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Big pharma dragging its feet on biotech buyouts

"Logic suggests we should have two months of a huge amount of M&A", says fund manager
Big pharma dragging its feet on biotech buyouts
  • Pharmaceutical industry M&A down on last year despite cash-rich majors and struggling small firms 
  • Big Pharma group faces 'patent cliff'

On paper, now is an opportune moment for the world’s biggest pharmaceutical companies to launch an acquisition spree. Many of the industry’s major players have seen revenue uplifts from the successful sale of Covid-19 vaccines and therapies, plumping cash holdings but also bringing on questions about the next big cash cows.

Meanwhile, smaller biotech firms have seen their valuations nosedive amid wider economic uncertainty. The Nasdaq Biotech Index is down about 20 per cent so far this year, while Merck (US:MRK), for example, is up 20 per cent. 

“You’ve got loads of companies with incredible amounts of cash, or incredible cash flow generation, and great ability to raise substantial debt should they need to do that as part of a transaction,” said Gareth Powell, manager of Polar Capital’s Healthcare Opportunities fund. “Logic suggests we should have two months of a huge amount of M&A. It just never works like that.”

Yet with the exception of a few notable deals, such as Pfizer’s (US:PFE) $11.6bn (£9.5bn) acquisition of Biohaven Pharmaceuticals, it has been a quiet year for M&A.

According to PwC, there was a 33 per cent decrease in US pharmaceutical deal volumes in the first half compared with the same period in 2021. 

While market volatility has dampened risk appetite, the lack of acquisitions looks strange given that many big pharma companies face an existential threat to revenues in the coming years: Moody’s estimates that about one-third of the investment-grade companies it covers have a high degree of exposure to the “patent cliff” between 2026 and 2030.

This means they are likely to experience a significant drop in revenue when they lose the exclusive right to produce a drug, and generic competitors enter the market. Bristol-Myers Squibb (US:BMY), Pfizer and Merck are most exposed, according to Moody’s.

However, some of the companies with the highest cliff exposure also have the financial headroom to make acquisitions. Moody’s highlights Pfizer – which according to consensus estimates will produce £35bn in free cash flow this fiscal year thanks to the sales of its Covid-19 therapies – as a particularly stable business. For its part, investment bank Berenberg calculates that AbbVie (US:ABBV), Pfizer and Roche (CH:ROG) have the most cash available for M&A. 

“Together, the three companies are positioned to generate over $150bn of unallocated cash over the next five years, which could be deployed in business development,” wrote Berenberg analysts in a note. “Pfizer and Roche are in particularly strong positions with leverage ratios below one.”

So why are these well-placed companies hesitating when it comes to M&A? Polar Capital’s Powell believes that smaller companies may be hesitant to sell at what they perceive to be a rock-bottom price.

“You’ve got management teams and boards who may still be attached to the highs they were trading at 12-plus months ago,” he said. “Now, access to capital is very challenging. Companies aren’t wanting to dilute very low valuations.”  

Growing regulatory risk could also explain why companies are hesitant to strike deals. The US Federal Trade Commission (FTC) is currently studying antitrust concerns involving pharmaceutical deals, having identified healthcare as an industry commonly affected by mergers that may shrink competition. In the recent past, the regulator has ordered companies to divest products in the acquisition process and analysts think could raise hurdles even further.

Michael Levesque, lead pharma analyst with Moody’s Investors Service, said that in the current climate,smaller companies were more likely to partner with a larger entity to produce a new drug.

“The most typical deal will likely be a pipeline-stage asset or perhaps something that has just been approved and has nice commercial potential, rather than a mega-merger,” he said. “Most companies seem to be guiding away from mega-mergers and there’s more value to be obtained in pipeline-stage deals.”

In the US, companies with revenues of less than $500mn now account for more than 70 per cent of the 3,000 drugs in phase III clinical trials.

The future of pharma’s biggest names is now partly dependent on buying up these innovative minnows, or at least partnering with them to bring novel treatments to market. Without these deals, big pharma might find itself uncomfortably close to the patent cliff’s edge.