Over the past 12 months, the 10 largest pharmaceutical companies in the UK have spent more than £12bn on mergers and acquisitions (M&A). Big-brand companies and small biotech specialists alike have been gripped by the dealmaking frenzy, which is showing no sign of letting up. This has led to a shift in the structure of the market and left many considering the long- and short-term impact on the companies that make up the sector.
Pharma M&A is not a new concept. At the turn of the millennium both GlaxoSmithKline (GSK) and AstraZeneca (AZN) were formed through dealmaking and for more than a decade these companies have dominated the UK pharmaceutical sector. But through this latest spree of acquisitions, there have emerged new giants hot on the heels of these two behemoths.
None more so than Shire (SHP). Established in 1986, Shire has expanded in recent years through a series of acquisitions. Although often criticised for overpaying for deals, Shire has a good track record of incorporating new businesses into its wider business model. Now a £22bn company, it's not stopping there. The group is currently undergoing late-stage discussions with US-based Baxalta. This £32bn acquisition, if it goes through, will help the group realise its aim of becoming the leading biotechnology company focused on rare diseases.
Jordan-based Hikma Pharmaceuticals (HIK) has also been on an acquisition frenzy, which has helped contribute to its meteoric growth. In May 2015 it became the fourth pharmaceutical company to join the FTSE 100, 10 years after listing on the London Stock Exchange.
Science is changing the face of the industry
It's not just deal-hungry mid-caps that have been causing market rumbles. The scientific developments at the heart of these businesses are progressing faster than ever before. It wasn't long ago that DNA, the carrier of all genetic information, was just a theory and now technology allows us to decode individual human genomes. Such advances in both the science and technology spaces have allowed small biotech companies with the expertise and equipment to discover and create drugs much more quickly than traditional research and development (R&D) departments in big pharmaceutical companies.
For example, Aim-listed Tiziana Life Sciences (TILS), which was only founded in 2013, has developed a platform for drug discovery allowing it to identify new drugs for the treatment of cancer and autoimmune diseases. Early studies to kick off this development process have moved astonishingly quickly with the help of this technology platform.
Big pharma buying growth
But as pressure mounts from second-tier companies and new innovative biotechs, both GSK and AstraZeneca have come under harsh scrutiny for not progressing drugs through their own pipelines quickly enough. This pressure, coupled with a loss of exclusivity rights on some high-earning "blockbuster" drugs, has created a competitive environment, forcing both groups to employ new strategies.
GSK's approach has been to strip out unwanted assets and focus on what it considers the main areas of business. In March 2015 it completed a $20bn asset swap with Novartis, through which it sold its oncology portfolio, in exchange for the Swiss giant's vaccines business.
AstraZeneca has bought in its growth through the acquisition of small biotech companies that already have drug candidates in the final stages of testing. By December 2015 it had completed three deals in quick succession to help strengthen its respiratory, cardiovascular and oncology pipelines. This is a strategy mirrored by many of the big American companies, where the M&A spending spree is still going strong.
On the R&D side, innovative biotechnology is making waves. But when it comes time to leave the lab and take a product to the market, big pharma's extensive resources make a significant difference - one that small companies just can't compete with. It's therefore a highly effective strategy for all involved if a big company acquires a small biotech, providing there's enough evidence the latter has effective drugs for the larger company to market and sell through its own commercial platform. It's a strategy that worked a treat for US company Gilead - arguably the world's largest biotech - which made an $11bn gamble on biotech company Pharmasset back in 2011. Pharmasset was conducting late-stage clinical studies for a hepatitis C drug. In 2014 that drug - by then named Sovaldi - made more than $10bn in sales.
Good or bad for healthcare?
With the pharmaceutical industry left in pyramidal shape (with several companies developing drugs at the bottom and only a handful commercialising them at the top), questions exist as to whether all this dealmaking is beneficial for global healthcare.
Although the constant upheaval makes for an unstable jobs market, the emerging development and commercialisation model may make for good medicine. More R&D means there's a better chance of discovering treatments for a greater range of diseases. And, once smaller firms have access to big pharma's commercialisation resources, it's likely those treatments can get to patients faster.
Investor sentiment wavering
From early 2014 to the summer of 2015, the pharma sector was generating big excitement in investment circles, and global lifescience indexes soared. Biotech companies benefited hugely from this froth, with many seeing massive share price spikes despite generating no revenue. But this did leave big pharma confronted with unrealistic premiums to pay and investor sentiment started turning sour.
In fact, the Financial Times found more than 50 per cent of deals greater than $1bn proposed in the second half of 2015 prompted a drop in the share price of the acquirer company in the next day's trading - compared with only 31 per cent of such deals announced during the first half of the year.
IC VIEW: It's likely M&A spending will continue, as buying small biotech companies seems to be the most efficient strategy for big pharma to keep their future product pipelines well stocked. Since last summer, global biotech and pharma share prices have fallen back to much more reasonable levels, following drug pricing concerns, which has left a lot of smaller companies looking more fairly valued.
Investing in a small biotech company prior to its acquisition by a big pharma is likely to generate big shareholder returns, and that eventual take-out is something many small companies are on the hunt for. But picking the right one, and investing in a company that really has nothing more than an idea is a risky business.
Favourites: Investing in pharmaceutical companies at the moment is tricky, as many are either fully valued or too risky. For many investors, Shire falls into the latter category - the Baxalta deal has generated a lot of scepticism, which has seen the share price fall. But we feel that whether the deal goes through or not, Shire is still a growing company, and with the shares trading on nine times forward earnings, current weakness provides a buying opportunity.
Hutchison China Meditech (HCM) is another fast-grower, on the cusp of commercialising a handful of drugs. Unlike other Aim-listed biotechs it has decided to market its own products, and has supported its research through joint venture arrangements and a pharmacy platform selling drugs in China. Its imminent Nasdaq listing adds to the excitement.
Abcam (ABC) has made a series of sensible acquisitions in the past few years to ensure it keeps growing. It's a company making all the right decisions, although at 31 times forward earnings, we can't recommend buying shares at this point. It's one to watch for now.
Outsiders: GSK has employed a strategy that we're not entirely convinced is working, as innovation appears pretty stagnant. In November 2015 we advised jumping ship due to concerns surrounding the group’s cash flow profile relative to its dividend and despite a tepid set of financial results in February, we remain unconvinced on the future prospects of the business.
