Stock Talk: Banking on a Biogen Buyout

Headquartered in Cambridge, Massachusetts, Biogen Idec develops, manufactures, and sells treatments in the areas of oncology, neurology, and immunology. The company generated $2.68 billion in revenues last year from five key products: Tysabri, Rituxan, Zevalin, Avonex, and Fumaderm. With a market cap of more than $20.5 billion, Biogen Idec is one of the bigger players in the biotechnology industry.

Takeover speculation has been rampant over the past month after the company said on October 15 that its Board had authorized management to evaluate the potential sale of the company. Biogen Idec did not mention any specific acquirers, but Pfizer () is considered to be one of the more likely contenders. Merck (), Novartis (), GlaxoSmithKline (), Switzerland’s Roche, and Johnson & Johnson () have also been mentioned.

Yet, while enthusiasm for a Biogen buyout pushed shares up 18.8% on October 15^th and to all-time highs of $84.75, the stock has since backed off those levels. Some believe that takeover premium had already inflated the stock price prior to the announcement. Rumors of a buyout had surfaced earlier in the year and the chatter helps to explain a six-month 50% rally in the share price that occurred prior to the October 15 announcement.  Now, there might be some concern that the company’s valuations are too rich for most potential suitors. Consequently, the stock has backed off and is now 17.1% below its mid-October highs.

Figure 1: BIIB Daily Chart  

Yet, despite the stock’s lackluster action over the past few weeks, optimism about a possible takeover remain high. According to Steven M. Sears, who wrote about Biogen last week (Buying Calls on a Biogen Buyout, November 16, 2007), Citigroup analysts “wager the likelihood of a takeover at 70%” and “options are probably the best way to trade this potential takeover.” As the title of Sears’ article suggests, his recommendation is to buy call options on BIIB ahead of a possible sale.

Yet, while it is probably true that options are the best way to play a potential takeover of Biogen, buying calls in this situation is not the best strategy for several reasons. For one, straight call buying is almost always inferior because of time decay. Given that the timing of a takeover announcement is unknown and the stock has been drifting lower, call options can lose value due further weakness in the stock and because of time decay. In this case, a simple bull call spread, which involves buying calls and selling calls with a higher strike price, would reduce some of the risk of straight call buying.

A few other strategies come to mind as well. Figure 1 shows that the stock has found support along its 50-day moving average at roughly $70 a share and buyout hope is likely to keep a floor under prices. At the same time, most analysts view the upside limited to $80 a share. With a floor under $70 and the ceiling at $80, a directional butterfly, condor, or other strategy for a rangebound market might make some sense here as well. 

Finally, as we can see from figure 2, the prospect of a buyout has pushed up BIIB levels of implied volatility to multi-year highs. Late Monday, the implied volatility of Biogen options was in the mid-50s, compared to a long-term average in the mid-30s. That, in turn, means the option premiums are jacked up and, for that reason, it is probably a better time to be a net seller, not a net buyer, of Biogen Idec options premiums.

Figure 2: BIIB Implied Volatlity

Frederic Ruffy
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