More than $200 billion is at play in the current round of M&A activity in the pharmaceutical industry – a frenzy that includes 14 deals announced so far this year. This compares with 10 deals last year, according to a Wall Street Journal report based on data from S&P Capital IQ, a unit of McGraw Hill Financial. Clearly, the global pharmaceutical industry is undergoing a major consolidation phase. Behind the stated objectives of access to new drugs, cost savings and synergies is a drive to focus on core competencies, say Wharton experts, who caution the companies involved to guard against overpaying and poor post-merger integration.
Here are examples of M&A activity during the past two months:
- New York City-based Pfizer launched a $99 billion bid in March for London-based AstraZeneca, raising that offer to $119 billion by the third week of May. But AstraZeneca, which makes cancer, cardiovascular and respiratory drugs, was resistant to moving forward, arguing that Pfizer’s offers undervalued the company. On Monday, Pfizer announced it was abandoning its efforts to acquire the company.
- Canada’s Valeant Pharmaceuticals wants to acquire botox maker Allergan, based in Irvine, Calif. On Wednesday, May 28, it raised its bid for the company to $50.4 billion from its previous offer of $47 billion, in partnership with activist investor Bill Ackman. Allergan had earlier said Valeant’s offer price undervalues the company.
- In early May, Germany’s Bayer clinched a $14.2 billion deal to buy the consumer care business of Whitehouse Station, N.J.-based Merck.
- Swiss pharma company Novartis is in the midst of a busy deal-making season. In April, it agreed to pay $16 billion for the cancer drugs business of U.K.-based GlaxoSmithKline (GSK). In conjunction with that deal, Novartis sold its vaccines business to GSK for $5.5 billion and its animal health business to Indianapolis-based Eli Lilly for $5.4 billion.
- In India, Sun Pharmaceuticals in April bought Ranbaxy Laboratories for $4 billion from Japan’s Daiichi Sankyo.
- And French pharmaceutical company Sanofi is said to be keen to sell its portfolio of mature drugs, including those for blood pressure and cardio-metabolic diseases, for between $7 billion and $8 billion.
Driving the M&A rush is a desire by pharmaceutical companies to buy products aligned with their strengths, selling noncore businesses and replenishing their new drug pipelines. Buying overseas companies is an attraction for U.S. pharmaceutical companies like Pfizer as they look to save on taxes in relatively friendlier regimes such as the U.K. “This is about how industry players need to be positioned over the next decade,” Andrew Witty, CEO of GlaxoSmithKline, told CNBC. “You need to look forward 10 to 20 years rather than two or three years.”
Declining research and development productivity is the prime driver of most of the pharmaceutical M&As underway, says Mark V. Pauly, Wharton professor of health care management. “For the most part, this seems to me like rearranging the deck chairs more than major changes,” he notes. “Of course, it’s billions of dollars flowing hither and yon in the market, but a very large fraction of the new innovative activity in the pharmaceutical sector isn’t coming from these big firms. That is, in part, why they are doing all this rearrangement. They’re trying to recapture the magic.”
According to Pauly, the current rush of M&A deals was “inevitable because R&D spending by the big companies wasn’t paying off.” He says the companies involved may use the acquisitions or divestitures as an occasion to cut their head count of researchers. “It looks like the old pharma model of a giant company funding a very large research operation has now been eclipsed by more productive research going on at smaller companies and biotechs,” Pauly adds.
Several of the “rearrangements” are attempts by the big pharmaceutical companies to restock their pipelines by buying or merging companies that have a relatively richer mix of new ideas, says Pauly. “The big companies are still quite good at shepherding good ideas through clinical trials and then marketing it. Small companies either don’t have the capabilities or the resources to do that.”
Wharton emeritus professor of management Lawrence G. Hrebiniak says the current rush of M&As in the pharmaceutical industry is a response to the failures of previous business models. He recalls that the industry in earlier years invested heavily in R&D, with disappointing results. Then, over the past decade or so, the large pharmaceutical companies looked at M&A as a route to acquire smaller biotech firms. “But they focused haphazardly, buying firms with no real underlying logic.”
Pfizer, for example, has grown in the past decade through a string of big-ticket mergers. It bought Warner-Lambert in 2000 for $90 billion, Pharmacia in 2003 for $60 billion and Wyeth in 2009 for $68 billion. As a result of those mergers, Pfizer found itself saddled with some businesses it didn’t want. In 2006, it sold brands, including Listerine and Sudafed, which it inherited from Warner-Lambert, to Johnson & Johnson; three years after buying Pharmacia, Pfizer closed down its cancer drug manufacturing facility, Sugen, in Redwood City, Calif.
While the industry is still pursuing M&As to replenish drug pipelines, Hrebiniak notes that the strategies are different this time around. “They are focusing on their strengths and capabilities, and you see a lot more divestitures, asset swaps and acquisitions,” he says. “This is a way of saying, ‘We can’t be all things to all people, so let’s focus on what we do well.’”
The bunching of patent expirations on major drugs has coincided with an industry-wide decline in R&D productivity, adds Patricia M. Danzon, Wharton professor of health care management. R&D productivity fell because treatments for “easy diseases,” such as statins for cholesterol and anti-ulcer drugs, already existed and had been on the market long enough to spawn generic versions.
“New R&D had to come up with either a significantly better way of treating existing diseases or be able to treat the diseases that remain untreated. They [remain] untreated precisely because they are hard to treat,” Danzon points out, noting that examples of tough-to-treat conditions include cancer, diabetes and Alzheimer’s disease. “It’s an extreme version of the low hanging fruit problem: The easy things have been done, and things that remain to be done are hard.”
Critics have pointed out that R&D has been a casualty of big-ticket M&As because the combined companies tend to cut research budgets and staffing. However, Danzon does not see that as a reason for declining R&D productivity. She says the evidence does not suggest that bigger R&D departments have higher productivity. Indeed, some pharmaceutical companies have tried to break up their R&D organizations into smaller units to get away from the bureaucracy of big departments and to create the nimbleness of small biotech firms. Danzon, howver, says there isn’t much evidence to support that strategy, either. Overall R&D spending within the industry has not suffered much because of M&A consolidation, she notes, since many small and mid-sized biotech companies have grown and are, to some extent, replacing the research cuts at the larger companies.
What does all this mean for the patient? Danzon says patients eventually benefit as drug companies chase new drugs, cost savings and increased R&D productivity. “The general search for efficiencies is good news for patients and from a public policy perspective.”
Consumer Products vs. Prescription Drugs
All companies in the pharmaceutical industry are “under significant pressure to be more efficient and reduce costs,” Danzon notes, adding that many of the pharmaceutical M&A deals of earlier years have been successful at achieving that financial savings.
“Several of the acquisitions [in earlier years] occurred precisely because the companies — oftentimes, both companies [involved in the deal] — were at a point of weakness,” she says. “A lot of the big consolidations have been a response to patent expirations, big losses of sales and the need to improve net revenues aggressively in the short run. The strategy for doing that was do an acquisition and take out a lot of the cost.”
In the case of Pfizer’s now-abandoned pursuit of AstraZeneca, Danzon says the main motivation was to gain cost savings from the elimination of duplicate capacity and personnel. In such acquisitions, the short-term cost savings by eliminating such activities can amount to between 10% and 15% of existing costs, she adds.
Tax savings was also a big attraction for Pfizer in its AstraZeneca bid. Pfizer had some $69 billion in untaxed cash reserves overseas as of March 2014, according to Bloomberg data. “If Pfizer brings the money into the U.S., it will get killed, tax-wise,” Hrebiniak notes. Media reports say Pfizer planned to finance its AstraZeneca purchase with some of those cash reserves.
Merck will benefit in two ways from the sale of its consumer division to Bayer, according to Danzon. In addition to the cost savings in removing overlapping functions, Merck also exits the consumer products business where it did not have a strong background or infrastructure. Merck came to own the consumer products division after its 2009 acquisition of Schering-Plough. Back then, Merck faced patent expirations on major brands – including its osteoporosis drug Fosamax and asthma drug Singulair — and Schering-Plough had a relatively stronger branded drugs portfolio. Schering-Plough’s consumer products division included Coppertone skincare and sunscreen products and Dr. Scholl’s foot care line, but the business was merely a side attraction to Merck at the time of the deal — and eventually it became a distraction.
“[Selling] consumer products is definitely a very different activity than selling prescription pharmaceuticals,” Danzon notes. “It is fairly natural that [Merck] is selling it off to a company [Bayer] that has a strong consumer division where there will probably be value created out of the synergies….”
In India, with Sun Pharmaceutical’s $3.2 billion purchase of Ranbaxy Laboratories, the latter’s depressed market valuation offered an attractive growth opportunity for the acquirer, says Danzon. Japan’s Daiichi Sankyo in 2008 bought a 64% stake in Ranbaxy for $4.2 billion, but problems followed soon thereafter, with the Food and Drug Administration banning the U.S. distribution of drugs produced in Ranbaxy facilities in India after discovering lapses in regulatory compliance. Ranbaxy’s problems with authorities persisted, leading up to last month’s sale. “Sun is on the ground in India and has experience in dealing with the FDA for the production of generics. The odds are it can turn things around,” Danzon states.
Become a Leader or Stay Out
The flurry of deals involving Novartis, GSK and Eli Lilly underlines a desire at each of those companies to either become a significant player in an industry niche or to vacate a particular vertical. “It is better to be number one, two or three in fewer businesses than trying to be the 8th, 9th or 10th player in major markets,” says Danzon.
Novartis’s sale of its animal health division for $5.4 billion to Eli Lilly made sense because the latter’s Elanco animal products division had a stronger presence in that business. Eli Lilly has said it expects to achieve annual savings of $200 million within three years. Alongside that transaction, Novartis sold its vaccines division to GSK for $7.1 billion and bought the latter’s cancer drugs portfolio for $16 billion.
Novartis entered the vaccines space with its 2006 acquisition of Chiron Corp. of Emeryville, Calif., “but they’ve never really had a big enough presence in vaccines,” Danzon notes. It makes sense to vacate the vaccines space where the existing major players are Sanofi, Merck and GSK. Manufacturing and marketing vaccines is also significantly different from manufacturing and marketing pharmaceuticals, she adds.
At the same time, Novartis happens to be “very strong in cancer,” Danzon points out. “GSK just didn’t have the strengths there.” Novartis already has a cancer drug, Gleevec, and the deal with GSK will bring under its umbrella melanoma drugs Tafinlar and Mekinist, which the FDA approved last January.
Focus is also the theme at Bayer. For example, Bayer in late 2012 bought Shiff Nutrition of Salt Lake City, Utah, for $1.1 billion to boost its vitamins and nutritional supplements business, notes Hrebiniak. Now, in buying Merck’s consumer products business, it has its eyes on products like allergy drug Claritin and nasal congestion drug Afrin. “In other words, [via the acquisition], Bayer is saying it is going to focus on the consumer products market,” he adds. The company was also in the race to buy Novartis’s animal health business.
Valeant Pharmaceuticals, which has its U.S. headquarters in Bridgewater, N.J., is also closely focused on skin care, eye care and related products, notes Hrebiniak. That explains its pursuit of Allergan, which makes dermatology and cosmetics products, including the popular Botox brand of anti-wrinkle treatments. As noted, after Allergan rejected Valeant’s $47 billion bid, the company raised its offer to $50.4 billion. Valeant has chosen to grow rapidly through the M&A route, and in the past four years has completed seven major acquisitions. In the past year alone, it completed two major purchases — eye care products maker Bausch + Lomb and Solta Medical, a maker of “medical aesthetics” products.
The so-called “herd instinct” is also at play, and that could send company valuations to unrealistic levels, Hrebiniak suggests. “Someone starts [the M&A cycle], and the others are afraid of losing out to their competitors. It’s like a tornado running through the industry.” A corollary of that frenzy is increased valuations for the companies being pursued and declines for firms whose acquisition overtures have been spurned.
For example, Pfizer increased its offer price for AstraZeneca from $99 billion in April to $106 billion in early May and again to $119 billion on May 18 before it gave up on the deal. Meanwhile, Pfizer’s share price has fallen from about $33 in early March to below $30 by mid-May. In the same period, AstraZeneca’s share price shot up from $66 to $73 before briefly crossing $82.
“The danger in all this, of course, is if you have too much [M&A] activity,” says Hrebiniak. “If you have an aggressive M&A strategy within the industry, then over time there is a loss in valuations.” When companies overpay for their acquisitions, shareholder value falls because [the firms] are not able to reap commensurate benefits in cost savings or synergies, he adds.
It is a risky strategy for U.S. companies to make acquisitions in the U.K. or elsewhere with the primary objective of saving taxes, according to Pauly. “Politics is unpredictable. We have one of the highest corporate tax rates of any developed country. What if — as many people, including me, have been suggesting — the U.S. lowered its corporate tax rate and shifted to some other, better tax to remove this distortion? If you go abroad to take advantage of lower tax rates than in the U.S., the U.S. could double-cross you by cutting its tax rate, or other countries could raise theirs.”
The potential shareholder value of a merger is also “destroyed” in many cases because companies fail to efficiently integrate their operations, says Hrebiniak, noting that the pharmaceutical companies involved in the latest M&A cycle must objectively confront some questions to ensure they are indeed on the right track: “Was the acquisition planned well? Does it make sense? Are we doing it knee-jerk because everyone else is doing it?”
The firms must also focus on integrating the companies’ operations, which includes “positive things” — like cost reductions and access to new drugs – but also potential negative ones, like layoffs, says Hrebiniak. “Some of the key words would be: good planning, solid integration, handling reputations, keeping an eye on valuations and just doing strategically those things that differentiate the company in the marketplace after the acquisition.”
Republished with permission from Knowledge@Wharton (http://knowledge.wharton.upenn.edu), the online research and business analysis journal of the Wharton School of the University of Pennsylvania