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Industry Spotlight > Mergers and Acquisitions

Biggest biotech fund expands bet amid ‘manic-depressive’ market

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(Bloomberg) — To Rajiv Kaul, who manages the biggest U.S. biotechnology fund, a correction is just a discount on his favorite stocks.

Kaul, who runs the $13.4 billion Fidelity Select Biotechnology Portfolio, said many drug companies’ research pipelines are still primed to pay off, and dealmaking isn’t going away. He expects the industry to bounce back over the next few years as new antibiotics, gene therapies and drugs for cancer and Alzheimer’s disease begin to reach the market. Kaul also manages the $3.3 billion Fidelity Advisor Biotechnology Fund.

The Nasdaq Biotechnology Index has dropped 24 percent from its July peak amid a U.S. debate on drug pricing and calls from Democratic presidential candidates to regulate the industry. In the party’s televised debate on Tuesday evening, candidates Hillary Clinton and Bernie Sanders said they were happy to have made enemies of drug companies.

“In the short term, biotech goes through these manic-depressive periods. It’s an extremely volatile group,” Kaul said Tuesday in a phone interview before the debate. “I’d like to really use this as an opportunity to upgrade names, to buy the better names at better prices.”

“Fear can turn into greed very quickly,” he said. “Some of these companies are approaching double-digit free cash flow yields, and you’re paying little for pipeline success.” Because the downturn was widespread, Kaul said he’s excited about his stakes in smaller companies that were especially hard hit over the past few weeks. He declined to discuss individual companies.

Beating a benchmark

Over the past five years, Kaul’s larger fund has returned 30 percent a year, with dividends reinvested, compared with a 28 percent annual return for the Nasdaq Biotechnology Index and 13 percent for the Standard & Poor’s 500 Index. The fund’s largest holdings include Gilead Sciences Inc. (Nasdaq:GILD), Biogen Inc. (NYSE:BIIB) and Regeneron Pharmaceuticals Inc. (Nasdaq:REGN). Both the biotech index and Kaul’s fund are down less than 1 percent this year.

Kaul expressed confidence about the areas all three are involved in, including hepatitis C and new treatments for Alzheimer’s and heart disease.

Not everyone is so sanguine about the industry’s prospects. One investor who called biotech stocks “bubble-like” in June still sees a rocky road ahead.

“They don’t look cheap to me, they don’t look like bargains,” said Todd Lowenstein, who helps manage $16 billion at HighMark Capital Management Inc. While his funds hold stock in some drugmakers, he said in a phone interview that the downturn isn’t over yet. “We’re in the hangover phase right now, and the hangover is so acute here because you had this toxic brew of conditions that really set it up for disappointment.”

Merger fever

Kaul said he sees what has been a record year for mergers and acquisitions continuing, with larger competitors swooping in to buy smaller companies at recently discounted prices. He takes his lesson from the 2008 economic crisis. The Nasdaq Biotechnology Index has returned 273 percent since the collapse of Lehman Brothers in September 2008.

“The larger pharma companies, for example, have a lot cash capacity on the balance sheet and need innovation,” he said. “Those companies tend to have a much longer-term view than Wall Street does.”

In 2008, Genentech Inc. “was the biggest position in the fund, and in the 2008 global economic downturn the markets created such a great opportunity for Roche to buy Genentech,” Kaul said. He said companies with rich pipelines that had been unfairly devalued in the selloff look especially attractive for acquisition.


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