Healthcare merger and acquisition activity has gathered steam over the past few years. A few big mergers in the recent past include that of Pfizer, Inc. (PFE Quick QuotePFE - Free Report) and Wyeth, Pfizer and Hospira, Novartis AG (NVS Quick QuoteNVS - Free Report) and Alcon, Sanofi (SNY Quick QuoteSNY - Free Report) and Genzyme, Roche Holding AG (RHHBY Quick QuoteRHHBY - Free Report) and Genentech, and AstraZeneca PLC (AZN Quick QuoteAZN - Free Report) and MedImmune. Consolidation helps large pharma companies gain more pricing power while simultaneously curbing competition.

Last November, Pfizer announced that it would acquire Allergan, Plc for $160 billion. However, this deal fell apart in Apr 2016 due to the new U.S. tax inversion rules.

There has been a flurry of mergers and acquisitions in the healthcare space this year too. In August, Pfizer announced the acquisition of oncology-focused Medivation, Inc. MDVN for approximately $14 billion. The deal is expected to close this year. This was preceded by the buyout of Anacor in Jun 2016.

Also in June, Shire plc SHPG acquired Baxalta to brace its rare disease portfolio further, while Aegerion Pharmaceuticals AEGR and QLT Inc. QLTI entered into a definitive merger agreement to form a new company, Novelion Therapeutics Inc.

In April, Abbott Laboratories (ABT Quick QuoteABT - Free Report) announced plans to buy St. Jude Medical Inc. in a move to bolster its share in the cardiovascular device market. In fact, the month of September probably saw higher merger/acquisition activity this year. Horizon Pharma plc HZNP announced plans to buy California-based Raptor Pharmaceuticals Corp. RPTP. This acquisition, slated to close in the fourth quarter, is likely to strengthen Horizon’s orphan business in the U.S. and expand it in Europe and key important markets.

After months of negotiations, German pharmaceutical maker, Bayer AG BAYRY last month announced a definitive merger agreement to acquire Monsanto Company in an all-cash deal worth $66 billion.

Allergan announced a string of small bolt-on acquisitions last month. It announced a definitive deal to acquire Tobira Therapeutics, Inc. TBRA, a clinical-stage biotechnology company focused on drugs to treat non-alcoholic steatohepatitis (NASH) and other liver diseases at a massive premium of 500%. Also, Allergan said it will be acquiring clinical-stage biotech company, Vitae, to boost its dermatology pipeline.

Last month, Allergan also bought privately held Akarna Therapeutics to add the latter’s lead product candidate AKN-083, a preclinical-stage FXR agonist, being evaluated for the treatment of NASH. Allergan also added the lead gene therapy development program RST-001 of privately held, clinical-stage biotechnology company RetroSense Therapeutics to its eye care pipeline last month.

In-licensing activities and collaborations for the development of pipeline candidates have also increased significantly. Several pharma companies are focusing on in-licensing, mid-to-late stage pipeline candidates that look promising, instead of developing a product from scratch, which involves a lot of funds and time.

Small biotech companies are open to such deals as most of them find it challenging to raise cash, thereby facing difficulty in surviving and continuing with the development of promising pipeline candidates. Therefore, it makes sense to seek deals with pharma companies sitting on huge piles of cash.

Merger and acquisitions, especially small bolt-on acquisitions, as well as aggressive in-licensing activities and collaborations are expected to increase, going forward. This in turn puts the spotlight on small cap biotech stocks.

Biotech companies with new therapies or interesting pipeline candidates can be strong takeover targets.

Here we have narrowed down the list of choices by focusing on five stocks with a favorable Zacks Rank of #1 (Strong Buy) or #2 (Buy). Also, these are small cap biotech companies with a market cap of less than $1 billion. These stocks are well positioned in today’s market environment and could see considerable upside riding on the aforementioned trends.

VIVUS Inc.

Mountain View, CA-based VIVUS, Inc. focuses on developing compounds to treat obesity, sleep apnea, diabetes and sexual health. VIVUS’ key product, Qsymia, targets the highly lucrative obesity market with huge commercial potential.

VIVUS delivered positive earnings surprises in three of the past four quarters, with an average beat of 39.88%. Its loss estimates for 2016 and 2017 have narrowed over the past 60 days. The company’s share price has increased 13% year to date. Currently, VIVUS sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Geron Corporation (GERN Quick QuoteGERN - Free Report)

Menlo Park, CA-based biopharmaceutical company, Geron Corporation focuses on the development of first-in-class therapeutic products for the treatment of cancer. Geron's product development programs are based on its patented core technology, telomerase, which represents significant commercial opportunity. The successful development of products that target telomeres could very well change the treatment paradigm for several diseases including oncology, which represents huge commercial potential.

Geron, which carries a Zacks Rank #1, delivered positive earnings surprises in each of the past four quarters, with an average beat of 20.78%. Its loss estimates for 2016 have narrowed from 26 cents to 24 cents in the past 60 days.

Achillion Pharmaceuticals, Inc. ACHN

Achillion Pharmaceuticals is a development-stage company, focused on the development of potent and specific complement factor D inhibitors for rare and other diseases. Achillion has out-licensed its HCV portfolio to Janssen, a Johnson & Johnson (JNJ Quick QuoteJNJ - Free Report) company.

Currently, Achillion holds Zacks Rank #1. It delivered positive earnings surprises in all the past four quarters, with an average beat of 364.79%. Its loss estimates for 2016 have narrowed from 66 cents to 62 cents in the past 60 days.

 Anika Therapeutics Inc ANIK

Anika Therapeutics makes therapeutic products and devices that promote the repair, protection and healing of bone, cartilage and soft tissues. Its products are based on hyaluronic acid, a naturally occurring, biocompatible polymer found in the body. The stock carries a Zacks Rank #1.

Anika Therapeutics’ earnings estimates for 2016 and 2017 have increased a respective 9.5% and 11.5% over the last 60 days. The company recorded a positive earnings surprise in each of the last four quarters, with an average beat of 42.19%. Its share price has jumped 25% year to date.

ANI Pharmaceuticals, Inc. ANIP

This Zacks Rank #2 specialty pharmaceutical company witnessed an increase of 9.5% and 4.7% in its earnings estimates for 2016 and 2017, respectively, in the last 60 days. It surpassed earnings estimates twice in the last four quarters, bringing the average positive surprise to 46.85%. The company’s share price has surged 50.6% year to date.

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