Understanding a Dynamic Industry Through Mergers and Acquisitions

NICE INSIGHT OVERVIEW: Mergers and Acquisitions

Biopharmaceutical companies have many different reasons for pursuing mergers and acquisitions. However, the drive to increase competitive advantage is a motivator in every deal. While individual motivations tend to shift over time, in the recent past, slowing growth, larger numbers of blockbuster drugs reaching patent expiry, and the shift to niche orphan drugs and personalized medicine have become important factors. These trends are expected to continue, and heightened mergers and acquisitions (M&A) activity is, therefore, anticipated.

Numerous Drivers for M&A

Traditional reasons for pursuing an acquisition or merger within the pharmaceutical industry have related to the desire to achieve cost synergies and the need to increase market share. Consolidation of pharmaceutical companies enables the elimination of duplicative work streams, creating potentially significant financial and operational savings. According to McKinsey, companies with high margin spreads have a tremendous opportunity to capture synergies by acquiring subscale portfolios.¹

With respect to portfolio expansion, in some cases, companies have purchased competitors with similar product portfolios but access to different regional markets. In others, the goal was to expand the product portfolio by acquiring a firm with a complementary product line or one that specialized in a different set of therapeutic areas.

In recent years, the growing interest in immuno-oncology and other novel cancer treatments has fueled a significant percentage of pharma M&A activity.² Key examples include the acquisitions of Celgene by Bristol-Myers Squibb, Array by Pfizer, Loxo Oncology by Eli Lilly, and Peloton Therapeutics by Merck. Next-generation medicines, notably cell and gene therapies, are also driving M&A activity, such as Roche’s $4.3 billion merger with Spark Therapeutics and, in the CDMO space, the acquisitions of Brammer Bio by Thermo Fisher Scientific and Paragon Bioservices by Catalent.

With many small and large molecule drugs reaching the patent cliff within the last decade and numerous more expected to in the coming few years, there has been a drive not to expand pipelines, but to replenish them. It has been estimated that within 2019–2021 alone, the top 25 drug makers will face the risk of losing revenues totaling approximately $85 billion due to patent expiries.¹

One recent example is the $63 billion acquisition of Allergan by AbbVie, the latter of which is faced with the patent expiry of Humira, its top-selling drug, which accounted for nearly two-thirds of the company’s revenues in 2018.³ In the face of growing generic and biosimilar competition and the reduced ability to develop blockbusters and achieve sufficient organic growth, pharma companies are relying on strategic M&A.

They are also hoping to address the problem of declining R&D productivity. A 2018 study by the Deloitte Centre for Health Solutions in the United Kingdom found that R&D returns for 12 large biopharma companies declined from 10.1% in 2010 to 1.9% in 2018.⁴ Even specialty pharma companies are seeing declines — the four evaluated firms saw R&D returns decline from 17.4% to 9.8% over the same period. With sales and profits for Big Pharma firms declining at a time when competition is increasing, pressure to reduce drug prices is mounting, and R&D productivity is falling, M&A provides an avenue for achieving gains in the face of slowing growth and rising R&D costs.⁵

Over the last two decades, large pharmaceutical companies have also used M&A to gain access to innovative technologies. According to McKinsey, the share of revenues coming from innovations sourced outside of Big Pharma grew from approximately 25% in 2001 to about 50% in 2016.¹ With early-stage clinical trials often failing and late-stage studies extraordinarily expensive, it has become the norm for innovation to be generated and supported through early-stage development by emerging firms, with large pharma companies acquiring those with candidates that have a high likelihood of success and supporting their advancement through late-stage development and commercialization.

Some acquisitions are related to novel technology that enables drug discovery and development, not just pipeline enhancement. Pharma companies are acquiring (or establishing close collaborations with) companies that have expertise in digital solutions, including artificial intelligence, machine learning, Big Data analysis, cloud-based services, and other software capabilities.²

Mergers and acquisitions also enable pharmaceutical companies to realign their portfolios in response to changes in strategy. In this case, firms may acquire companies to add new assets, as well as to sell off assets they acquired in previous deals, or for which they have elected to no longer pursue development. In the United States, owing to the tax reforms passed in 2017, it is now more attractive to divest noncore assets, with after-tax proceeds increasing by a potential 23% due to reduced taxes for the seller. Large pharma companies have been taking advantage of this benefit ever since.¹

Many Megadeals

Multibillion dollar M&A deals are no longer unusual in the pharmaceutical industry. According to Statista, between 1999 and February 2019, there have been eight pharma industry acquisitions valued above $60 million, with the 1999 merger of Warner-Lambert with Pfizer topping the list at $87.3 billion.⁶ Pfizer has two other deals on the list: its acquisitions of Pharmacia for $64.3 billion and Wyeth for $64.2 billion. Three deals came in above $70 billion: the recent BMS purchase of Celgene ($74 billion), Sanofi’s acquisition of Aventis ($73.5 billion), and Glaxo’s buyout of SmithKline Beecham ($72.4 billion). That list doesn’t include the $63 billion AbbVie/Allergan deal.

Deals in the single-digit billion-dollar range are now a dime a dozen. In 2018 alone, there were six valued between $2 and $9 billion: Celgene/Juno Therapeutics ($9 billion), Novartis/AveXis ($8.7 billion), Celgene/Impact Biomedicines ($7 billion), GlaxoSmithKline/Tesaro ($5.1 billion), Sanofi/Ablynx ($4.8 billion), and Novartis/ Endocyte ($2.1 billion).⁷ Overall, the number of deals completed annually grew from approximately 100 in the late 1980s to nearly 800 in 2015.⁸

A Continued Debate on the Impact of M&A

The heightened M&A activity in the pharmaceutical industry, and, in particular, the increasing rate of occurrence of megadeals, has raised questions about the potential consequences that the overall consolidation might have and the impacts on individual company performance.

Two key concerns exist, and both are related to the expectation that increasing consolidation will lead to reduced competition.⁷ The first is related to the impact of drug discovery, with the greatest fear being that all M&A activity will lead to reduced innovation via a concentrated market for discovery. The second involves concerns over weaker downstream competition, which can lead to control of the market by a limited number of players and ultimately higher prices.

There is some evidence to support the claim that M&A leads to a reduction in innovation. In one study on R&D spending, the number of patents and indicators of innovation declined in companies involved in 65 different mergers/acquisitions.⁶ Some of this decline was attributed to the elimination of duplicate projects, and some to the disruptive nature (e.g., massive layoffs, reduced employee morale, conflicting cultures, changing strategies) and high costs associated with M&A.

On the other hand, when R&D productivity is a key indicator, there is also data to suggest that M&A leads to increased innovation.⁶ For companies formed from larger mergers, the value of new FDA-approved compounds reaching the market is higher, which can be attributed to the fact that larger firms can better manage the high cost of failure associated with drug development. The overall approval rate for new molecular entities (NMEs) and biologic license applications (BLAs) submitted to the U.S. Food and Drug Administration has also increased during the latest period of heightened M&A activity.⁷

Furthermore, the view that higher levels of M&A reflect a faltering industry is based on the assumption that large pharma companies should be the drivers of innovation, a situation that is no longer the case.⁷ The pharmaceutical sector comprises many types and sizes of organizations with a wide range of skills and research strategies.

Many of these other organizations are driving innovation. An array of small and mid-sized biotech and specialty pharma firms have displaced large established U.S. and European companies in the development space.⁷ Thus, reduced innovation within the leading large pharma companies does not mean the entire industry is faltering. The higher level of M&A does, however, reflect the fact that the pharma sector is experiencing a substantial period of transition.

M&A not only promotes development activities by creating economies of scale, but also creates opportunities for innovative emerging companies.⁷ This shift in the focus on innovation is being facilitated by the advance of digital technologies. At the same time, these smaller and specialty firms often do not have the resources to bring their innovative medicines to market or to support commercialization in multiple geographic regions. Partnering — and in many cases the acquisition of specific products or the entire company by larger firms — is an actively sought-after solution. The spread of innovation to a greater collection of organizations is thus a key driver of M&A.⁷

Recent research has also shown that M&A appears to play a limited role in pricing.⁷ Most acquisitions are driven by technological and geopolitical changes rather than to consolidate market power. Two areas that need to be monitored are the concentration of expertise in regulatory compliance and the reimbursement process in the hands of a limited number of companies.

The key to successful mergers and acquisitions is to unite the right companies, in the right manner, applying appropriate cost optimization strategies and effectively leveraging human capital.⁶ Individual price increases result from changes in company strategies for specific products under specific situations, with most price hikes made for branded and generic drugs with little or no competition.⁷

More M&A Activity to Come

The conditions driving the heightened M&A activity in recent years are expected to continue in 2020. Megadeals and cross-sector acquisitions will continue to make news, with the desire to gain access to technology a key incentive.⁹ Uncertainties surrounding the U.S. presidential election, international trade, and other geopolitical issues, as well as significant changes in the workforce, are also likely to influence M&A activity.

Notably, despite concerns that a recession is coming in the United States, PE firms and corporations hold more than $2 trillion in capital for investment, providing fuel for megadeals greater than $5 billion, even if a downturn does occur.⁹ If history repeats itself, valuations will decline in a slowing economy, making acquisition targets even more attractive.

With geopolitical tensions increasing and regulatory scrutiny becoming more varied from country to country, more domestic deals are anticipated at the expense of cross-border acquisitions.⁹ Regional, rather than global transactions, will be leveraged for growth. Within the United States, states and municipalities are passing their own regulations, particularly around deals that involve technology and data firms (e.g., privacy laws) that could also impact deals.

Acquisitions designed to provide access to unique talent pools and workplace cultures will also be important in 2020. In the United States, in particular, with the unemployment rate at record-low levels, competition for skilled workers is heating up. At the same time, companies must manage a workforce comprising multiple generations, all of which have different needs and expectations.⁹

The types of acquisitions might be changing, however. During the past 10 years, more M&A deals valued above $40 billion have been completed in the pharma sector than in any other industry.² The emphasis appears to be switching, however, to smaller, bolt-on-type deals focused on specific therapy areas.

Many of the companies that have been active in M&A in the past are good candidates for further dealmaking in the near future.¹⁰ Biogen, whose investigational Alzheimer therapy failed to advance, needs to bolster its pipeline. It recently acquired gene therapy developer Nightstar Therapeutics ($877 million) and will likely seek other deals. When Eli Lilly spun off its animal health division in 2019, it announced plans to pursue bolt-on acquisitions as a means for diversifying its portfolio. One recent example was its purchase of cancer treatment firm Loxo Oncology ($8 billion). Pfizer is also interested in diversifying its portfolio through bolt-on deals of a “few” billion dollars, such as the recent purchase of oncology developer Array Biopharma ($10.6 billion). Amgen is open to large and small deals to expand its position in cancer and metabolic disorders, while Merck & Co. has also indicated it will focus on bolt-on transactions to add candidates to its pipeline and reduce its dependence on Keytruda, its blockbuster cancer treatment.

Looking at specific therapeutic areas, gene therapy, immuno-oncology, the microbiome, and orphan drugs have dominated M&A activity, with nearly 2,900 deals worth more than $1 trillion completed around the world during the past five years.¹¹ It is also worth noting that North American biopharma firms have completed two and seven times the number of transactions as European and Asian companies, respectively. While most of the deals have been small, some have been megadeals that are affecting the behavior of large biopharma companies across the sector. Activity in these four areas is likely to continue, with companies focused on expanding their pipelines and gaining access to innovative drug candidates and technologies.

Overall, significant M&A activity in the pharmaceutical industry can be expected going forward as companies jockey to retain or gain a greater competitive advantage in an evolving marketplace faced with numerous pressures. While there are risks associated with the continuation of such heightened levels of M&A, the potential rewards are great, not only financially, but more importantly in terms of increased innovation and the ability to create novel medicines for patients in need.

References

1. Bansal, Roerich, Ruth De Backer and Vikram Ranade. “What’s behind the pharmaceutical sector’s M&A push.” McKinsey Insights. Oct. 2018. Web.

2. Parrish, Meagan. “What’s behind all the M&A deals in pharma?” Pharma Manufacturing. 31 Jul. 2019. Web.

3.  Masters, Nick. “Rising M&A Activity Shakes Up Pharmaceutical Industries.” IBISWorld Insights.  1 Aug. 2019. Web.

4. Teitelman, Robert. “Big Pharma Can’t Resist Big Mergers. Here’s Why.” Barrons. 18 Feb. 2019. Web.

5. Back, Matthias. “The Top 10 Largest Pharmaceutical Mergers in History.” Process Worldwide. 17 May 2019. Web.

6. Mikulic, Matej. “Largest M&A pharmaceutical deals ever as of 2019.” Statista. 25 Feb. 2019. Web.

7. Bonomi, Anna. “Implications of Consolidation in the Pharma & Biotech Sector.” Sustainalytics. 12 Dec. 2018. Web.

8. Richman, Barak Will Mitchell, Elena Vidal and Kevin Schulma.  “Pharmaceutical M&A Activity: Effects on Prices, Innovation, and Competition.” Loyola University Chicago Law Journal. 48: 787 (2017).

9. “Deals 2020 outlook: Making bold M&A deals during times of rapid change.” PricewaterhouseCoopers. n.d. Web.

10.  “Who is next in big pharma’s merger spree?” Reuters. 19 Aug. 2019. Web.

11. Keown, Alex. “M&A Will Continue to Be a Mainstay for Growth in the Pharma Industry.” Biospace. 2
    Oct. 2019. Web.