In a sector scan on health care I published recently, I mentioned that many of our positions within the health care sector were in the Pharmaceutical and Biotechnology industries.
Recently, we have seen a flurry of mergers and acquisitions (M&A) in this space—more than $30 billion year to date in 2018, most of that within biotechnology.
Here are the factors that have contributed to the intense round of M&A activity among some of the major players worldwide.
Changes in U.S. tax policy
2017 was a very slow year for health care sector M&A, largely because of the uncertainty around tax policy. Much of this uncertainty has been lifted thanks to the U.S. tax reform in December 2017 with management at health care companies more willing to pursue acquisitions.
Thanks to the tax reform, companies can also tap into cash more easily, whereas it was previously ‘trapped’ overseas. New lower corporate tax rates also improve the economics of the transactions.
Lots of financial firepower
Health care companies and pharmaceutical companies in particular are generally ‘higher quality’ businesses with conservative balance sheets, limited debt and/or high cash balances. It means the sector has access to a lot of capital that can be deployed for M&A activity.
Research from Goldman Sachs estimated large biotechnology and pharmaceutical companies may have access to more than US$460 billion in capital through a combination of existing cash and the ability to take on leverage.
Bolstering competitive positioning and forging niches
Much of the M&A seen in 2018 has been related to biotech, as many firms are trying to position themselves for future products, in particular, based on genomic technology, which has the potential to revolutionize the pharmaceutical industry.
Many firms have been acquiring companies to gain access to complementary technology, to help build their franchise. This has especially been the case in oncology treatments. For example, Celgene Corporation spent US$9 billion in January to acquire Juno Therapeutics, Inc., an experimental cancer drug lab. Juno is advancing the state of chimeric antigen receptor T-cell therapy (CAR T).
GlaxoSmithKline Inc. (GSK) recently bought out Novartis International AG’s 36.5% stake in their consumer health care joint venture for US$13 billion. That slate of products includes such familiar names as Sensodyne toothpaste, Panadol pain relievers, and muscle gel Voltaren. GSK wants to use these consumer products as a source of cash flow, enabling the firm to boost its R&D investments. Novartis quickly turned around and used a portion of those proceeds to purchase Avexis for US$8.7 billion to bolster their neuroscience portfolio.
Consumer health care has had concerns over growth and pricing pressures particularly as online retailers like Amazon get into the distribution and cheaper-store branded products.
However, Mondrian Investment Partners, who owns both Novartis and GSK in the MDPIM International Equity Pool, MD Equity Fund and MD International Value Fund, believes the consumer health sector still has compelling long-term drives.
Consumer health provides stable recurring cash flow, and access to logistics and distribution, and should benefit from population aging, and the scope for consolidation in an extremely fragmented sector. Mondrian notes there are merits to both approaches: Novartis’ focus on pharma and innovation, versus the more diversified approach GSK is pursuing.
Less risky business strategy
Bringing new medicines to market is a long, expensive and risky proposition. Returns on R&D have fallen from 10.1% in 2010 to just 3.2% in 2017, according to a study by Deloitte. Part of the decrease in returns on R&D is the unprecedented scrutiny governments have applied to the approval of new drugs, to the point where only about 14% of new drugs make it to market.
Purchasing later stage technology through acquisition can be a less risky strategy for larger companies looking to replace revenue streams from previous blockbuster drugs coming off patent. This has been the case with Sanofi, a position in the MDPIM International Equity Pool, MD Equity and MD International Value Fund, which has been active in M&A this year as it looks to offset expected declines in their diabetes (Lantus) portfolios.
As high as $200 billion
How big will the M&A wave be this year in the pharmaceutical industry? Only four months into the year, the tally is already about US$30 billion. Some industry observers think the total this year could go as high as US$200 billion. Last year was unusually slow for M&A activity in the industry, as major players waited for details and implementation of the new Trump administration tax reforms. The reduction in tax uncertainty and the more favourable tax rules have turned tax into an advantage for M&A. The bigger limitation on future M&A may be valuations themselves as prices for smaller biotechnology players have moved higher.
Resilience in the face of headwinds
The pharmaceutical industry will continue to face some headwinds in the years to come, with pricing pressures and patent expiries, but there is also a lot of exciting innovation occurring, particularly in genomics.
Pharmaceutical companies continue to be some of the most resourceful corporations in the world. The heightened M&A activity we are seeing this year is one more indication of an industry responding quickly and effectively to its current business conditions, while keeping an eye to the future of new drug technology. From an investment point of view, the pharmaceutical industry is still worthy of attention.