Managing M&A in the biotech and pharma sector
May 2015 | TALKINGPOINT | MERGERS & ACQUISITIONS
FW moderates a discussion on managing M&A in the biotech and pharma sector between David Schechner, a managing director at Baird, Gemma Descoteaux, a shareholder at Polsinelli and Graham Robinson, a partner at Skadden, Arps, Slate, Meagher & Flom LLP.
FW: Could you provide a brief overview of M&A activity in the biotech and pharmaceutical sector over the last 18 months? Have any particular deals caught your eye?
Schechner: M&A activity over the last 15 months has been robust. In comparison to 2013, the number of transactions increased approximately 25 percent in 2014, while the deal value of the transactions increased approximately 80 percent. In other words, the number of deals and deal size increased significantly in 2014. We are continuing to see these trends in 2015. One particular transaction that has proved noteworthy is Teva’s acquisition of Auspex for approximately $3.4bn, announced in March 2015. Auspex went public in January 2014 at a pre-money value of only $186.3m. This shows how M&A opportunities may be enhanced for a target by completing an IPO.
Descoteaux: M&A activity in the biotech and pharmaceutical sector has boomed over the past 18 months. Many of the recent deals have had an international flavour, largely fuelled by tax advantages of cross-border mergers. In fact, tax inversion transactions – deals where the buyer acquires a target in a country where the taxes are lower and takes on the residence of the target company thereby reducing its overall tax rate – have been one of the hottest trends in M&A generally, and particularly in the pharma/biotech sector. Buyers have been willing to pay a premium for inversion deals.
Robinson: Needless to say, M&A activity in the sector was robust in 2014. There were a few notably large transactions, some of which closed, such as Actavis/Allergan, and some of which did not, such as Pfizer/AstraZeneca and AbbVie/Shire. But the bulk of the activity remains acquisitions by large pharma/biotech companies of smaller companies that are developing innovative therapeutics. While the targets are smaller than the buyers, these can still be fairly large, multibillion-dollar deals. Targets with orphan drug programs continue to be a significant focus for many buyers.
FW: What were the key elements driving M&A deals in 2014? Were any regional hotspots identified and, if so, what does this tell us about future growth opportunities?
Robinson: Pharma/biotech M&A is largely driven by the availability of attractive targets. The venture capital funding cycle, as well as important innovations in medical science, have together produced a healthy number of mid-to-late-stage target companies for buyers. Meanwhile, chief executives and boards are increasingly confident, interest rates are low, and many buyers have significant amounts of cash – and, in some cases, a need to refill their sales force’s bags with new therapies. Still, there are some clear areas of focus for large pharma and biotech companies: orphan drugs, gene therapies and immunotherapy. Regionally, Boston has emerged as the leading market for biotechnology.
Schechner: In addition to momentum in the pharma/biotech sector, M&A transactions have been driven by the desire of large pharma and large biotech companies to be ‘best-in-class’ and ‘first-in-class’ in specific therapeutic categories. In order to create and maintain leadership in a specific therapeutic area, these large companies have been using significant financial resources to buy companies with unique proprietary technologies and assets. Acquirers have also experienced increases in stock prices and cash balances, which also fuel their acquisition activities. Currently, the cash balances-to-patent-expirations ratio for the pharma industry is approximately 3:1 in the aggregate. Thus, large pharma is in a strong financial position to complete acquisitions. In the specialty pharma sector, growth and synergies have been the drivers of consolidation.
FW: How do regional incubators fuel growth in this sector and what strengths do communities outside of Palo Alto and Boston need to foster to support these industries?
Descoteaux: Communities outside of Palo Alto and Boston can create similar environments by working with colleges and universities, local corporations and local governments to provide training and resources for growing companies. Regional incubators and accelerators that are focused on biotech and healthcare can enable innovation, as well as the transition from innovation to industry. For example, the BioResearch Valley Bio Corridor in College Station, Texas, near Texas A&M University, is designed to provide a ‘one-stop-shop’ for resources necessary for biotech research and innovation. The goal is to provide an infrastructure pipeline that facilitates the development of the next generation of products in the medical device, drug and therapeutic industries. The resources that are available include training and education, access to the Texas A&M Bioscience Business Accelerator, access to the Texas A&M Center for Innovation in Advanced Development & Manufacturing and other resources that enable preclinical evaluations and state of the art biopharmaceutical manufacturing. Access to capital is critical to fuelling growth and creating an environment for successful incubators. To create access to capital, and to supplement the already existing angel and venture capital funding sources, the Texas Legislature, at the governor’s request, formed the Texas Emerging Technology Fund, a $485m fund created in 2005 and reauthorised in 2007, 2009, 2011 and 2013. Kalon Biotherapeutics is a prime example of what has been accomplished in the Bio Corridor. Kalon was formed by the Texas A&M University System and the Office of the Governor of the State of Texas to develop state of the art capabilities for viral and cell culture vaccine development. Kalon was funded, in part, by the TETF. In December 2014, Fujifilm Diosynth Biotechnologies announced the completion of its acquisition of Kalon Biotherapeutics.
Robinson: Boston and the Bay Area both bring together large communities of scientists and doctors who lead new innovative companies, along with enormous pools of talent in clinical development, drug manufacturing and other key areas. There is a real network effect, where companies build on one another’s successes, and innovation breeds more innovation. In Boston, initiatives at Harvard Medical School to bring industry and academia more closely together have played a significant role in driving development in the region.
FW: Could a tighter regulatory environment in the US lead to tax loopholes being closed, and result in a drop in M&A activity? Or will tax inversions continue to be a major driver of cross-border transactions?
Robinson: While the regulatory environment continues to evolve, we see many of the factors which contributed to a high level of M&A activity last year supporting a robust market in 2015. Most of the past year’s M&A activity in this sector has been based on a strategic and financial acquisition thesis. Strategic cross-border M&A has been and will remain a vital portion of the M&A market.
Descoteaux: The Obama administration has clearly come down in opposition to tax inversions and continues to press for new legislation that would charge fees to companies that implement a tax inversion strategy. In addition, the US Treasury has implemented new rules that disfavour tax inversions and minimise their advantages in certain situations. Furthermore, shareholder activists have objected to tax inversions calling them unpatriotic. All of the aforementioned measures will likely continue to dampen M&A activity where the tax advantages were the primary driver behind the transaction. The tax advantages of these transactions resulted in a greater premium being paid for those transactions, which raised the expectations for sellers in the market regarding the values that they hoped to see.
FW: What capital sources are available to biotech and pharma companies at each stage of development? What are the markers for angel, then VC and the PE investment?
Schechner: The capital markets for biotech and pharma companies are very strong. Biotech mutual fund flows continue to fuel index performance and capital markets activity. In 2014, the Biotech Index finished its fourth consecutive year as the top performing major sector. Early stage companies are able to go public. For example, two Phase 1 and 10 Preclinical/Phase 1 companies went public in the first quarter 2015 and full year 2014, respectively. In addition, over 65 percent of pharmaceutical follow-on financings in the first quarter of 2015 were for companies that had gone public within the past 30 months. Thus, quality companies in all stages of development can be financed in the public markets. Angel, VC and crossover investors have also been very active in the private financing markets.
Robinson: Angel investments don’t play a significant role in biotech. The capital needs of biotech companies are too large, and the risks too high. Angel investments are mostly focused in technology spaces – software, web, media, and so on. Generally, the initial capital for biotech development often comes from VCs, but after that the sources of money evolve primarily based on market conditions and what is available. As such, CEOs have to be creative in finding the money needed to advance their programs. Biotech CEOs are great at finding capital from a multitude of sources, including more VC money, partnerships with big pharma/biotech, grant money, public markets and, in some cases, debt. The source of capital isn’t really tied to stage of development, but instead comes more from what is available for a particular company at a particular time.
FW: What advice would you give to acquirers on identifying targets and unlocking post-deal synergies?
Descoteaux: Companies should stick with what they know. They should focus on deals that are truly accretive, that make good business sense and that open up new markets. Are the target’s products compatible with the buyer’s existing product portfolio? Does the buyer have the right resources to ensure a successful new product launch? Does the buyer have the experience in the market that will enable it to strategically price the product? Companies need to have the right resources to accurately evaluate the target. Purchasing a biotech company today is somewhat reminiscent of investing in tech companies in the dotcom heyday. Biotech companies are generally losing money and are spending significant amounts to develop new drugs that are as yet unproven. Often, they are not yet even at the clinical trial stage and their value comes from an assessment, which in many cases is an educated guess, of the product’s potential and the market size – how large is the pool of potential patients and what are the potential sales? Companies need to have an accurate picture of the additional capital investment that will be required to fully develop the products that they are acquiring. A lot can happen on the road from the completion of a promising Phase I study to the successful completion of Phase 3. During Phase 3, the drug or treatment is given to large groups of people to confirm its effectiveness, monitor side effects, compare it to commonly used treatments, and collect information that will allow the drug or treatment to be used safely. It is only if Phase 3 is successful that the buyer will reap the rewards from the acquisition.
Schechner: The capital markets are rewarding acquirers for smart acquisitions. Some acquirers’ stocks have increased following acquisition announcements. In addition to orphan drugs, investors appear especially enthusiastic about transactions and investment opportunities in the following sectors: cancer, CNS, autoimmune, infectious disease, cardiovascular, pulmonary and ophthalmology. Option agreements have also increased over the past several years. In 2014, there were approximately 120 announced option agreements, which is the highest number of such agreements over the past four years. This trend appears to be continuing in 2015.
Robinson: For large pharma/biotech companies, their main strategic issue is deciding when to buy – whether to go early stage, paying less and taking on more development risk, or later stage, where there are lower risks but acquiring can be much more expensive. The right answer on timing is very specific to each buyer.
FW: What are some of the common due diligence and transactional risk management challenges that exist in this sector?
Schechner: Clinical and regulatory risks are significant challenges for the pharmaceutical industry. In addition, commercial risks, such as launching a new product upon regulatory approval, can be a daunting task.
Descoteaux: Since many acquisitions in this sector are speculative, the typical risk management techniques that are employed in other acquisitions are simply not effective. Fulsome representations, warranties and indemnities will not be particularly helpful to the buyer of a company with products in the early stages of development. There simply are no guarantees that the products will make it to market. Self help, in the form of due diligence, is a sophisticated buyer’s best tool. However, due diligence in this sector can be very expensive and time consuming. Further, targets are often reluctant to give the buyer’s experts and scientists access to sensitive and highly competitive information regarding technology advancements being made. The regulatory and intellectual property due diligence that should be done is extensive if a buyer wants to ensure that it fully understands the assets of the target and post-closing value that the target’s portfolio will bring and to identify risks to success. There is frequently internal tension within the buyer to minimise transaction costs, but the money spent doing full due diligence will pay dividends in the integration and execution phases. Keep in mind that the due diligence which tells a buyer why it should not do a deal is every bit as valuable as due diligence that tells it to proceed.
Robinson: For companies that have approved products, diligence into sales practices is typically very thorough. The buyer’s policies – and in some cases, commitments to the government – may require the buyer to manage the sales process differently than the target company did. If a target’s products are sold outside the US, FCPA diligence is also very important. For companies with pre-approval programs, clinical diligence is critical, and for biologics, manufacturing diligence will often be front and centre.
FW: What impact is the generics industry having on M&A activity among biotech and pharmaceutical companies?
Descoteaux: Generic versions of a drug can cost substantially less than the original drug, in some instances as much as 80 percent less. And the speed with which a generic can capture market share continues to accelerate. As we all know, the composition of a target’s product portfolio drives its valuation. If the target has products that are approaching the introduction of a generic version in the near term, buyers are factoring that into the price that they are willing to pay for the target. Buyers look for targets that have a robust R&D pipeline that is likely to offset aging products, or other clearly identifiable value adds, such as a specialised sales force that could be used to sell other products of the buyer into a new market or needed manufacturing capabilities or a specific technology that would have other applications beyond the current product lines, before deciding to do the deal.
Robinson: Generics and branded are really two different sectors, as one doesn’t really affect the other. Interest by branded companies in having a generics business has led to M&A, as branded companies have acquired generics companies. There may be a bit more focus on biosimilars – a generic-like version of a biologic – in 2015.
Schechner: The generic industry and the biosimilar initiatives at some companies are causing large pharma and large biotech companies to be more careful in their considerations regarding M&A. As in the past, patent life is critical to assure enough time to recoup the significant investment required to develop a drug. The robust activity in the generic sector keeps pricing and payer receptivity critical factors in pharma M&A activity.
FW: Do acquirers give enough consideration to how research, development and technology activities will be integrated into the merged concern? To what extent can underestimating these issues have a detrimental effect on long-term performance and value?
Robinson: Where an acquired company has important pre-approval programs, large pharma/biotech companies sometimes find it hard to retain the target company’s talent post-acquisition. With private targets, sometimes the deal terms can incentivise retention, at least for a while. But in most cases, the buyer has the capability to manage the remaining development of the acquired programs. In fact, in many cases the buyer would prefer to manage the late-stage development itself.
Descoteaux: Some buyers value a rich R&D pipeline and value internal development of new products and product evolutions. Other buyers prefer to keep their powder dry to purchase promising new products that are being developed by smaller pharmaceutical companies who are able to focus their energies and talents on a particular drug or therapy. Failure to have an R&D strategy, whether it be a buy strategy or a development strategy, can negatively impact the bottom line, particularly when highly profitable products approach the introduction of a generic and there isn’t a replacement ready in the wings.
FW: With post-merger integration and divestitures cited by corporate board members and CFOs as a leading concern over the success or failure of an M&A transaction, what steps can companies take to achieve a strong cultural fit and maximise value?
Descoteaux: First of all, companies should employ what I refer to as ‘belly-button accountability’. They should establish clear accountability at the buyer and the target for each area of integration. That accountability should belong to an individual person, a belly-button that the integration manager can push on when something is falling behind schedule or issues pop up. There should be no doubt as to who had the responsibility for the task and the timetable for the task to be accomplished. Equally, firms must ensure that they communicate. Be as open as you possibly can be with the target’s management. Fear of the unknown will frequently cause people to behave irrationally. If their jobs are safe, let them know that. If there will be consolidations and reductions, make them quickly. If there are specific expectations regarding performance, profitability, product line synergies, and so on, be sure that all members who are involved are informed. If the team doesn’t have the playbook, they can’t possibly advance the ball up the field. It is also important that companies carry out detailed due diligence procedures. It’s painful and expensive but necessary. Due diligence must be thorough and fully cover the products, the pipeline, the intellectual property, operations, sales and financials of the target. Much more importantly, however, and this is frequently ignored, the due diligence needs to include spending a significant amount of time with the management team to understand what motivates them. Acquirers must employ a dedicated team. The most successful acquirers are those who are serial acquirers with a dedicated integration and transition team that has processes that have been tried and found to be true over many acquisitions. They document their processes so that they can quickly integrate without reinventing the wheel. Heavy reliance on consultants can bridge a gap in staffing, but is not a substitute for allocating full time internal resources to integration – people who have been with the buyer for a significant period of time, who understand its culture and who know the processes for getting things done. When a buyer tries to integrate a target using a team comprised of members who already have full time ‘real’ jobs, their attention to integration suffers, and no one benefits.
Robinson: For the bulk of M&A activity in this sector, integration tends not to be as much of a concern as it may be in other sectors. For very large transactions – such as the merger of two large drug companies – of course these issues are very important, but the remedy is likely the same as in any other industry: careful planning and very strong board leadership.
FW: How do you see M&A activity in the biotech and pharmaceutical sector progressing in 2015? Can we expect levels comparable to 2014?
Schechner: We believe we are in the ‘early innings’ of a robust M&A market in the pharmaceutical industry.
Robinson: Thus far in 2015, the high level of M&A activity in the pharma and biotech sectors has continued at the pace we saw in 2014. Absent significant changes in the economic and financial markets, we expect the trend of continued growth and consolidation in the pharma and biotech sectors to continue, sustaining the appetite for M&A in this space.
Descoteaux: We do not see any slowing in M&A activity in the biotech and pharmaceutical sector, particularly in the middle market. Smaller pharmaceutical companies with specialty products and robust R&D continue to be attractive targets for big pharma.
David Schechner is a managing director and Head of Baird’s Life Science Investment BankingGroup. Prior to joining Baird, he was a managing director at Goldman Sachs, Head of Corporate Finance at Needham & Company and Global Head of Life Sciences at Canaccord Genuity. Mr Schechner has represented large pharmaceutical and telecommunications companies in M&A transactions including NYNEX, Bell Atlantic, LIN Broadcasting, Wyeth, Warner Lambert and Pharmacia. Over the past eight years, Mr Schechner has completed over 95 M&A and equity transactions. He can be contacted on +1 (617) 426 5424 or by email: firstname.lastname@example.org.
Gemma Descoteaux represents buyers and sellers in public and private mergers, acquisitions and divestitures, participants in complex domestic, international and cross-border joint ventures and partnerships, providers and customers of outsourcing services, and companies who are in need of sound corporate commercial counsel in a wide range of industries, including technology, pharmaceuticals/biotech, health care, steel manufacturing, business process outsourcing, entertainment/news media, transportation and energy. She can be contacted on +1 (214) 661 5557 or by email: email@example.com.
Graham Robinson focuses his practice on mergers, acquisitions and other transactions in the pharmaceutical, medical device and technology industries in the US and internationally. He regularly represents public and private companies, as well as private equity and venture capital funds in acquisitions and divestitures, both negotiated and contested. He has significant experience advising companies in preparing for and responding to unsolicited acquisition proposals. Mr Robinson also advises companies in pharmaceutical and medical device collaborations, and issuers and underwriters in connection with initial public offerings and other corporate finance transactions. He can be contacted on +1 (617) 573 4850 or by email: firstname.lastname@example.org.
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