Ken Kam's Best Ideas Blog

Last week Friday, Elan (nyse: ELN) shares gained over 7% on the rumor that Biogen (nasdaq: BIIB), Elan’s 50% partner for its multiple sclerosis drug Tysabri, is interested in acquiring the company. Today, Elan is up another 14% on news that the company’s Alzheimer’s drug (AAB-001), which is partnered with Wyeth (nyse: WYE), is being advanced to Phase 3 trials.

When a stock makes a big move in a short period, there is a tremendous temptation to sell and “lock in profits.” However, when then price move is accompanied with good news, the initial bump may be the start of a major move up. If you are too quick on the trigger, you may miss the bigger, longer-term, move which in my view is the main reason to make an investment in the first place. So, before we decide what to do, lets take a look at the news.

The Biogen rumor

There are lots of rumors on Wall Street and most of them turn out to have nothing to them. If the rumor is true, there are some on Wall Street who know and they are driving the price up. I never have this kind of information advantage so I don’t trade just because of a rumor. The rumor has to make sense.

The majority of Biogen’s sales comes from Avonex, a multiple sclerosis drug that competes with Tysabri. Last year, Biogen’s impressive overall sales growth was lead by higher sales of Avonex. However, as I read the numbers, it seems to me that Avonex sales increased less than the price increase that Biogen put through last year. This implies that the number of MS patients using Avonex probably went down last year! Since Biogen probably cannot keep raising the price of Avonex at last year’s pace, they are going to have a hard time maintaining their sales growth this year especially if Avonex is losing patients.

Biogen gets 50% of Tysabri sales but Tysabri’s price is just about double that of Avonex. Therefore, as things stand today, whether an MS patient uses Avonex or Tysabri, Biogen gets the same revenue. For Biogen, sales growth from the MS market depends on Tysabri taking market share away from other competitors.

If Biogen were to acquire Elan, however, a patient that switches from Avonex to Tysabri would generate twice as much revenue for Biogen. And, patients who switch to Tysabri from any other drug would have double the impact on Biogen’s sales than they do now. In short, this acquisition can make a lot of sense for Biogen especially if its done before Tysabri sales ramp up.

The main problem I see is that it would be a big acquisition for Biogen whose market cap is $16 billion — roughly double Elan’s. But, interest rates are low, and capital seems to be available to do deals of this size. If a deal is done, however, I suspect that it will involve Wyeth because of its involvement with Elan’s Alzheimer’s drug. That’s why today’s news on AAB-001 is so interesting.

Alzheimer’s drug (AAB-001)

Today’s announcement that Elan and Wyeth are going to start a Phase 3 trial for AAB-001 even before the Phase 2 trial is finished speaks volumes. Phase 2 trial results have not yet been announced, but I infer that both companies must believe that the results are going to be positive or they would not be willing to spend the millions of dollars its going to cost to run the Phase 3 trial.

A successful Alzheimer’s drug would be a home run for Elan. About 18 million people worldwide currently have Alzheimer’s compared to 2 million who have multiple sclerosis. Judging just from the number of patient’s, AAB-001’s potential may be almost 10x bigger than Tysabri’s. That’s why I think that if a deal to acquire Elan is in the works, it probably involves Wyeth as well as Biogen.

A deal in which Wyeth ends up with 100% of AAB-001, and Biogen ends up with 100% of Tysabri makes a lot more sense than Biogen acquiring all of Elan on its own.

Bottom Line

I cannot be sure, but there may be some truth behind the rumors. In the next few days, I suspect that many people will decide to sell to lock in the gains of the past 2 trading days. I would not be surprised if the stock gave back half of its recent gains. If it does, I’ll be buying.

The Marketocracy member who has made the most money on Elan is Chris Rees (view track record) and Elan is currently his biggest position.

The things I’ve discussed above are based on facts that are readily available to anyone. However, interpreting the facts to come up with the right investment decision requires judgment that is not common. I trust Chris’ judgment because of his Marketocracy track record which is now over 5 years long. Chris is the mFOLIO Master I use to manage separate accounts for clients who have a large position in Elan. For information about this program click here.