Executives at Japanese pharma group Takeda (Jap:4502) and its British peer Shire (SHP) seem to like catchy, date-driven targets. Takeda is working towards its Vision 2025. Shire was aiming for sales of $20bn (£14bn) by 2020 (although this target has since been lessened to the less-catchy “between $17bn and $18bn”). It suggests they might get along well.
Takeda has floated the idea of a takeover of the rare diseases specialist, sending the prospective target’s investors into a flurry of excitement. In fact, Shire's shares jumped by more than a fifth once Takeda’s management confirmed it was at a “preliminary and exploratory stage” of a possible deal. Although there's no official offer on the table yet – something Shire was quick to confirm – the news has reignited speculation that 2018 could be a big year for pharmaceutical mergers and acquisitions (M&A).
Consolidation is integral to the global pharmaceutical industry. It gives small- and mid-sized drug companies an opportunity to launch their medicines without having to spend money on marketing or distribution. At the same time, big pharma groups can avoid time consuming, high-risk early-stage drug development by buying medicines from smaller peers to bulk up their future product pipelines.
But lately it’s been quiet on the M&A front. Since 2014 when 229 healthcare acquisitions completed – including Allergan’s (US:AGN) two multi-billion dollar purchases and GlaxoSmithKline’s (GSK) $23bn asset swap with Novartis (CH:NOVN) – the total annual value of these sorts of takeovers has fallen. 2015 wasn’t bad – the deal count actually grew – but a lack of major opportunities compared with the prior year meant the total M&A value dropped 14 per cent to $189bn. By 2016, the uncertainty of a presidential election meant both the number of acquisitions and their value plummeted. Last year, doubt about the outcome of the new tax proposals dampened sentiment even further.
Now, big pharma faces a problem. A lack of recent transactions, combined with low levels of internal research and development (R&D) investment means many companies have gaps in their early-stage drug pipelines. And as ageing medicines begin to lose patent protection and sales potential, those pipelines are key to survival.
Thus, pharma M&A is expected to pick up again this year. Donald Trump’s new tax laws have increased the likelihood of deals, as many of the world’s biggest pharma groups now have more cash to fund consolidation. Baker McKenzie, an international corporate law firm, thinks global healthcare deals will hit $418bn this year, up 50 per cent compared with 2017. By the end of January, healthcare companies had already signed deals worth $30bn, according to data collected by Thomson Reuters – the best start to a year for pharma M&A since 2007.
Who’s buying?
French group Sanofi (FR:SAN) and US-giant Celgene (US:CELG) were the first off the mark this year. The two companies have made no secret of their increasing desperation for a deal: in 2016, Sanofi was beaten to two potential acquisitions by Pfizer (US:PFE) and Johnson & Johnson (US:JNJ), while Celgene faces the loss of patent protection on a drug that contributed 63 per cent of revenues last year.
GSK has also been in the market. In March, management spent $13bn on the remainder of the consumer healthcare business it shared with Novartis. The acquisition is expected to be earnings accretive, but GSK still has a weak new drugs pipeline which will need filling.
It's been speculated that fellow British group Vectura (VEC) might be able to plug this gap. Vectura – which also specialises in respiratory medicines – has struggled since US regulators turned down its generic version of GSK’s asthma blockbuster Advair which was developed alongside Hikma (HIK). The share price has fallen 49 per cent in the last year, making it an attractive acquisition target.
The same is true of Shire, which has been the source of takeover speculation for many months. Pfizer and Novartis were both thought to have their eye on the group’s impressive pipeline of rare disease medicines, Takeda has now revealed its hand and AbbVie (US:ABBV) may be considering another bid after its previous failure to buy the company in 2015.
Mega-deals aren't the only route to consolidation. At the JP Morgan Healthcare conference in January, Eli Lilly’s (US:LLY) head of corporate business, Darren Carroll, said big deals don't serve shareholders: “Every time we look at them, they just don’t make sense; what they do is distract people.” Instead, Eli Lilly – which has suffered a series of setbacks following the failure of expensive clinical trials – is likely to scout individual drugs that could bolster its immunology focus. Mr Carroll also said the group would "look to act" in oncology as well, albeit on a "very selective" basis.
AstraZeneca (AZN) already has an incredibly strong pipeline of new drugs – particularly in the oncology space – which is quickly absorbing its spare capital. Instead of major M&A, the group has sold or partnered a lot of products it doesn’t consider key to future success. Earlier this year it spun out six early-stage autoimmune drugs into a separate biotech company, in which it is the largest minority shareholder.
Breaking the bank
The problem with bulking up the pipeline via M&A is that it's pretty expensive: small- and mid-cap pharma valuations have been driven upwards by historic demand for deal making. For example, Sanofi paid $11.6bn for US haemophilia group Bioverativ in January — 63 per cent more than its undisturbed share price, while Celgene agreed to pay $9bn for Juno, an experimental cancer drug specialist. The price was almost twice what the biotech company was worth before rumours of a deal. In fact, so far this year, buyers of healthcare companies have agreed to pay an average premium of 81 per cent, according to data provider Dealogic.
Merck's (US:MRK) chief financial officer, Rob Davis, is concerned that high expectations for more deals will generate further froth in the valuations of small- and medium-sized pharma companies. He and other industry experts have warned of a bubble like that of 2014, when excessive M&A and a huge number of IPOs sent biotech share prices rocketing.
Meanwhile, debt could be the undoing of the potential Shire-Takeda merger. The Japanese group has historically been very conservative in its acquisitions, rarely ever buying large companies. Last time the group bought a big company, its net debt was stretched so far that its credit rating was cut – and that was only a $5bn deal. Shire has a current market capitalisation just shy of $30bn. Factor in a share price premium and the group's $13.5bn debt pile, and the Japanese group might have to fork out $50bn. The two companies would carry combined net debt of roughly $22bn, two times the prospective adjusted cash profits. Successful integration would also be challenging, considering Shire is still absorbing its $32bn Baxalta acquisition.
