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Play This “Hidden” M&A Boom – and Beat the Market for the Next 2 Years

3 | By Michael A. Robinson

When Wall Street says something is “dead,” you know what to do.

You check for a pulse – because you never trust Wall Street.

So, when Streeters declared the “death” of the big biotech merger after the feds started cracking down on so-called “tax inversions,” I started my “crime scene” investigation.

Here’s what I turned up: Global healthcare mergers and acquisitions (M&As) have soared 124% so far this year, to $35.1 billion. That makes this the best start for since 2009.

But let’s thank Wall Street for this bit of misdirection – because it gives us a chance to pounce on the ongoing biopharma M&A trend while other Main Street investors are getting bluffed.

Today I want to show you how you can use the little-noticed M&A boom to outperform the wider market – maybe by as much as 95% over the next two years…

Avoidance Strategy

No doubt, some of the economics behind these marriages has eroded now that Washington has cracked down on tax-inversion deals.

These are transactions in which a U.S.-based company attempts to reduce its corporate tax bill by buying a foreign firm where corporate taxes are cheaper and then moving its “official’ headquarters there.

You probably remember the $11 billion Burger King Worldwide Inc.-Tim Hortons Inc. merger last year, which created Restaurant Brands International Inc. (NYSE: QSR). That fast-food deal ended up with Burger King moving its headquarters to tax-friendlier Canada.

That was the big reason behind these deals.

The U.S. corporate income tax rate stands at 35% – the highest in the developed world, according to the nonpartisan think tank the Tax Foundation. By contrast, the 33 other industrialized countries in the Organization for Economic Cooperation and Development have an average rate of 25%.

Big-cap pharmaceutical and biotech firms found these deals alluring for two reasons. First, they could lower overhead quickly at a time of greater concern about rising healthcare costs.

Second, global firms generate a lot of sales offshore. By moving their headquarters overseas, biopharma companies could use the money “back home” without paying high U.S. tax rates.

But all that reasoning basically has gone out the window.

That Burger King-Tim Hortons deal and others received a lot of negative attention last summer – and led to new U.S. Treasury Department regulations that make tax inversions less lucrative.

Then, AbbVie Inc. (NYSE: ABBV) backed out of its $54 billion merger with Shire PLC (Nasdaq: SHPG) in October. And that’s when Wall Street told everyone that the number biopharma industry M&As would plummet in 2015 and beyond.

Since then, however, we’ve actually seen an increase in healthcare mergers. Just two weeks ago, Pfizer Inc. (NYSE: PFE) said it’s buying Hospira Inc. (NYSE: HSP) for $17 billion.

And there’s plenty more where that came from…

On the Rise

A new report by Thomson Reuters shows that deal making in the healthcare sector (including the biotech and pharmaceutical firms we look at here in Strategic Tech Investor) ranks as the third highest by sector after telecom and financial firms.

But that rankinggreatly understatesthe healthcare industry’s feverish activity. Like I said before, global healthcare M&As have soared 124% to $35.1 billion so far this year.

For total U.S. M&A deals, Thomson Reuters found they’re up 60% from a year ago, to $101.3 billion. And the Pfizer-Hospira deal is the largest so far in 2015, bigger than the next two combined.

M&A deals will remain a big driver for the whole healthcare industry. The pickup in M&A activity will translate into healthy bonuses for bankers and lawyers, certainly, but it will also continue accelerate stocks in the biotech and pharmaceutical sectors way past the overall market.

Since the start of 2014, the S&P 500 Health Care Index has soared 29.2%, and the Nasdaq Biotech Index has advanced 48.4%. The wider Standard & Poor’s 500 Index, meanwhile, has jumped just 14.1%.

Here’s one reason why biopharma deals will keep happening. Older patents at several leadings firms are expiring, leaving the companies open to new competition.

It can take 10 years and $1 billion to get a new drug to market.

The Way to Play It

That means big players with large cash reserves often find it easier to buy competitors’ product lines or those competitors themselves than to launch new drugs from scratch.

So, I want to introduce you to SPDR S&P Pharmaceuticals (NYSE: XPH). This is an exchange-traded fund (ETF) composed of some of the biopharma industry’s leading firms and a smattering of aggressive small caps.

XPH is not an M&A fund – but it’s a great way to take advantage of the trend. This ETF focuses on the industry’s bread and butter: high earnings.

And many companies in the fund’s portfolio will likely end up growing through mergers. Or they could become targets themselves.

For instance, XPH holds both Pfizer and Hospira. So, XPH profits from the sale of Hospira stock and, over the long haul, from Pfizer’s lower-cost, higher-growth business model.

XPH holds 36 stocks, with an average market cap of $36 billion. Several of them are prime examples of the biopharma M&A boom that we seek to get a piece of:

  • Actavis PLC (NYSE: ACT) is a global specialty drug firm that makes generic and branded compounds. The firm markets approximately 1,000 products, including both prescription and over-the-counter drugs. The company has been on an acquisition binge. In November, the Dublin, Ireland-based firm said it will buy Botox maker Allergan Inc. (NYSE: AGN) – which XPH also holds-for $66 billion. And in July, it picked up Forest Laboratories Inc. for $25 billion.
  • Jazz Pharmaceuticals PLC (Nasdaq: JAZZ), also based in Dublin with substantial operations in California, has grown quickly since its founding in 2003. Buying products from other firms has played a big role in its global expansion. It has either licensed or acquired outright six major drugs in 11 years. It’s best known for Xyrem, a drug that treats sleeping disorders. In late 2013, it agreed to acquire all of Italy‘s Gentium SPA (OTC: GENTY) for $1 billion.
  • Eli Lilly and Co. (NYSE: LLY) is one of the best-known firms in pharmaceuticals. And now it is moving aggressively into high-margin products for animals. Last April, it announced the $5.4 billion acquisition of the animal health division from Novartis AG (NYSE ADR: NVS).The move makes Lilly the world’s second-largest animal healthcare business after Zoetis Inc. (NYSE: ZTS), which XPH also holds. The world’s 10th-largest pharmaceutical firm operates in 125 countries.
  • Merck & Co Inc. (NYSE: MRK) is a company I know well, having had lunch with a former CEO several years ago. He talked me into trying Claritin for my allergies, and I’ve been taking it ever since. The company is in a state of transition, as evidenced by its recent M&A activity. In December, Merck announced it’s buying Cubist Pharmaceuticals Inc. (Nasdaq: CBST) for $8.4 billion. The move followed a decision last May to sell Merck’s consumer unit to Bayer AG (OTC: BAYRY) for $14 billion.

No wonder XPH has greatly outperformed the overall market for the last two years.

During the period, XPH returned roughly 95% to investors. That’s well over double the S&P’s return of 38% during the period.

And it’s more than just a great way to cash in on the steady stream of biotechnology and pharmaceutical M&A activity.

This is an ETF that, at its heart, is focused on biopharma firms’ ongoing high earnings growth.

The beauty of a play like this one is that rather than try to pick a single winner, we get to benefit of the entire sector’s operations.

That makes XPH an excellent foundational investment to pave your road to wealth.

P.S. I encourage you to “Like” and “Follow” my communities of friends, colleagues and readers who are eager to make big money in tech stocks not in some future time… but right now – today.

Editor’s Note: This week we beat back the suggestion that the biopharma M&A boom is over. What Wall Street “myth” have you ignored – and made out big on? Let us know in the comments below. We love hearing from you.

3 Responses to Play This “Hidden” M&A Boom – and Beat the Market for the Next 2 Years

  1. Bill says:

    Good info and made me think of what is in the future for all the Medical Device Companies, that seems more cut throat than the other sectors!
    Thanks
    Bill K.

  2. John B. says:

    I don’t know if it’s just me, but it seems like the vast majority of recommendations I am seeing are for stocks & ETFs that are at their all time highs. Is it really prudent to be investing in stocks when they are at their all time highs? Stock markets never go up forever.

  3. Catharina Thorne says:

    Good morning,

    I live in the UK and follow your letter of course. Yesterday I tried to buy shares in Repligen, but got the reply from the brokers: “cannot be purchased”. The same happened with the recommended funds FPXI and XLK and XPH.

    Can you see a way round this, and why are they not available in the UK, are there restrictions on their trade?

    I am baffled, but otherwise doing fine with your other recommendations.

    In appreciation,

    Catharina T

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