Industry Engine Check

New innovations, a spike in drug approvals, and signs of an M&A rebound point to more stabilized financial roads ahead for the pharma and biotech markets-but valuations remain challenging amid pricing, geopolitical, and regulatory concerns

2017 and the last couple of years have been somewhat of a roller coaster ride for the biopharma industry.

There  have been a number of very positive developments. The number of new drugs approved and under development escalated for both pharma and biotech companies. A host of new methods, such as immuno-oncology, CRISPR, personalized medicine, stem cells, and biologics have opened up a surge in productive innovation. We are beginning to see drugs that cure difficult diseases rather than just extend life, an extraordinary development. There have even been recent US regulatory and funding changes that are intended to increase government funding and ease the drug approval process. Time will tell if the actual results match the intent.

Amid these examples of industry progress, however, there have been times when heavy clouds have appeared in terms of biopharma stock market volatility, access to private and public capital, pricing controversies, geopolitical challenges, and uncertainties around the ongoing regulatory structural changes in a number of the major markets such as the US and China. 

This article will look at what happened in the past year from an M&A, stock market, and financing point of view-and what we expect in the future. We will comment on the implications of these trends for senior executives and investor decisions in the pharma and biotech industries.

Pharma equity market performance

Following 2016, a year where equity markets plunged and recovered sporadically before the overall stock market rallied late in the year, the global equity markets performed well in 2017. The S&P 500 rose by 18.4% and the FTSE 100 increased by 7.1%. 

The performance of the pharma and biotech industries varied dramatically by company type and sector. The Y&P US Pharma and European indices did equally well or better, increasing by 17.3% and 17.1%, respectively. The Y&P Specialty Pharma index, however, decreased by 10.4%, as many of the companies have come under attack for price increases for older drugs and for newer orphan drugs. The Y&P Generic Pharma index decreased by 10.9% for a different set of reasons. The generic drug companies are suffering, as the number of drugs coming off patent has slowed and the level of competition in generics has increased many fold. 

Pharma equity financing and M&A

Equity issuance in 2017 was a mere $7.7 billion versus $16.4 billion for all of 2016, a dramatic decline on an annualized basis. In addition, there were only 12 pharmaceutical IPOs in 2017. There are generally very few IPOs in pharma, so this is not a change from the past. 

In 2017, only 23 deals were completed worth $42.1 billion versus 45 deals completed worth $119.3 billion in 2016. This was a dramatic decrease in both the number of transactions and the total dollar volume. This decrease in M&A activity was a reflection of the great uncertainties facing the industry around pricing and regulation and the loss of the tax inversion-driven deals. The drop was not due to any reduced desire to grow or to enhance business portfolios.

Clearly, there was a sparsity of mega deals. There was only one such deal in 2017-J&J’s acquisition of Actelion for $29.2 billion. The next largest deal was only $5 billion in size. The rationale for deals remained the same as pharma companies seek to strengthen their product portfolios, replace pending revenue losses from patent expirations, and restructure their business portfolios. 

So why the dampening of M&A activity? Three of the principal reasons were the loss of tax inversions as an alternative for US drug companies, the negative publicity around drug pricing, and the political uncertainties associated with the new and unknown policies of the new administration in the US.

As of Dec. 31, 2017, the pipeline of the deals announced but not closed was only $19.6 billion (12 deals), an indication that in the near-term we will be operating at a level that is slightly higher than 2017, but not at record levels. The recently announced acquisition of Bioveritiu by Sanofi for $11.4 billion  may be a sign of a pick-up in M&A activity.

Biotech equity market performance

On the biotech stock market front, the Y&P Mid and Small Cap Biotech indices performed exceptionally well during 2017, increasing by 23.2% and 37.4%, respectively.  The Y&P Large Cap Biotech index, however, did not perform as well, increasing by a solid but less spectacular 9.5% last year. 

This was a welcomed improvement over the poor performance overall in 2016. The growth was driven by the strong overall stock market and by indications by senior Washington officials that the FDA drug approval process will accelerate. However, this was partially off-set by the negative impact of the drug pricing issue and signs that orphan drugs will not get a free ride with regard to pricing.

Biotech equity financing and M&A

Equity issuance (secondary and IPO) in 2017 totaled 205 offerings worth $21.1 billion. This was a record dollar amount and a record number of issuances and a significant pick-up in pace compared to the 124 offerings worth $8.7 billion completed in 2016. 

There was a partial rebound in the biotech IPO issuance market. Forty-five IPOs were completed in 2017 for a total of $4 billion. This was well above 2016, when only 26 IPOs totaling $2.4 billion were completed. For those companies who struggled to complete IPOs in 2016, it was a partial improvement, but still well below the levels in 2014 and 2015.

Biotech M&A activity has almost always been modest historically, with small spurts of activity from time to time. This trend continued in 2017, with only 23 biotech M&A deals completed, worth only $14.9 billion. The acquisition of Kite Pharma by Gilead dominated that number with a value of $10.1 billion of the total. That meant that the remaining 22 deals totaled just $4.8 billion.

This was a significant slowdown on an annualized basis compared to 2016, when 41 deals worth $20 billion were completed, driven by six deals that exceeded $1 billion in value. This mirrored the slowdown in the pharma M&A market. 

Although the pipeline of biotech deals as of Dec. 31, 2017, was modest at only $4.1 billion (eight deals), there has been a flurry of recently announced large biotech deals, such as Novo Nordisk’s €2.6 billion offer (since rejected) to buy biotech Ablynx and Celgene’s deals to acquire CAR-T therapy company Juno Therapeutics for $9 billion and cancer drugmaker Impact Biomedicines for $1.1 billion up front and a potential $1.25 billion extra depending on performance.

Outlook: Pharma 

Business. The business outlook for pharma companies will continue to be positive in terms of drug development, with promising therapies in the pipeline. The industry’s trajectory in drug development innovation and productivity, directly and indirectly through the biotech industry, is strong and should continue to be strong.

There was some concern about the drop in FDA drug approvals in 2016 to only 22, but activity picked up considerably in 2017, with 44 new drugs approved, and there is a push to ease the FDA approval process in the US. In addition, the agency announced in late June that it plans to promote drug competition, including expedited reviews of generic drug applications. This will be helpful to the generic drug companies, but potentially harmful for the ethical pharmaceutical companies.

Drug manufacturers will continue to adjust their business models and strategies, as the environment around them changes and new technologies are discovered. We fully expect big pharma to continue to pursue structural changes to shift the nature and quality of its business portfolios.

Generic pharma companies will continue to consolidate, cut costs, and push selectively into higher value and more protected product areas. They are and will continue to be under intense pricing and competitive pressures. 

Specialty pharma organizations will partner, license, and acquire to maintain the strength of their overall business portfolios and scale. However, many of these companies are under severe attack around the drug pricing issue and some are finding that their orphan drug strategies have limitations in terms of insurance company reimbursement policies.

Equity markets. The stock market prices and valuations of the ethical pharma industry suffered for some time, but rebounded nicely in 2017. We expect that to continue in 2018 as long as the overall stock market performs well.

 Specialty and generic pharma company stock prices have suffered heavily due to industry pricing issues and competition and will continue to be under pressure in 2018. It is our expectation that the negative news will continue to counterbalance the positive news for these two sectors of the biopharma industry.

M&A. Young & Partners expects M&A activity in 2018 to see a major uptick, as the recent overhaul to the US tax code reduces R&D credits but lowers the penalty for repatriating cash, encouraging pharma to buy rather than build. Volume will also be driven by the restructuring and strategic needs of pharma companies, as they continue to acquire to enhance their product pipelines and strategic thrusts, while selling off non-core businesses. 

The need to fill the shrinking pipeline will also fuel in-licensing arrangements, partnerships, and joint ventures with biotechs and other pharma companies.

Outlook: Biotech 

Business. The development capabilities of biotech companies have been and should continue to be positive overall. Although there will be successes and failures by individual companies, biotech organizations have demonstrated their ability to develop new drugs at a faster pace than larger pharma firms. There is also the hope that novel drugs and arrangements with payers will allow biopharma companies to achieve attractive and sustainable pricing. 

Equity markets. The stock market favored biotech companies for a number of years, but that sentiment weakened starting in the second half of 2015 with a number of negative stories hitting the biopharma industry around pricing and other issues, impacting the IPO and secondary equity issuance volume. We expect the recent moderate improvement in the stock market and equity issuance market to continue for the biotech industry, with the positive regulatory changes being discussed. This will help the stronger biotechs raise equity capital, but we do not expect a near-term return to the frenzy of 2014 and 2015.

M&A. Although the pipeline of deals announced but not closed at the end of 2017 was relatively modest, we believe there will be a significant pick-up in the biotech M&A market this year. With the ability to repatriate cash at reduced tax rates for US firms, the ongoing successes of biotech companies in their drug development programs, and the validation of a number of new technologies, pharma organizations will likely become more aggressive in their pursuit of biotech acquisitions. 

However, their interest will be focused on specific targets in favored therapeutic and technology areas and on biotechs that have made strong clinical progress.

Implications for senior management

For ethical pharma companies, there will continue to be a wide variety of tools to acquire revenues and pipeline drugs, but the valuations will continue to be challenging, particularly for companies with promising products in late-stage clinical trials or FDA approval. The challenge will be to pick the right overall mix of M&A, licensing, and partnering to accomplish corporate strategic goals and defend and deliver shareholder value.

For specialty pharma companies, the key will be a rethinking of their strategies, since it is not clear that the pursuit of niche and orphan drug markets will continue to bear fruit in the same way they have in the past. The high price of acquisitions and the pressure on drug pricing, even for orphan drugs, will have a disproportionate impact on specialty pharmas. 

Generic drug companies will continue to face a number of industry challenges. This will result in a continuation of the current industry consolidation and selective strategies around diversification. The CEOs of  generic drugmakers must be prepared to shift to very different strategies to survive and to thrive.

For biotech companies, public and private, the future is exciting from the drug development side in terms of the approval environment and innovation and the improvements  they have seen in the IPO, secondary equity financing, and M&A markets. Unfortunately, the markets have been volatile and have played favorites with regard to therapies, technologies, and stages of development. 

The key for biotechs will be to properly assess their cash flow requirements and to create and execute a flexible financing/M&A plan that properly assesses how much capital and at what cost of equity the various alternatives will provide, whether it is private placements, partnering, IPOs and secondary offerings, royalty monetizations, or sources of non-dilutive financing. 

Peter Young is President and Managing Director of Young & Partners, a life science and chemicals investment banking firm, and a member of Pharm Exec’s Editorial Advisory Board. He can be reached at pyoung@youngandpartners.com