Michael Jewell, healthcare partner at sell-side mergers and acquisitions (M&A) advisory firm Cavendish Corporate Finance, writes an Expert View piece on the potentially busy year ahead for dealmaking in the pharma sector.
M&A activity in healthcare has been hectic in the past few months with big pharma a significant factor in this deal drive. There were some $11 billion of bids and deals in the biotech sector alone last month. What’s behind this renewed pharma M&A is blockbuster drugs coming off patent, competition from generics, weak new drug pipelines, faltering R&D and big pharma companies’ perennial search for the next generation of market-leading medicines. Also a factor has been US tax reform, which is prompting US corporates, including big pharma companies, to repatriate billions of dollars with some of it being spent on acquisitions. Though the sheer pace of dealflow has raised concerns of a valuation bubble, the fundamental forces behind this renewed deal activity are likely to see 2018 be a very strong year for pharma M&A.
There are already signs that 2018 might be a record breaking year for pharma M&A. Since the start of January, French healthcare group Sanofi (Euronext: SAN) bought US hemophilia specialist Bioverativ (Nasdaq: BIVV) for $11.6 billion, Belgian biotech company Ablynx (Nasdaq: ABLX) for $4.8 billion and Juno Therapeutics (Nasdaq: JUNO) for $9 billion. This comes alongside Celgene’s (Nasdaq: CELG) $7 billion agreed takeover of Impact Biomedicines and Novo Nordisk’s (NOV: N) $3.1 billion offer for Ablynx. In raw numbers, these deals, along with others that have been announced, have led to the sector’s strongest start for dealmaking in more than a decade.
Weak returns on R&D
There are multiple reasons for such a strong start. A key factor is big pharma blockbuster drugs going off patent. According to Thessalus Capital, such drugs that represent an estimated $17 billion in annual sales are set to lose patent protection over the next decade.
The loss of patents means there will be stiffer competition from generic drugs and biologic alternatives and as more generic drugs are approved, prices of big pharma’s previously patented drugs will fall. Losers will include major firms including Pfizer (NYSE: PFE), Johnson&Johnson (NYSE: JNJ) and GlaxoSmithKline (LSE: GSK), all of which are on strategic acquisition drives to mitigate any potential threat to their revenues, including looking at potential acquisitions of smaller pharma players, which have promising drug development programmes.
The performance of big pharma’s R&D departments is also a factor. The world’s 12 biggest drug companies are making a return of just 3.2% on their research and development spending this year — down from 10.1% in 2010. Investing in R&D is a high-risk, high-reward endeavor for big pharma companies and they face many challenges to recoup investments, including increased competition, expiring patents, declining profitability and mounting regulatory scrutiny so acquiring new drugs via buying other more innovative pharma businesses is an increasingly attractive option.
Furthermore, many of the big pharma companies are facing pressures due to aging and, increasingly, weak new pipelines. An MIT study found that only 14% of drugs in clinical trials are eventually approved by the US Food and Drug Administration. Thus, it is often more cost-effective for big pharmas to strengthen their pipelines through acquisitions of smaller firms that have specialist drugs.
A landscape for deals
US tax reforms, too, are having a significant positive impact on M&A activity. The new tax regime brings the corporate tax down from a top rate of 35%, to 21% and also allows for full expensing of certain capital investments such as machinery and equipment through 2021.The tax reforms have also enabled healthcare groups and pharma companies to access billions of dollars of cash that was trapped overseas by encouraging capital repatriation given these more favorable tax rates. This is undoubtedly a factor in the recent run of deals.
Clearly, the landscape is ripe for further deals and, despite recent market volatility and political upset, the broad pharma sector including areas such as biotech and life sciences, robust enough to maintain its healthy position. Indeed, Ernst and Young’s 2018 M&A Outlook and Firepower Report: Life Sciences Deals and Data predicts that new sources of capital will drive this year’s M&A activity well past the $200 billion annual volume of deals seen last year.
Probably one of the leaders among likely acquirers in this deal drive will be Pfizer. Indeed, the pharma giant is tipped to acquire either Bristol-Myers Squibb (NYSE: BMY), or niche neurological player Biogen (Nasdaq: BIIB). In addition, Impax Laboratories (Nasdaq: IPXL) and Amneal are looking to close their merger in the first half of 2018, which will make the newly-formed company the fifth largest generics maker in the USA.
Given the hectic pace of dealmaking, there is increased speculation that this is causing a valuation bubble. The surge has certainly led to inflated prices. According to the data provider Dealogic, this year buyers of healthcare companies have agreed to pay an average premium of 81%, which is significantly higher than the 42% typically paid in 2017.
However, while there are certainly signs of possible overheating, the fundamental drivers and commercial necessity for big pharma to stay on the acquisition trail should make sure 2018 is a bumper year for pharma M&A.
This was published in the Pharma Letter