Diagnosis merger – examining the mega M&A trend

The pharmaceutical industry has witnessed a huge wave of mergers and acquisitions (M&As) in the past decade. Historically, Big Pharma has been fighting with little success on various issues, such as patent expiry of blockbuster molecules, regulatory hurdles, generics competition and price pressure, under-use of resources and low R&D productivity. Significant opportunities in biologics - especially high-growth therapeutics like oncology, autoimmune and central nervous system (CNS) ones - are the key impetus for M&As in this industry. However, the real intention behind these mergers remains a question, as the past mergers have not yielded substantial value additions in terms of R&D productivity.

Additionally, these mega deals may lead to further M&A activity since some of the non-core units of the acquired or merged companies would need to be divested. In theory, mergers and asset swaps are expected to improve efficiency and productivity of the drug development process. Nevertheless, the integration process post-M&A has never been an easy task.

Better, faster, stronger

We are now witnessing another surge in M&A activity, with mega mergers in the pharmaceutical industry in particular resulting in further consolidation. However, this time around, Big Pharma companies are seeking to strengthen their core businesses and divest the weaker ones.

For instance, GlaxoSmithKline (GSK) has more or less shed its oncology business for $14.5 billion and in return acquired Novartis's vaccines business for approximately $7.1 billion plus royalties. It should be noted that GSK recently terminated its late-stage study of MAGE-A3 for cancer therapy due to poor clinical trial data.

Vaccines is a low-margin business; gaining scale is a critical requirement for GSK but is non-priority segment for Novartis. Similarly, Novartis will be able to consolidate its already strong position in the highly lucrative oncology business and pose a key challenge to oncology market leader Roche. Hence, this is a win-win deal for GSK and Novartis. Moreover, Novartis is divesting its rather weak animal health division to Eli Lilly for approximately $5.4 billion.

Much has been written about the changing revenue model of Big Pharma from the current blockbuster model. However, it must be noted that it is the blockbuster drugs that have contributed a very significant share of top and bottom-line growth for Big Pharma. The rising number of mega mergers only suggests that this model is unlikely to change in the near future.

However, there is a clear shift from small-molecule-based blockbuster model to biologics blockbuster. Monoclonal antibodies (mAbs) such as Rituxan, Humira, Avastin and Herceptin have already proved the blockbuster potential of biologics. Having realised the tremendous opportunity in biologics, especially in high-growth therapeutics such as oncology, autoimmune and CNS, there has been a surge in M&A activities in the pharma-biotech space. Antibody drug conjugates is another high-growth area. Additionally, manufacturing and commercialisation of biosimilars is challenging compared with small-molecule generic drugs. This ensures a lower generics threat for biologics.

Tax inversion

Another key reason for mega mergers is tax inversion. For example, Pfizer has been strongly - and thus far unsuccessfully - pursuing the acquisition of UK-based AstraZeneca, whose strong pipeline in immuno-oncology would help Pfizer increase its market share in this lucrative segment. It would also boost its footprint in emerging markets.

However the major reason behind Pfizer's move is tax inversion. That is, it intends to move its tax base to the UK, which has a much lower corporate tax than the US, thereby saving immensely on the income tax of its profits from markets outside the US. Although AstraZeneca has rejected Pfizer's offer twice, the reason for this seems to be a price negotiation tactic.

Another example is that of AbbVie's agreement to acquire Shire for about $54 billion this year. It must be noted that there is a clear lack of benefits to be gained on synergy in this potential merger. The product portfolio of these companies is quite different. The key rationale behind this move is tax inversion, whereby AbbVie would shift its tax domicile to the UK in order to save on paying US rates.

However, it must be noted that the US Government is likely to come up with measures to counter this strategy pursued by US-based Big Pharma companies. There is a possibility of the imposition of hefty penalties for such inversion deals.

Impact on employment

It must be noted that Pfizer's $68-billion acquisition of Wyeth in 2009 was due to Wyeth's strong biologics pipeline, particularly in CNS. However, Pfizer closed six of its 20 research facilities worldwide. Most of the large acquisitions or mergers from pharma companies have resulted in large-scale layoffs in the past, and this trend is expected continue in the future.

Similarly, the Canadian pharma company Valeant Pharmaceuticals is vigorously pursuing the acquisition of Allergan but is facing stiff resistance from the latter.

In August 2013, Valeant acquired Bausch & Lomb, a maker of contact lens solution and surgical devices, for $8.7 billion. One of the objectives of this acquisition was to save about $800 million annually, mostly from lower R&D cost through reduced use of human resources. Its ophthalmology business is also well integrated into the Bausch & Lomb division, creating a global eye-health unit. The potential acquisition of Allergan fits well into its already strong ophthalmology business.

Many Big Pharma firms are sitting on huge cash piles and are hunting for acquisition targets with promising drug pipelines - particularly those in biologics. Consequently, this has created a favourable climate for large-scale M&As in this industry. Biopharmaceutical companies companies with a strong drug development pipeline and low exposure to patent expiries are the most attractive M&A targets. Moreover, companies based in countries with lower corporate tax rates, such as the UK, the Netherlands and the Republic of Ireland, are potential acquisition targets.