Merger and acquisition activity of late has been characterized as a drought. But that drought hasn’t been quite as severe in the pharmaceutical industry, where there’s been a relatively steady stream of deal-making.

A total of 39 pharmaceutical acquisitions have been made since 2008, by Goldman Sachs’ reckoning. For 2009 to date, four major pharmaceutical deals have been made, at prices ranging from $7 billion to $62 billion: Abbott Laboratories bought the pharmaceutical unit of Belgian conglomerate Solvay, Merck acquired Schering-Plough, Pfizer took over Wyeth, and Roche Holdings purchased Genentech. Most of the deals, however, have been smaller in scale, such as the $1.4-billion purchase of CV Therapeutics by Gilead Sciences, the $1.8-billion acquisition of the generic-drug business of Austria’s Ebewe Pharma by Novartis, and the $846-million buyout of Cougar Biotechnology by Johnson & Johnson.

The primary motivation for all of this M&A activity is that the big drug companies need to make acquisitions to compensate for the expiration of key product patents between 2010 and 2015; they are teetering on the edge of what Wall Street analysts call a "patent cliff" over the next six years. The drug companies are losing patent protection on more than 30 "blockbuster" drugs, i.e., drugs with annual sales of at least $1 billion, and generally have been unable to come up with comparable replacements. More than $60 billion of annual sales may be lost as patents for those drugs lapse over the next five years, in our estimation. That would be the equivalent of about half of the big drug companies’ combined annual sales in 2007.

The magnitude of potential lost sales is such that Datamonitor, a research firm, anticipates that between 2011 and 2012 the drug industry’s revenue will decline, the first time that would happen in at least four decades.

In short, the pharmaceutical companies have apparently concluded that the most cost-effective way to avoid falling off the patent cliff is via acquisition. In our judgment, the rate of M&A activity will probably pick up over the next 15 months, with most of it involving relatively modest acquisitions. For Big Pharma, the benefit of buying a number of smaller companies (as opposed to engaging in mega-deals) is that it helps them to diversify their risk and gives them more chances to replenish their evaporating drug pipelines.

Fortunately for them, it appears an opportune time to make acquisitions. The stock valuations of biotechnology companies, among others, are markedly lower now than they were earlier in the decade. Plus, more than a few small companies urgently require substantial infusions of cash to help finance the expensive process of developing new drugs; research and development can cost $800 million or more to ready a drug for submission to the Food and Drug Administration (FDA).

Flush with cash

To be sure, the big drug companies have the means to fund research and development and make deals. Their balance sheets are flush with cash, and they have raised an additional $72 billion in new debt offerings this year, according to Goldman Sachs; most of that money, in our opinion, is being earmarked for acquisitions.

We think many of their acquisition targets may be biotechnology companies that specialize in "orphan drugs" (drugs that treat rare medical conditions and typically command high prices). The Wall Street Journal summarized the commercial attractiveness of biotechnology well: "Unlike traditional chemistry-based drug development, biotechnology uses biological tools to create entire proteins, often similar to those that occur in the human body. This approach has yielded successful drugs to treat diseases such as anemia, cancer, and rheumatoid arthritis. Biotech drugs are especially appealing because they face no competition from generics; no regulatory pathway yet exists in the U.S. for bringing to market generic biotech drugs. . . . And biotechnology products tend to target specialized areas of medicine that don’t require mass advertising or armies of sales people."

So, which biotechnology companies may be in the sights of acquisition-minded Big Pharma?

We think these six enterprises -- Acorda Therapeutics, Alexion Pharmaceuticals, Human Genome Sciences, Onyx Pharmaceuticals, Savient Pharmaceuticals, and Vertex Pharmaceuticals -- are among those in a universe of thousands that could make compelling acquisition targets. They have shown an innovative streak in new-product development, a streak that we think the big drug companies need badly. Indeed, all six of them have critical, proprietary products either already approved by the FDA or being tested in clinical trials that could help them deliver above-average earnings growth in the years ahead. And most of them are on a solid financial footing, with hundreds of millions of dollars in cash on their balance sheets, which we think may help them to prevail as winners, whether they’re acquired or not.

Here are brief profiles of the six:

*  Acorda Therapeutics (market capitalization: about $930 million, headquarters: Hawthorne, New York) has chosen to focus on products that treat spinal-cord injuries, multiple sclerosis, and problems of the nervous system. Sales of its primary commercial products, Zanaflex capsules and tablets (which help people with spastic disorders, the involuntary stiffening or contracting of muscles), rose 22% year-over-year in 2008. The company’s most promising product in clinical development, Fampridine-SR, has been shown to help improve the walking ability of people with multiple sclerosis. A major differentiating characteristic of Fampridine-SR is that it’s designed to actually enhance a patient’s neurological functioning; in contrast, other remedies merely treat symptoms or slow the progression of multiple sclerosis. In mid-October an FDA panel gave a positive vote on Fampridine-SR, and the FDA is expected to grant final approval within the next three months.

*  Alexion Pharmaceuticals (market capitalization: about $4 billion, headquarters: Cheshire, Connecticut) has an orphan drug, Soliris, that we think could contribute to the earnings of an acquirer for many years to come. Soliris, introduced two years ago, generates more than $400 million in sales annually in treating paroxysmal nocturnal hemoglobinuria (PNH), a rare, life-threatening disorder that destroys red-blood cells. It’s the only drug of its kind approved in the U.S. and is also authorized for use in Europe, Canada, and Australia. Credit Suisse estimates that Soliris could ultimately account for sales of at least $1 billion annually. Also, the next prospective leg of growth for the company is becoming apparent: Alexion is investigating new applications for Soliris and other drugs for diseases such as atypical hemolytic uremic syndrome (aHUS) and myasthenia gravis. In our analysis, the aHUS market may be as large as the PNH market.

*  Human Genome Sciences (market capitalization: about $2.7 billion, headquarters: Rockville, Maryland) has one of the most extensive product pipelines in the biotechnology industry. We think the company has two notable drug candidates in late-stage development, Benlysta, which treats lupus, and Zalbin, for hepatitis C. The company reported encouraging results from its first Phase III trial for Benlysta. In our judgment, Lupus is a multibillion-dollar market, and should the second Phase III trial for Benlysta succeed, Human Genome Sciences is likely to have a bona fide blockbuster drug in its portfolio.

*  Onyx Pharmaceuticals (market capitalization: about $2 billion, headquarters: Emeryville, California) has Nexavar as its flagship product. It’s an oral medicine sanctioned for treating liver cancer in more than 80 countries (and the only such medicine approved in the U.S.) and kidney cancer in more than 90 countries. Onyx is investigating other uses for Nexavar, such as the treatment of breast cancer. Recently the company presented data showing that in a clinical trial of 3,500 patients, Nexavar proved beneficial to patients with serious cardiovascular conditions, elderly patients, and patients with bone or brain tumors. Nexavar has gained more than $670 million in annual sales since it was first marketed four years ago, with 2008 sales increasing by 82% from the previous year. The profit margins for the drug have steadily improved.

*  Savient Pharmaceuticals (market capitalization: about $990 million, headquarters: East Brunswick, New Jersey) is concentrating on orphan drugs to combat gout and other rheumatic diseases. In two Phase III studies, its principal product, Krystexxa, has helped reduce the chronic pain of patients with treatment-failure gout (gout that has proven untreatable by other methods). The drug has received a positive review from an FDA advisory panel, but the FDA has thus far refrained from approving it, citing technical problems related to manufacturing. Savient is adjusting its manufacturing procedures accordingly and plans to resubmit the drug for FDA approval in early 2010.

*  Vertex Pharmaceuticals (market capitalization: about $6.8 billion, headquarters: Cambridge, Massachusetts) has a hepatitis drug, telaprevir, that’s widely regarded in the industry as the best in class and as a potentially lucrative prize for an acquirer. The drug is currently being administered to about 2,200 patients in a Phase III clinical trial. Goldman Sachs projects telaprevir to have sales potential as high as $5 billion annually, in light of the more than 3.2 million people in the U.S. estimated to be infected with hepatitis C. The drug, a protease inhibitor (a medicine for treating or preventing infection by viruses), has been effective in clearing hepatitis C, and infectious-disease specialists are enthused about its prospects.

The views expressed represent the opinions of Turner Investment Partners as of the date indicated and may change. They are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. Opinions about individual securities mentioned may change, and there can be no guarantee that Turner will select and hold any particular security for its client portfolios. Earnings growth may not result in an increase in share price. Past performance is no guarantee of future results.

Turner Investment Partners, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm that manages more than $17 billion in stocks in separately managed accounts and mutual funds for institutions and individuals, as of September 30, 2009.

As of September 30, 2009, Turner held in client accounts 56,950 shares of Abbott Laboratories, 5.8 million shares of Pfizer, 7,210 shares of Roche Holdings, 5.9 million shares of Gilead Sciences, 34,650 shares of Johnson & Johnson, 1.3 million shares of Acorda Therapeutics, 2.8 million shares of Alexion Pharmaceuticals, 1.1 million shares of Human Genome Sciences, 1.2 million shares of Savient Pharmaceuticals, and 486,900 shares of Vertex Pharmaceuticals. Turner held no shares of Merck, Novartis, and Onyx Pharmaceuticals.