Bristol/Celgene Made Perfect Sense, But Doesn’t Promise Big M&A Year, EY Says
Executive Summary
The conditions that produced a sluggish biopharma M&A environment in 2018 persist, with bolt-on deals like Lilly/Loxo more likely than another mega-merger.
Bristol-Myers Squibb Co.’s $74bn acquisition of Celgene Corp. doesn’t necessarily portend a hectic year of biopharmaceutical M&A, according to EY Global Life Sciences Transaction Leader Peter Behner, nor does Eli Lilly & Co.’s $8bn purchase of Loxo Oncology Inc. – but weighing transformational M&A versus bolt-on deals, he predicts more of the latter.
Interviewed during the J.P. Morgan Healthcare Conference Jan. 8, where EY released its 2019 M&A Firepower Report estimating the M&A capacity of the life sciences sector, Behner pointed out that the same factors that held down biopharma M&A in 2018 still apply. Potential buyers remain in hold mode due to what they perceive as high valuations for the available companies and assets as well as concerns about geopolitical uncertainties, such as the pricing environment in the US, he said.
If the stock market remains stable, the valuation situation will remain static for now, Behner said. “Therefore, high valuations, which were a reason [for M&A sluggishness] last year, are still a reason now,” he said. “Interest rates in the US have gone up, Europe is drying up its liquidity despite the fact that they haven’t raised interest rates yet. So, deals do get a bit more expensive, although it’s not dramatic. … That’s why we’re projecting that 2019 will be similar to last year.”
Still, EY’s projections are for one or two major biopharma M&A deals this year, and if a second of the magnitude of Bristol/Celgene occurs in 2019, the aggregate M&A numbers are fairly certain to rise, he conceded. Bristol agreed to pay $74bn to acquire the big biotech on Jan. 3, enhancing its oncology and immunology businesses and making it the seventh-largest biopharma company globally. (Also see "Bristol Values Celgene's Hematology, Immunology Portfolio At $74bn, But Does It Price In Risk?" - Scrip, 3 Jan, 2019.) It was the third-largest biopharma M&A deal by value in industry history, and Behner noted that another deal in that range would put the industry three-quarters of the way to last year’s M&A total of $198bn. (Also see "Bristol/Celgene A Record-Setting Merger, If It Happens" - Scrip, 3 Jan, 2019.)
But, the factors that made sense for a Bristol/Celgene combination might not easily be repeated in biopharma, he said. “There were in my opinion clear reasons why this deal made sense,” Behner explained. “Celgene’s stock price had come down dramatically, so the valuation argument was gone and the deal for these two companies seemed to make perfect sense. It’s like all the puzzle pieces coming together from a portfolio point-of-view; it strengthens both companies tremendously in my opinion, it creates significant scale for the combined firm in oncology and it catapults them to being the number-one or two company [in cancer] depending on which year you look at.”
Bolt-On Deals Likely The Norm Again In 2019
So for now, he cautioned, it might be best to view Bristol/Celgene as an outlier, while a smaller acquisition like the $8bn Lilly/Loxo deal might be more typical of what will occur in 2019 – though the oncology-focused acquisition would have been the sixth largest transaction of 2018. (Also see "Lift-Off For Lilly In Cancer Genetics With Loxo Buy" - Scrip, 7 Jan, 2019.)
In 2018, bolt-ons comprised 81% of deal volume and 43% of total deal value in the life sciences, EY reported. Of executives in its latest survey, only 3% cited a focus on major M&A in the coming year, while more than 70% said they hoped to make deals that offer product-focused innovations or portfolio optimization.
“I would say we’re off to a great start this year, but that doesn’t necessarily mean there’s going to be another mega-deal this year,” he said. “And if there isn’t another mega-deal this year, then we’re probably still in the [2018] window. Now, when you run around [this conference] and talk to people, there is rumor of a bunch of other smaller deals, bolt-on deals being in the hopper and probably coming in the next couple of days, so that’s all good stuff. But again, it would not indicate that this will be an exceptional year.”
M&A activity has declined since 2014 as a percentage of the industry’s firepower, according to EY, due largely to the concurrent increase in valuations for the kinds of smaller companies that typically get acquired. EY defines “firepower” as a company’s individual or industry’s aggregate capacity to do M&A based on balance sheet strength. Inclusive of big pharma, big biotech and medtech, the life sciences sector had a combined M&A firepower of $1.2 trillion in 2018, but used only 16% for M&A activity, the report states. In 2014, the life sciences sector deployed 27% of its firepower on M&A.
EY’s survey of 22 life sciences executives showed that 68% cited high valuations and 62% mentioned geopolitical uncertainty as the primary factors that held back large deal-making in 2018. Behner said “geopolitical uncertainty” is a vague phrase, but likely indicates concerns about the drug pricing environment both in the US and globally; the slowing down of the economy in China, now the world’s second-largest market for prescription drugs; and the potential complications of the UK’s pending departure from the EU, i.e., Brexit.
“When you look at the concerns that pharma executives have, number one is pricing,” Behner told Scrip. “That’s anywhere in the world. The US probably is the single-most important so clearly there’s that focus in the US, but it’s a global question. Most governments are concerned about this and talk about this, and pharma companies would rather talk about value than prices.”
China’s roaring economy, while still strong, is showing signs of cooling off and that poses worry for biopharma companies too since the second-largest market is also largely an out-of-pocket market for pharmaceutical products, he added. “An economic crisis or cooling would have an effect on people’s ability to buy drugs or pay for drugs, so that’s clearly another concern,” he said.
Therapeutically Focused Firms Do Better In General
Another finding of EY’s report was that of the 25 largest biopharma companies, those that are more focused – meaning they derive 50% of sales or more from one therapeutic area – perform better on classical financial measures than unfocused companies.
For this reason, Behner thinks Bristol’s buyout of Celgene has very strong rationale. EY sees Bristol, despite its pioneering position in immuno-oncology, as lacking therapeutic focus and strong growth prospects. Celgene, meanwhile, should bolster the pharma in both areas, adding its hematology portfolio and bolstering a combined pipeline that should offer six new approvals in the next 12-24 months.
Since 2014, according to EY’s research, more-focused biopharmas have enjoyed 40% EBITDA (earnings before interest, tax, depreciation and amortization) growth on average, compared to 28% for unfocused companies. The five-year compound annual growth rate is 14% for the focused entities and 2% for the unfocused, it found, while return on investment saw a five-year average of 14% for focused companies and 3% for unfocused ones. Meanwhile, valuation as measured by enterprise value to revenue multiple was 5x for focused companies, 4.1x for unfocused companies.
EY sees the best rationale for major M&A for Eisai Co. Ltd., Boehringer Ingelheim GMBH, Sanofi, Merck & Co. Inc., Novartis AG, Astellas Pharma Inc., Pfizer Inc. and Daiichi Sankyo Co. Ltd.. Pfizer is often at the center of M&A speculation, but incoming CEO Albert Bourla reiterated during a JPM talk on Jan. 7 that it is not seeking such a transaction. (Also see "J.P. Morgan Notebook Day 1: Pfizer, Gilead, Alnylam, Novartis, Sarepta, Deal Trends And Cell Therapy Challenges" - Scrip, 8 Jan, 2019.)
For companies not in the low-growth/therapeutically unfocused “bucket,” EY says bolt-on deals make greater sense in the near term. “For the other buckets, we recommend the bolt-on deals,” Behner said, “always with the assumption that mega-deals are somewhat disruptive. It takes a couple of years to integrate, you’re losing a lot of talent, you eventually get re-focused in the market, there are all sorts of issues related to that. And the other impact obviously is that if you think about how valuations are high, then yields become diluted to your existing shareholders. If the market thinks you’re overpriced, consequently your stock price goes down, which is in fact what happened to Bristol.”
Bolt-on deals offer growth potential with lesser downside in terms of stockholder dilution, he said, making for safer bets. Companies with therapeutic focus and better growth prospects can look to these less-risky transactions for potential progress.