By Genia Turanova
There’s nothing like cash to show how successful a company has been. When a fledgling enterprise first turns cash-flow positive — that is, when the money going in starts exceeding the money going out — it’s a sign the company is on its way to profitability.
Growing companies need cash to invest in their businesses, and, until they turn profitable, will have to either borrow or issue new equity to supplement their cash positions.
When a mature company is doing well, it may choose to borrow — but it often does not need to. Its business might already generate enough cash to cover all the ongoing expenses, pay for share buybacks and/or dividends and have some cash left over.
This is where mergers and acquisitions come into play.
While cash is usually not the only reason a company gets taken over, having a large cash balance can well make a company an acquisition target.
Let’s Run a Screen for Cash-Rich Healthcare Stocks
To identify potential takeover candidates, I’ve restricted my search to a single sector: health care. Within the sector, I concentrated my efforts on the 36 companies with market capitalizations larger than $10 billion but smaller than $50 billion.
Prompted by massive patent expirations, large pharmaceutical companies have been buying smaller peers to get their hands on novel drugs and promising pipelines. And so far, 2018 has been a banner year for health care M&A: In the first six months of this year alone, in the health care sector, the dollar amount of the deals more than doubled to $315.7 billion compared with the first half of 2017.
Many of those deals were quite lucrative for investors in the companies being acquired. For example, cancer biotech Foundation Medicine was taken over this summer by Swiss giant Roche for a nearly 40% premium; all said, Foundation Medicine shares jumped more than 287% in one year. Another large acquisition happened in the first few months of the year, when U.S.-based biotech giant Celgene bought a smaller competitor, Juno Therapeutics, at a whopping 72% premium. In the year preceding the takeover offer, shares of Juno more than quadrupled in price.
While price-to-earnings ratios are important, future growth for a pharmaceutical company or biotech takes on an additional importance: The higher the market sees its future growth, the better its outlook, both as an independent company and as a prospective takeover candidate.
In my quest to find potential take-over targets, I screened for companies are expected to grow the fastest — and also have the most cash on balance sheet.
Here are the results:
The top three are all biotech stocks. No surprise here — it’s among the fastest-growing sectors of the market.
What might be surprising is Nektar’s (NKTR) appearance on this list. The stock itself was added to the S&P 500 only a little more than six months ago. Another sign of Nektar’s fast rise: the biotech — whose two main product lines address pain and cancer — has still not garnered enough consensus estimates to peg long-term growth.
Even shorter-term, its path, if you’re willing to take a look beyond the P/E, is messy: while this year NKTR is going to make money (more than $3.50 per share), in FY19 it will lose about $0.50 per share [this irregularity is due to NKTR’s beginning-of-the year arrangement with Bristol-Myers Squibb, and the recognition of $1.06 billion of license revenue from the BMY collaboration agreement]. In an agreement dated February 14, 2018, in exchange for a 35% share of future profits from Nektar’s phase-2 investigational immuno-oncology drug NKTR-214, BMY paid Nektar $1.85 billion, with some of it in cash and some via the purchase of NKTR shares.
But what it does have, as a result, is cash — as a percentage of market cap, it’s one of the largest in the group, 17%, thanks to Bristol-Myers. NKTR stands out from the crowd because of its attractive valuation and all that cash on its balance sheet.
2017 was the first year since 2013 when Vertex (VRTX), a biotech that targets cystic fibrosis, cancer, autoimmune diseases and more, broke even — and in 2019 it is likely to make $3.76 per share in profits. No wonder VRTX has made it to the top of today’s screen.
Growth expectations that exceed 60%, nearly $2.8 billion of cash (or 6% of total market cap) on the balance sheet and no debt — VRTX is an interesting company that will be on my watch list in Fast-Track Millionaire.
Incyte (INCY), an oncology-focused biotech, looks expensive on a P/E-only basis. But consider its consensus growth estimates exceed 50%, and it instantly looks more attractive.
On top of this, INCY has $1.2 billion in cash and equivalents on its balance sheet — 8% of its market cap — and almost no long-term debt. Some of that cash is, without a doubt, earmarked for a pending acquisition of a minority stake in smaller peer Syros Pharmaceutical, but this just supports my theory that a large amount of cash on a balance sheet is conducive to at least some M&A activity. INCY also joins my Fast-Track Millionaire watch list.
The other two entries from this screen that are listed here are also extremely fast-growing, but they get lower marks on the “cash as percentage of total market cap factor” — and so, they’re not among my favorites.
Align Technology, the manufacturer of the Invisalign alternative to metal dental braces for adults and teens, took off a couple of years ago together with its product. The company is still expected to growth far better than the market, but it isn’t exactly cash-rich (although neither does it have any debt). And Abiomed, a red-hot medical technology stock, did not make the cut because its cash is relatively low. These two companies, while presenting interesting investment cases on their own, did not pass the strict requirements of this particular stock screen.