Is COVID-19 changing the rules of the game for biopharmaceuticals M&A?

January 2021 | EXPERT BRIEFING | MERGERS & ACQUISITIONS

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Leading up to the coronavirus (COVID-19) pandemic, M&A activity in the pharmaceuticals sector was soaring, with $414bn worth of deals in 2019, an all-time high. With the onset of COVID-19, the pace and volume of M&A announcements have been rather muted.

What has changed and what will change?

The immediate impact of COVID-19 on biopharmaceuticals M&A, even as the sector continues to work overtime to find a preventive (and possibly curative) solution to the pandemic and restore the ‘health currency’ necessary to drive the broader global economy, is that processes have been stalled and there has been a definite ‘timing shift’.

M&A is a labour-intensive activity that requires a lot of diligence, evaluation and collaborative effort across several organisations, multiple negotiation meetings, site visits to assess physical assets, evaluating markets, sifting through millions of documents, and so on. Industry participants have adjusted to the reality of virtual meeting rooms and virtual data rooms. But the complete standstill of the first few months and the need for physical diligence for a few critical parts have caused the timing shift.

One M&A driver that has accelerated events has been the need to secure supply chains lines and de-risk dependence on China.

M&A, long a key lever for creating value in pharmaceuticals, will and should remain a big part of pharmaceutical companies’ strategies post pandemic. To assess how the rules of the game change with the lessons forced upon us by COVID-19, the logical steps would be to identify how: (i) business in general would be impacted; (ii) how value is created in every step of the process in biopharmaceuticals; (iii) how each of these steps could have an impact with the lessons learnt during COVID-19 (e.g., reducing the physical footprint, economic use of capital); and (iv) how M&A may play its part in the dual imperatives.

Historically, pharmaceutical companies have been motivated to pursue M&A for three core reasons: innovation, economies of scale and portfolio realignment.

Innovation is more critical to the big pharma ‘innovators’. Achieving economies of scale and realigning the portfolio to meet ever-changing market requirements are critical to both innovators and generics.

The innovation process

The whole innovation process in biopharmaceuticals is very fragmented. Many small compounds and processes, worked on in different far corners of the world, must come together to make one big successful drug. Scientific developments spark plenty of excitement. The upsides are huge – the pursuit of which attracts a lot of capital, scientific entrepreneurial talent.

Testing for new drugs and treatments requires rigorous work in laboratories and on animals before they are cleared for trials in humans. Even with all the computational tools and platforms available, exploiting efficiencies from previous research, human trials – spread over three phases of complex processes – could run up to a decade. The human body responds in unpredictable ways to medical interventions. Often it is very different from what a modelling exercise would predict. In some cases, the benefits are insufficient, while in others there are side effects and even death. Quite often, the causes of failure surface after a lot of time and money has been spent.

Trials are declared successfully only once the results are evaluated and approved by regulators, such as the US Food and Drug Administration (FDA) in the US, the European Medicines Agency (EMA), the National Medical Products Administration (NMPA) in China and the Pharmaceuticals and Medical Devices Agency (PMDA) in Japan.

The challenges do not end with a successful trial. The addition of bio to bio pharmaceuticals means that the treatment of human beings has transitioned from chemical sciences alone, to the even more complex science of biology. Biological therapies involve a complex logistical chain of manufacturing and administration to the patient. Manufacturing complexity ranges from – the preparation and purification of a customised drug taking place months of the administration event to the patient’s own cells being extracted, sent to the manufacturer for processing and then sent back to be administered to the patient.

Finally, and perhaps most important of all, health insurers or government health ministries must agree that these new treatments are substantially improvements over older treatments, and are therefore worth paying for. Those who pour years of scientific and clinical work, as well as millions of dollars, into converting revolutionary science into new treatments are at risk of hitting a wall at the end of it all. Health insurers and government health agencies have limited budgets, and therefore seek to limit prices regardless of the cost and time it took to develop the product.

Impact of COVID-19 on M&A

The nature of the innovation process will continue to prompt pharmaceutical companies to acquire smaller, more creative firms – inside and outside the industry – to gain new platform technologies, digital talent, and regulatory and policy expertise to accelerate the research & development process.

The need to limit the physical footprint is the second step in the value creation process. Clinical trials is one area with a high degree of human touch. Taking a cue from how timelines changed for COVID-19 vaccine approval, regulators could take a view that if the pre-clinical stage itself could throw up more convincing data, smaller clinical populations would be justified.

This is a definite trend and, if it plays out, can be attributed to COVID-19. The M&A impact of this would be a more intense focus on buying assets and platforms with cutting-edge capabilities in drug discovery, artificial intelligence and human bio modelling – tools that could generate data to convince regulators to allow reduced clinical populations, speeding up the regulatory pathway to product approval.

It is expensive to develop, manufacture and market biopharmaceutical products. It is imperative for industry players to find ways to cut costs, or to realise production, distribution or other efficiencies. As in other industries, acquisitions, mergers, joint ventures and strategic partnerships are effective ways for companies to make these kinds of financial and operational gains, quickly.

How might COVID-19 impact the value chain?

COVID-19 opened up the ‘cost savings’ versus ‘securing supply’ debate in the supply chain part of the biopharmaceutical sector. The paracetamol export ban imposed by the government of India (later overturned) caused a ripple in several countries at the peak of the pandemic.

The criticality importance of the supply chain surfaced like never before in strategic conversations. At a global level, it became clear that the manufacturing footprint is clustered in China and India, creating substantial risk. If this manufacturing footprint is not spread, the risk of non-supply will persist.

Every part of the of the supply chain is now being reevaluated through the lens of ‘strategic assurance of supply’, ‘cost-effectiveness’, and the opportunity emerging from governments seeking to maintain ‘stockpiles of strategic reserves’.

Furthermore, specific M&A opportunities could emerge from three specific issues: procurement, manufacturing and distribution.

Raw material procurement. The reassessment of products for which control over active pharmaceutical ingredients (API) supply has to be strategic priority versus cost optimisation, will see significant M&A activity and private equity interest.

Manufacturing. The ‘strategic priority versus cost optimisation’ debate will continue. The added dimensions would be: (i) a focus on automation and robotics – in addition to best practices from other industries being brought to biopharmaceuticals; (ii) acquisitions to enhance robotics and automation capabilities; and (iii) M&A to have manufacturing capabilities closer to markets – a requirement for some government stockpiling policies.

Distribution – from the plant to the patient. COVID-19 has severely tested the robustness of distribution. Geographies with fragmented distribution industries were tested in the early stages of COVID-19, spurring the consolidation process in the distribution industry in multiple emerging markets. The trend will create international growth opportunities for the big three distributors in the US.

Portfolio realignment

Portfolio realignment in the normal course, managing commercial pipelines in the face of the patent cliff, evolving therapy shifts and franchisee strengths will be key areas of focus. M&A will remain an active tool to manage these processes – filling in product gaps and divesting non-core assets to fill cash flow gaps and free sales force capacities.

What COVID-19 has changed is the ‘rerating’ of infectious disease – the area of early innovation in pharmaceuticals. In the period leading up to COVID-19, it was surpassed by ‘hotter’ therapy areas, such as oncology and neurology. Over and above the race to develop and make COVID-19 vaccines accessible, there will be an increased focus on developing capabilities in infectious disease. R&D dollars will be reallocated, we will see broad-based, cutting edge platforms around immunotherapy and, possibly, cell and gene therapy to tackle the infectious disease problem.

The last leg in the biopharmaceutical industry – the sale & marketing process – has seen possibly the most COVID-19-driven change. The move from in-person to digital communication will continue, and likely have a long-term cost containment impact. Every brand owner will continue to build and customise these tools for niche, specific needs. We are unlikely to see any ‘capability addition’ M&A of any meaningful scale in this area.

But, whatever the underlying drivers, M&A ambitions can only be fulfilled by the availability of capital.

Going forward, M&A buying capacity will come from two sources of capital: private equity (PE) and corporate buyers. PE (excluding venture capital) is sitting on $1.45 trillion of dry powder. Post-COVID 19, biopharmaceutical has become a focus even for non-specialist investors.

In general, companies with excess cash reserves pursue M&A as a growth driver more often. Right now, the top dozen global pharmaceutical companies have more than $170bn in M&A dry powder (or excess reserves) on their balance sheets – $76bn in excess cash and $94bn in debt capacity.

Historically, pharmaceutical companies have returned up to one-third of available cash flow to shareholders through buybacks. For political, economic and strategic reasons, this is unlikely to continue through the COVID-19 crisis. As a result, more capital may be available for investment in strategic or opportunistic acquisitions.

Rahul Saikia is head of global strategy at Rising Pharmaceuticals. He can be contacted by email: rahul_saikia@hotmail.com.

Rahul Saikia

Rising Pharmaceuticals