Two ‘Free Money’ Trades for the Taking

It’s happening… just like we knew it would.

Since last summer, I’ve been telling you 2009 would be the year of massive consolidation in health care. So far, we’ve seen 18 notable merger and acquisition deals.

Big Pharma (Pfizer, Merck, etc.) is the driving force behind the flurry of deals. Just this week, British drugmaker GlaxoSmithKline shelled out $2.9 billion to acquire Stiefel, a drug company focused on skin care.

Big Pharma is desperate. The world’s biggest drugmakers are staring down billions in sales losses over the next few years due to patent expirations. And the only way to rebuild their pipelines and earn reasonable returns on investment is to scoop up health care assets at distressed prices. Meanwhile, the ongoing credit crunch has starved the biotech industry of cash, and the small drug developers are anxious to tap Big Pharma’s $100 billion-plus cash hoard. It’s a perfect marriage.

But with more than 500 possible acquisition targets, trying to guess the next takeout is a sucker’s bet. It’s simply too difficult to generate consistent profits trading that way.

Instead, we’ve employed a trading strategy that profits from mergers after an offer is made. The fancy term for this strategy is "merger arbitrage."

I prefer to call them "free money" trades because they have generated monstrous returns for my FDA Report subscribers since the credit crisis began, with very little risk. For example, here’s how well it worked during the Genentech buyout saga…

In July, Swiss drug company Roche offered to buy Genentech for $89 per share in cash. Shortly after the news, Genentech shares skyrocketed to $99 – a full $10 above the offer price – before settling back down in the low $90s. The market not only believed the deal would go through, it assumed Roche would eventually offer more than $100 per share for Genentech. So Genentech shareholders expected to book a small profit (3%-7%) when the deal wrapped up. Then the credit crisis hit…

With banks in distress and corporate-bond markets in turmoil, investors became skeptical of Roche’s ability to conjure up the $20 billion in financing to buy Genentech. The $100 dream vanished. Even the original $89 offer seemed far from certain. So investors dumped Genentech stock. During the panic selling late last year, Genentech shares fell to less than $75 each.

Last month, Roche finally closed the Genentech deal, coughing up $95 per share. Readers who bought Genentech in November booked more than 20%.

If you believed Roche would prevail, you could’ve bought the greatest biotech of our time… and sold it off to Roche a few months later for 80% annualized profits.

The Genentech situation is not unique. The credit crisis, coupled with the flurry of health care buyouts, has provided us the opportunity of a lifetime. Mergers that depend on heavy financing no longer look like a sure thing. But most investors would never bet on the completion of these deals.

So… as long as those investors remain skittish and we stick to deals with a high probability of success, we can rake in huge profits with little risk.

And Genentech is only the beginning. I expect we’ll see 40-50 deals like this in 2009 alone. If you are looking for other "free money" trades, check out the two biggest pending health care mergers: Pfizer-Wyeth and Merck-Schering.

Both mergers have a more than 95% chance of being completed. Yet both Wyeth and Schering are trading at around a 9% discount to the offer price. You can make more than 20% annualized by betting that these deals close in a few months.

Good investing,

By Dr. George Huang
Growth Stock Wire