Buyout Cycle Boosts Biotech ETFs [SPDR S&P Biotech (ETF), Achillion Pharmaceuticals, Inc., Merck & Co., Inc.]

biotechDavid Fabian: The recent buyout of Idenix Pharmaceuticals (NASDAQ:IDIX) by drug maker Merck & Co (NYSE:MRK) is another high-profile example of the race to scoop up promising biotechnology companies before they hit it big. Drug companies know the pipeline for new products must constantly be refreshed by cutting-edge innovations that can lead to billions in future profits.

The 230% single day gain that IDIX experienced as a result of the buyout had a huge impact on the SPDR Biotechnology ETF (NYSEARCA:XBI), which rose more than 6% that day. Because XBI is a modified equal weighted index, IDIX had a much larger impact on the total returns than a market-cap weighted fund such as the iShares NASDAQ Biotechnology ETF (NASDAQ:IBB).

IDIX previously represented just 1.5% of the underlying holdings in XBI, but the recent jump has catapulted its total weight within the index to 4.5%.

XBI

This acquisition also sparked a strong rally in companies with competitive products such as Achillion Pharmaceuticals (NASDAQ:ACHN), which is developing a similar hepatitis C treatment.

The latest round of M&A activity in the biotechnology arena got me thinking about how these buyouts can positively impact ETF indexes in addition to the direct equity holders. From a fundamental perspective, the attractiveness of smaller firms that can be bought out for billions of dollars by heavy-hitters is a win for many niche industry-level ETF participants.

When most indexes are constructed, underlying stocks are added or removed based on their market cap or fundamental merits according to the constraints of the index provider.

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