3 Reasons Why Gilead Sciences Will Buy Incyte -- and 1 Reason Why It Won't

By Keith Speights Markets Fool.com

Gilead Sciences (NASDAQ: GILD) CEO John Milligan made the audience laugh at the Barclays healthcare conference on Tuesday. Barclays analyst Geoff Meacham referenced a letter he had sent to Gilead's management team urging the company to take steps to increase its valuation, including making transformational acquisitions. Milligan's response was perfectly timed: "There was a letter?"

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Anyone hoping that Milligan might provide a clue as to whether rumors that Gilead plans to acquire Incyte (NASDAQ: INCY) walked away disappointed. However, it's entirely possible that such a deal is in the works. Here are three reasons why Gilead Sciences could buy Incyte -- and one reason why it might not.

Image source: Getty Images.

Reason No. 1: Big replacement needed for big gaps

Gilead Sciences didn't need Geoff Meacham or anyone else to tell it that there's a major problem. The company's executives know fully well that Gilead has two big gaps. One of those gaps stems fromdeclining hepatitis C virus (HCV) franchise sales. Fewer HCV patients are seeking treatment.

The other gap is the biotech's pipeline. Milligan stated at the Barclays conference that Gilead's top two pipeline candidates outside of HIV were still a few years away from potentially reaching the market.He acknowledged that "the best way have a change of opinion on the stock is to change the pipeline."

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It's clear that management realizes an acquisition is needed. There aren't too many biotechs large enough to help fill Gilead's big gaps. Incyte is one of the few. That by itself could make Gilead more likely to pursue Incyte than to buy out another smaller biotech.

Reason No. 2: Desire to boost oncology portfolio

In November, Milligansaid that Gilead is focused on "augmenting [its] portfolio withexternal opportunities, particularly in the field of oncology." The big biotech hiredAlessandro Riva away from Novartisin January to head up its oncology program. This move appeared to confirm that Milligan's statement that Gilead is seriously considering boosting its oncology portfolio.

There are quite a few biotechs with promising cancer drugs that Gilead could go after. However, Incyte could be in a league of its own.

Incyte already has a successful cancer drug on the market with Jakafi. (Perhaps not coincidentally, Alessandro Riva should be quite familiar with the drug, since Novartis markets the JAK inhibitor outside of the U.S.) Incyte also claims one of the most promising immunotherapies in late-stage development with epacadostat. In addition, the biotech's pipeline includes 11 other experimental cancer drugs in development.

Reason No. 3: Explorations into increasing leverage

I have thought for a while that Kite Pharma (NASDAQ: KITE) could be a good buyout target for Gilead Sciences. But there are some potential hints from Gilead's executives that they're looking for a bigger deal than a Kite acquisition would be.

Kite's market cap is a little over $4 billion. Gilead could write a check for that amount plus a nice premium and barely miss the money. Incyte, on the other hand, has a market cap of around $28 billion. Even though Gilead's cash stockpile is larger than that, the company would need to borrow to fund an acquisition of the biotech.

During Gilead's fourth-quarter earnings call, CFO Robin Washington mentioned that the company had been in discussions with ratings agencies about increasing its debt levels. That seems to indicate that Gilead is preparing for a large acquisition rather than a small one.

Again, there aren't too many biotechs out there that are large enough to significantly impact Gilead's leverage ratios. Several of those specialize in rare diseases, an area for which Gilead hasn't expressed much interest in the past. If Gilead really wants a game-changing acquisition to beef up its presence in oncology that's big enough to require taking on a notable amount of debt, Incyte appears to be the best fit.

Why an Incyte deal still might not happen

In my view, there's one compelling reason why Gilead Sciences might not buy Incyte. Milligan made a few comments at the Piper Jaffray healthcare conference in November that could be construed in a way that may make an Incyte acquisition less likely.

Milligan said then that some wanted Gilead to make an acquisition "prices be damned," but he disagreed with that approach. He also added that somedeals "might look good on spreadsheets," but would be difficult to manage. Those comments were made when Incyte stock traded roughly 50% below current levels.

It could be that Gilead simply doesn't want to pay the amount needed to acquire Incyte. Perhaps the company is instead planning to spend a lot of money on a "string of pearls" strategy, buying multiple smaller companies like maybe Kite Pharma and others.

Milligan said on Tuesday that Gilead "thinks 10 years out." Will Incyte's Jakafi and epacadostat be part of that future? I think there's a pretty good chance they will be. For now, though, the answer remains "maybe."

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Keith Speights owns shares of Gilead Sciences. The Motley Fool owns shares of and recommends Gilead Sciences. The Motley Fool has a disclosure policy.