diagnostics tests have been approved by the FDA for clinical use. And most of these target infectious diseases and cancerous conditions. As science grows more biological pathways are discovered and relationship between genes and pathology is understood, the area of molecular diagnostics will grow.

Today, the pharmaceutical sector is facing the toughest time. Many blockbuster drugs go off-patent soon, there aren’t many in the pipeline and those that are face increased scrutiny from the FDA. Safety being the biggest issue, most of the failed drugs can be introduced in the market with the help of molecular diagnostics. These tests can recognize the fraction of people who stand to gain the most from these previously failed blockbuster drugs with minimal or no side-effects.

Patient-privacy issues pose a big hurdle for this growing segment. There is concern regarding how the insurance companies and hospitals will use the genetic information. People with pre-disposition to certain diseases might be denied insurance. Also, with hospitals competing for the top-spot in the ranking tables might deny treating some of these patients. For molecular diagnostics to reach its full potential these issues must be tackled in coming years.

Fall of Bear Stearns - A Lesson for Starters

The Fall of Bear Stearns teaches many lessons. In this article I would like to put forth one of these.

In 2007 Q4, the Board of Directors implemented a share repurchase program a part of which was to acquire shares of common stock for the company's employee stock award plans. Usually a company buys back its shares when it perceives the share price as undervalued. Under efficient market theory, buying back stock should not affect the share price however it does send a positive signal to the investors - the management believes in the future of the business. Hence, keeping track of share buyback programs is one of the many indicators that complete the picture of the street. But, this indirect indicator of management's perception must be viewed in tandem with other fundamental and technical parameters, because sometimes buying back shares is implemented to improve certain valuation ratios, such as EPS (company buys back its common stock, which leads to reduced float and increased valuation of the shares). In this case, the time when BSC implemented this program it was also reporting devastating financial numbers. Its total revenues had fallen ~35% in 2007 and its operating income had suffered a massive drop of ~75% mainly because of the sub-prime mortgage crisis. Now, some might argue that the shares were actually undervalued and once the dark cloud would pass BSC's operations would resume to normalcy. However, digging deeper shows that around the same time the insiders were selling some portion of their shares contradicting the share buyback plan.

This is one good example that stresses the necessity to look at the whole investing picture, evaluate share buyback programs with caution and use such indicators only as a confirmation of the balance sheet.

Short -Term Future of NYX

NYSE Euronext, Inc. (NYX) is a low-debt growth company that has benefited from the recent increased market volatility and reported impressive numbers in the recent quarters. However, being in the NYX camp has been simply painful. NYX had dropped approximately 30% from its all-time high highlighting the fact that investing against the market is risky and can be painful. In the last 2 days NYX shares rose by 10% alleviating some of the pain and prompting THE question – is it time to sell and book these gains?

To look for the significance of the present trend, money flow index (MFI), a measure of the strength of money going in and out of a security, was used. MFI over 80 signals a top and under 20 indicates a bottom. Currently, MFI for NYX is approximately equal to 50 implying that there is more room for gains. This observation was confirmed by relative strength index (RSI) analysis. RSI enables assessment of risk for correction on overbought/oversold conditions of the security. Current 14-day RSI for NYX is slightly less than 50 (RSI = 70 is considered overbought and RSI = 30 is considered oversold) indicating that the top is yet to come.

Another indicator, stochastic oscillator comparing closing stock price to the range of price over a time period, was employed to shed some light on the future of NYX. Stochastic oscillator for NYX rises after falling below the level of 20 indicating a BUY sign. Also, recently %K-line crossed the %D-line rising above it and stressing the BUY sign.

Bottom line, competition, regulatory environment and ability to integrate acquisitions will define 2008 for NYX. However, in the short-term NYX should be able to extend its 2-day rally.

AUY in 2008

Current times have once again brought into focus the importance of gold stocks in any well-diversified portfolio. In the first two week of 2008 GOLD has delivered, and it is poised to have a strong run as the fiscal year continues.

Yamana Gold (AUY) is my absolute favorite gold stock primarily because the company’s focus on growing its operations and producing gold at cheap levels is well poised to benefit from the rising gold prices. AUY has gained more than 20% since the start of the year and the current volatility in the market demands a look into the future.

Financial analysis employing Moving Average Convergence/Divergence (MACD - a trend following indicator) and Money Flow Index (MFI - a momentum indicator) reinforces the positive outlook for AUY. The recent rise of MACD above the reference MACD-signal and the zero level signals a BUY sign. Moreover, the fact that there is no divergence between the AUY prices and the aforementioned indicators (MACD and MFI) indicates that the reversal in current upward trend is not expected.

Bottom line, AUY is well poised to shine.

Determinants of Stock Prices - A Firm Level Analysis of the Energy Sector

Investors rely on massive amount of fundamental and technical information to make profitable investment decisions. Advocates of efficient market theory believe that stock prices reflect everything that is known about a company and hence can be predicted based on fundamental analysis, while proponents of technical analysis attempt at forecasting future security prices based on historical data. However, quantitative measures indicating stock price movements in relation to these factors are not entirely understood. The main purpose of this study is to identify the most important technical and fundamental variables that dictate capital gains at firm level for companies in the energy sector, specifically those involved in oil and gas exploration and production.

Vast amount of data and information regarding the movement of major indices such as S&P500 and DOW is available. Such studies provide a bigger picture on the health of the equity market and of the economy but lend less than needed support to investors who are focusing on a specific sector. The main focus of this research is firm level analysis of oil and gas exploration industry because it is an important element of every well-diversified portfolio.

A multivariate regression model with fixed cross-section effects is employed to examine the effects of fundamental and technical variables on movements of stock prices. Quarterly data for 39 companies from June-1997 to March-2007 was collected and the dependence of stock price relative to the S&P sector index (RELSP) on return on investment (ROI), current ratio (CURR), gross profit margin (GRPRMARG), dividends paid per share (DIV) and trading volume (TRVOL) was analyzed.

The results show that the dependence of RELSP is statistically significant on TRVOL (p-value: 0.0000), ROI (p-value: 0.0702) and GRPRMARG (p-value: 0.0334). For all else constant, on average as TRVOL increases by 1%, RELSP increases by 8.6%; as GRPRMARG increases by 1%, RELSP increases by 2.8% and as ROI increases by 1%, RELSP increases by 0.1%. These results are in accordance with the available literature; as the corporate executives become more efficient (ROI rises), the company increases its market share (GRPRMARG rises) and trading volume increases (TRVOL rises), the value of stock prices increase (RELSP rises).

Also, the model shows that the effects of CURR (p-value: 0.1787) and DIV (p-value: 0.5745) on RELSP are statistically insignificant. However, a nonlinear trend pertaining to DIV and CURR was revealed. The analysis shows that initially as DIV increases RELSP increases but investors start to penalize companies as a greater percentage of earnings are paid in dividends and not retained to be invested in increasing shareholder value. Similarly, it was found that initially as CURR increases RELSP increases but after a certain point stock prices are penalized for increased amount of uninvested cash in hand.

Moreover, the model shows that mean systematic effect of all variables ignored in the model is approximately 4.6% (p-values = 0.00000). Thus, this model must be employed with other variables such as seasonal effects inflation, number of shareholders, investor’s perception of the health of the economy etc.

Bottom line, investors must employ both fundamental and technical variables in making investing decisions so as to maximize profits.

EMC - A BULL in the bear market

EMC Corporation (EMC), involved in development, delivery and support of information infrastructure, is traded on NYSE and is one bull among the bears.

I recommended EMC to one of my close friends this summer and since then EMC has shown a solid upward movement (except in November - the story of every stock). This recent dip presents a great opportunity to load EMC in your portfolio.

Technical Analysis:
EMC stock price moved sideways for the last 3 years, but has had a very good run (more than 50% gains) in the past one year. The % increase in stock price in next 1 year is estimated to be 2%, which is very low. However, the much-anticipated spin-off of VMware has been a huge success and I would not be surprised if EMC stock prices pound the estimates.

Fundamental Analysis:
EMC has a strong balance sheet. Also, EMC has better profit margins and revenue growth than the rest of the industry. However, when compared to its competitors, EMC shares have a higher PE and thus are more expensive.

Another parameter, corporate governance quotient (CGQ) indicating the relative strength of the management is one of the important parameters that long-term investors consider. EMC CGQ is better than 85% of S&P500 companies and better than 98% of the technology hardware and equipment companies.

Bottom line, BUY EMC at any dip.