Robust M&A displays value despite pushback.

BY Jason Spizer

US Biopharmaceutical Investment Climate

June 17, 2020

M&A activity is rampant in the biopharma industry. From Big Pharma mega-mergers to smaller acquisitions of emerging startups, the life sciences industry has seen a huge amount of deal activity in the biopharma space every year for the past decade. 2019 saw several large M&A transactions closed or announced, highlighted by the BMS-Celgene, and AbbVie-Allergan mega-deals. On the biotech side, Loxo-Lily and ArQule-Merck also made waves. According to BMO Capital Markets data, there was nearly US$260 billion in M&A deal activity for 2019. Over the past eight years, the value of biopharma M&A deals in aggregate is US$1 trillion.

While high profile biotech acquisitions are often celebrated as wins, rarely are the bigger mergers viewed favorably. Pundits and policymakers often claim these larger M&A deals do a myriad of bad things: destroy value, distract R&D groups, consolidate market power, take out emerging competitors, and negatively impact drug pricing. The recent dissenting opinions on the BMS-Celgene merger from two Federal Trade Commission members highlighted this perspective. Both were against approving the dea, because of the possible negative competitive impact.

What these analyses failed to consider is the overall ecosystem benefits of M&A activity. It is a crucially important aspect that needs to be better appreciated by politicians and policymakers in Washington. Fundamentally, large and small M&A deals help catalyze a more efficient allocation of scarce resources across the sector, especially over the longer term.

According to Arda Ural, partner and life sciences sector strategy and transactions leader at Ernst & Young: “There is a myth that mergers don’t add value. We see value being created by both mega-mergers and bolt-ons. In terms of generating shareholder value, EY research shows that mega-mergers take up to five years to be reflected in stock appreciation, whereas bolt-ons can attain that within one year.  Companies that tend to do more acquisitions and divestitures have better capital efficiency and return on capital.”

Relative to many R&D-intensive industries, pharma is remarkably fragmented. No single player has more than a 10% market share in most broad market categories.

There is also a massive difference in the ‘cost of capital’ across different players in the sector. This means there is a huge variation in the ability of players to fund the long journey from idea to full market commercialization. The larger profitable biopharma companies have significant cash flows, large balance sheets, and can raise low interest rate debt at will. Contrast this to the loss-making biotech world, where access to new funding is always an issue. Even in the latter group, there are a huge variation in the cost of capital between startups, whose cost is very high, to pre-profit small and mid cap biotech companies that command better conditions. As a sector, the efficient allocation of capital and, by extension, talent and science resources is critically important, and it creates new opportunities for investors.

In short, M&A helps address some of the ecosystem’s redundant and bureaucratic inefficiencies by helping the sector better allocate the scarce value-creating resources over the long term.

Another critical function of M&A is the role it plays in replenishing big pharma’s pipelines. According to EY, there are looming patent expirations valued at US$180 billion over the next four years. This will ultimately lead to a permanent decline in revenue if new assets are not acquired. Big pharma therefore needs to actively pursue deals to maintain revenue lost from pending patent cliffs.

With the Covid-19 driven uncertainty in valuations in the first quarter of the year, it is still unclear how the rest of 2020 will play out on the deal front. However, regardless of these dynamics, the fundamentals of the biopharma industry are holding up and big pharma will still need to deploy cash for external innovation.

It can be argued that the fall in valuations in Q1 presents an advantageous opportunity for big pharma. However, Christiana Goh Bardon, managing director of UBS Oncology Impact Fund holds a slightly different view: “Big pharma is not so much focused on the price, but on the certainty of success of the assets that they acquire. It is not that they are willing to buy an asset today because it is cheaper than it was yesterday. What they are waiting for is the critical proof of concept, which indicates that the drug is going to be successful through the clinical and regulatory process and ultimately commercially successful. They do not really want to pay less money for an uncertain asset… The main difference in varying economic environments is that big pharma may have slightly better negotiating terms should the capital markets become more difficult. “

Regardless, in contrast to government rhetoric, the prevailing view in the industry is that M&A transactions are an essential part of a healthy ecosystem and deals will continue, albeit in a more subdued manner given the uncertainties that COVID-19 and the upcoming presidential election present.

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