March 2014 Issue
For big pharma, 2013 was supposed to be a big year. To keep pace with the overall drug market, big pharma companies were expected to carry out a number of large, high profile acquisitions. However, in reality the year was something of a disappointment. A lack of significant investment from big pharma groups came despite a continuing need to close the widening revenue ‘growth gap’ expected to reach $100bn by 2015. The majority of acquisitions completed were of the smaller, bolt-on variety, or carried out by companies in rival sectors such as specialty pharma and big biotech. Indeed, according to data from EY’s latest report ‘Firepower and Growth Gap’, big pharma’s share of M&A transactions actually fell to a new low in 2013.
Furthermore, new drug approvals from the heavyweights of the sector were also surprisingly lacklustre last year. In 2012 the wider pharmaceutical industry witnessed a significant rise in new-drug approvals; however, in 2013 only 27 new products received approval from the US Food & Drug Administration (FDA). Although this number is on par with approval rates for the past decade, it did represent a considerable fall from the 39 approvals granted in the prior year. However, many of the new products approved last year did manage to demonstrate their potential to become blockbuster products with peak annual sales of more than $1bn. A further boost for the pharma industry has been provided by the FDA of late. The department has become much more efficient when it comes to reviewing drug applications. The FDA is now utilising a number of new mechanisms to help speed up the drug approval process.
In the big pharma sector, only half of the industry’s firms gained approval for new drugs in 2013. Indeed, many of the companies that were rebuffed in their attempts to gain approval were among the most desperate to replace the significant revenue that has been recently lost to generic competition. With 2014 unlikely to offer as many top-selling drugs, it is entirely possible that big pharma companies will continue to struggle for growth, according to EY.
In 2013, the total value of M&A deals was more than $85bn, according to EY’s data, representative of an increase of around 30 percent on 2012. However, big pharma accounted for a rather small amount of the overall total, with no single deal even approaching $10bn or above. In total, big pharma contributed less than $5bn of total M&A volume. By way of comparison, between 2010 and 2012 big pharma contributed 59 percent. Big biotech and specialty pharma companies contributed substantially to M&A activity in 2013, accounting for 80 percent of total M&A activity by deal value during 2013. Many big biotech and specialty pharma companies competed against, and often bested, the big pharma firms for growth driving assets during 2013.
“Big pharma accounted for a rather small amount of the overall total, with no single deal even approaching $10bn or above.”
M&A activity in the pharmaceutical, biotechnology and generic drugs sectors in 2013 was relatively steady. However, it would appear that the days of mega mergers are long gone, perhaps never to return, as the number of giant players in the industry has diminished. In total, last year 122 M&A deals were completed across the pharmaceutical sector – a drop of nine on 2012’s 131 deals. However, the value of deals completed in the first 11 months of 2013 rose to $115.7bn, compared with $101.1bn in the same period of 2012. “With strong shareholder returns and robust pipelines at a few companies, big pharma was largely absent from M&A in 2013,” said Glen Giovannetti, EY’s Global Life Sciences leader. “As they face significant growth challenges ahead, pharma companies will need to become more acquisitive, but the growing strengths of big biotech and emerging pharma are leading to both increased competition for deals and more expensive targets.”
Firepower
According to EY’s data, the ‘firepower’ of big pharma companies, or their capacity for conducting M&A deals, did increase in 2013 by nearly $100bn. Yet, despite the impressive increase in firepower, big pharma firms now face the dual challenges of higher valuations for attractive assets and lower purchasing power compared to competitors in big biotech and specialty pharma. The increase in big pharma firepower, however, is not due to an increase in cash balances or a reduction of overall debt levels; rather, it is the result of higher equity values in a booming stock market. Rising equity market valuations accounted for more than 90 percent of the growth in firepower in 2013. For the first time in three years, big pharma buybacks declined in 2013, another factor in the industry’s rising firepower.
While big pharma’s collective market capitalisation was up 25 percent in 2013, big biotech’s increased by 50 percent. The increase in big biotech’s market capitalisation was a result of markedly healthier balance sheets and continued healthy cash flows from previous industry restructuring. Firepower within the industry also grew by around 20 percent in 2013, climbing to over $1 trillion. This increase must be seen as a positive indicator for future M&A deals in the sector. Acquisition targets also saw their values rise considerably in 2013, a development which was no doubt partially responsible for the dearth of M&A deals over the last 12 months.
Big pharma’s growing firepower was clearly overshadowed by that witnessed in big biotech and speciality pharma. Growth of firepower in these sectors over the last 12 months is indicative of the greater competition for M&A deals faced by big pharma companies. In the 12 months to the end of November 2013, big biotech’s spending capabilities increased by 55 percent. Since 2006, firepower for big biotech has increased by 150 percent. Specialty pharma’s spending power did not increase by comparable levels in 2013; the increase in this sector was relatively modest compared with big biotech. However, specialty pharma firms made significantly better use of their existing firepower to complete deals.
The sector was more reliant on debt to drive its M&A deal volume in 2013, in contrast with big pharma and big biotech. As a result of these changes, big pharma’s share of total combined firepower declined from 85 percent in 2006 to just 70 percent by the end of 2013. Big biotech has been the main beneficiary of the shift in firepower over the last seven years.
In addition to the increased competition for targets from big biotech and specialty pharma companies, EY’s report also identified two further causes for big pharma’s failure to complete further M&A deals. First, shareholder returns have remained strong despite weaker top-line growth. In 2013, big pharma stocks were up 27 percent, dividends added another 4 percent and buybacks an additional 1 percent for an estimated 32 percent total shareholder returns. The second likely cause related to replenished pipelines improving organic growth prospects. A number of big pharma companies will have forgone M&A deals in the hope that they will restore growth via their current product pipelines.
Growth gap
For big pharma companies, despite efforts to drive growth forward, the estimated growth gap for 2015 will remain essentially unchanged at $100bn. According to EY, that figure could have grown significantly were it not for industry forecasts being revised downwards in 2013. Although there is likely to be some organic growth over the coming years, there will be a great deal of pressure on big pharma companies to help redress the growth gap by completing significant acquisitions as quickly as possible.
However, big pharma companies face a number of challenges to close the growth gap. While many analysts are calling for the major players to make transformative purchases in the coming years, this is often easier said than done. That the most attractive assets are currently priced at an all time high only serves to make the task of closing the growth gap even more difficult. In order to add long term value to their organisations, the industry’s most powerful companies will need to target the right assets at the right time. Due diligence will undoubtedly be as important for big pharma in the coming year as a robust target selection process. The high value of acquisition targets will mean that firms may also have to consider divesting assets in order to help complement their spending power over the next 12 months.
2012 was a difficult year for big pharma companies. The patent cliff led to a significant decline in sales. However, many companies expected 2013 to be a year of recovery, albeit modest. In reality, 2013 was another poor year for big pharma sales: aggregate sales for the industry are believed to have been down 1 percent on 2012 levels. Furthermore, global pharmaceutical growth in 2012 was just 1 percent, with a range of 3 percent to 6 percent expected between 2013 and 2017. All of these factors have also contributed significantly to the big pharma growth gap.
EY notes in its report that big pharma companies have been suffering from a ‘patent cliff hangover’. In the period up to the end of November 2013, total US prescription volume growth was 3 percent – an increase of 1 percent on 2012. However, all of the growth was registered in generics which rose 4 percent in 2013. Income lost to generics actually decreased in 2013; however, brand sales losing exclusivity over the next 12 months are expected to double to nearly $30bn.
Emerging markets have also been a difficult issue for big pharma in recent years. Although they saw growth of 12 percent in emerging markets in 2011, 2013 likely saw only single digit growth for big pharma. Although big pharma has struggled to grow in recent times, big biotech and specialty pharma have both experienced periods of substantial growth. Aggregate sales of the top 25 companies in these sectors are expected to reach $200bn by 2015, doubling big pharma’s growth gap.
Conclusion
M&A growth in the wider pharmaceutical sector is expected in 2014; however, for big pharma, much depends on how senior executives and management boards align their strategic priorities. In the modern pharmaceutical and life sciences industry, big pharma companies are facing increasingly stiff competition for the right deals. With high prices for acquisition targets likely to persist, it is imperative that big pharma companies rise to meet those valuations. In order to do so, some companies may choose to divest a number of non-core assets.
Big pharma companies must ensure that they have their houses in order over the coming year. If they are to close the growth gap and beat out competitors from other sectors for M&A deals, the right resources and processes must be in place or 2014 could be another lean year for big pharma.
© Financier Worldwide
BY
Richard Summerfield