Pharma and Biotech Trends 2014

Peter Young examines the fast-moving growth drivers for the two segments and what their 2014 numbers mean for respective M&A and other strategies going forward.

The pharmaceutical and biotechnology industries, like all industries, are facing industry-specific changes coupled with disruptive events in the external global environment. The industry business factors include the productivity and cost of R&D; the changing relationships with patients and providers; shifts in patent laws and regulation; and reductions in global government spending and behavior with regard to pricing and intellectual property. External factors include a global economy struggling to achieve growth; the financial and economic woes of many of the emerging market countries such as India and Brazil; a deterioration in the Euro Zone business and economic conditions; a solid economic recovery in the US; an outbreak of geopolitical tensions around the world; and a positive surge in global stock market valuations.

Peter Young, Young & Partners

Highlighted in this article are these and other details from the “Pharma and Biotech Strategic, M&A, and Financial Trends Report,” recently completed by Young & Partners (Y&P), that covers the first three quarters of 2014 and the outlook for the future.

Pharma trends

Pharmaceutical companies of all sizes have been revamping their strategies to survive in this new business environment. The diversity of strategies being followed is remarkable. Strategies range from the following:

• Diversification

• Moving to be a pure play pharma company

• Focusing on leadership businesses and exiting weaker businesses

• Large-scale mergers

• Exiting the pharma industry altogether

• Geographic expansions

• Regional consolidation

• Pursuit of biologics

• Expansion of generics

• Movement into vaccines

• Pursuit of orphan and niche drugs

• Movement away from primary care indications to specialized areas

• Cost reduction programs

• Restructured R&D efforts (making research more nimble and collaborative; prudently stopping research projects earlier than in the past; and pursuit of singles and doubles rather than just home runs)

• Pursuit of biotech acquisitions and partnering/alliances

In most cases, company strategies are a combination of the above.

Although no clear picture has emerged with regard to who the winners and losers will be, these changes in the environment and the diverse strategies of pharma companies are driving the pharma M&A market to a frenzied pace.

Looking back, pharma merger and acquisition volume in 2012 and 2013 was fairly soft in terms of the number of deals and the dollar volume.

That slower pace was driven by a number of factors. In those years, pharma companies were tentative with regard to attempting larger acquisitions given a host of uncertainties they were facing. In addition, the valuations of public pharma companies had gone up considerably, making public company acquisitions more expensive.

That has changed in 2014 as companies are more aggressively pursuing a variety of strategic changes that require a high level of M&A and related activities.

With regard to financing, the equity market side of the picture has been positive but modest, as pharma companies have not had to go to the equity markets because their earnings, cash flows, and access to debt financing have carried the day. Even IPOs are sparse compared to other industries.

Debt issuance by the pharma industry has been very strong, driven heavily by acquisition financing and a love affair between the debt markets and pharma.

Biotech trends
On the biotech side, M&A volume has historically been very modest, and that has continued in 2014. Acquirers have balked at the price tags and have relied extensively on alternatives such as partnering and licensing. A combination of high stock market valuations and the bidding up of prices for late-stage biotech companies has dampened the pharma company pursuit of certain biotech companies.

In the stock market, biotech companies are now clearly in favor and the share prices of biotech companies have benefited. Investors are excited about the new products and technologies and are strong believers that the biotech business model is working.

In terms of biotech financing, debt issuance continues to be at a virtual standstill as the debt markets have shunned the biotech sector. However, the situation has been quite the opposite in terms of equity offerings since early 2013. The strong overall IPO market, coupled with the stock market’s love affair with biotech, has resulted in a high level of equity issuance, including IPOs.

Surge in pharma M&A deal activity
Forty-three deals worth $73.6 billion were completed in the first three quarters of 2014, versus 42 deals worth $39.9 billion completed during all of 2013. This represents a significant increase in both the number of deals and dollar activity from an annualized point of view. The $27 billion acquisition of Forest Laboratories by Actavis contributed heavily to the total. Activity has been particularly high in the US versus Europe and the rest of the world.

Pharma companies have become more aggressive with regard to acquisitions, with companies looking to replenish their pipelines, strengthen their leading businesses, either push their borderline businesses into leadership or an exit, and, in some cases, to re-domicile in more favorable tax jurisdictions via tax inversion transactions.

In some cases, drugmakers are acting as both buyers and sellers, forming strategic alliances and swapping to shore up their core businesses. For example, in a $19-billion swap, Novartis sold GlaxoSmithKline its vaccine unit while GSK sold its oncology business to Novartis. The two companies also formed a joint venture to develop a consumer healthcare business.

What does the M&A pipeline look like?
There were a large number of deals announced but not closed as of the end of the third quarter. As of Sept. 30, 2014, the value of deals announced but not closed was $86.6 billion (14 deals), a hefty dollar amount.

A few of the announced but not closed deals, however, are tax inversion transactions that may be in jeopardy. AbbVie’s proposed acquisition of Shire for $54.2 billion was recently terminated due to new Treasury regulations that remove some of the financial benefits of tax inversions. A number of the other tax inversion deals may fail, but some will still go through.

Pharma: What will the future bring?
The business outlook for pharma companies is mixed, as they struggle to realign themselves to a new business model that will work. The solution will be different for each company. However, there are very positive signs for the health of the industry as growth has resumed, innovative products are arriving, and interesting strategies are bearing fruit.

Big and specialty pharma companies are facing a myriad of business and financial decisions about what strategies to follow and the trade-offs they have to make with regard to dividends and stock repurchases versus acquisitions and internal investments.

Generics did well as long as they achieved growth, but with high volatility. However, the clear slowdown in patent expirations and the ethical drug company expansions of their generic efforts have forced generic companies to consolidate, acquire, and push into non-generic businesses

M&A activity through the first three quarters of 2014, on an annualized basis, was far above last year’s dollar pace and also higher in terms of the number of deals.

We believe there will be strong volume ahead of us driven by the strategic initiatives of pharma companies. This view is supported by a surge in announced but not closed deals as of the end of the last quarter. This surge will drive an increase in the fourth quarter and spill over into the first part of 2015.

Biotech: What will the future bring?
The development capabilities of biotech companies have been and will continue to be positive overall. Although there will be successes and failures by individual companies, biotech companies are demonstrating and will continue to demonstrate their ability to successfully develop new drugs.

Biotech M&A will continue to be active, with the primary theme being pharma and big biotech acquisitions of biotech companies for pipeline enhancement. However, M&A dollar volume will continue to be modest, mainly because pharma and big biotech companies are heavily using non-M&A methods to achieve their pipeline goals, such as licensing and partnering.

M&A valuations will continue to be high, with the most promising biotech companies at all stages attracting the greatest interest and relatively high prices.

Historically, the biotech industry’s relationship with the debt and equity markets has been volatile. The structural challenge has been the misalignment of when the funding sources or industry acquirers are available versus the time and costs to get to milestones

However, that has not been the case in the equity market for biotech for the last two years. Venture funding has returned and there has been a dramatic surge in volume of IPOs since the beginning of 2013. Barring a major disruption in the global equity markets, we expect the positive environment for equity funding to continue. Equity issuance was very strong in the first three quarters of 2014. It remains to be seen, however, whether the biotech IPO window will remain open going forward with the volatility of the equity markets.

The full version of this article will be available in the December issue of Pharmaceutical Executive.

Peter Young is President and Managing Director, Young & Partners, Life Science Investment Banking. He can be reached at pyoung@youngandpartners.com.