After a year of disappointment, news of a massive merger in what was once regarded as a key sector to stoke investor appetite has to be welcoming news. On January 4, Swiss pharmaceutical giant Novartis agreed to take full control of eyecare company Alcon in a deal worth nearly $40bn. Novartis will spend $28.1bn on raising its stake in the company to 77 percent, up from the 25 percent stake it bought from Nestle in 2008. It then plans to spend a further $11.2bn on buying the remaining 23 percent stake it does not own.
The acquisition is expected to help Novartis diversify its business away from prescription drugs. Several large drug companies have been eyeing acquisitions in other areas of healthcare as they begin losing patent protection of their own drugs. “The addition of Alcon will strategically strengthen our healthcare portfolio and our position in eyecare, a sector with dynamic growth,” said Daniel Vasella, chairman and chief executive of Novartis. He added that the two companies would be able to combine research and development operations, potentially saving them $200m over three years.
Even with the credit crunch, the pharmaceutical sector has been one area of massive investor interest. Between 1995 and 2009 an astonishing 11,207 deals took place in the sector, worth a total value of nearly $2trn. And mergers and acquisitions remain an integral part of Big Pharma’s strategy, contributing almost two-thirds of peer-set sales growth until 2014 according to market analyst Datamonitor.
The past decade has seen a wave of major M&A activity in the sector, from the creation of AstraZeneca and GlaxoSmithKline to the merger of Pfizer and Wyeth and Merck and Schering-Plough. To quantify how much sales growth has been driven by M&A versus how much has been self-produced through organic growth, Datamonitor analysed a 20-year sales dataset comprising 14 years (1995–2008) of company reported sales and six years (2009–2014) of forecast data. According to the data, Big Pharma’s sales were $84bn in 1995 and, based on organic growth only, are forecast to increase to $195bn by 2014. Furthermore, the analyst believes that M&A activity will lift 2014 sales to $381bn. As a result, between 1995 and 2014, M&A activity is expected to account for 63 percent of absolute growth. Datamonitor also notes that the mergers may help Big Pharma maintain its share of the total prescription pharmaceutical market.
Drug drug druggy
But the performance of some pharmaceutical and biotech company stocks has been mixed at best. G Steven Burrill, CEO of Burrill & Company, a San Francisco-based merchant bank specialising in funding for life sciences companies, says that the performance of some blue-chip biotech firms weighed down the sector’s performance on the stock market. He points out, for example, that both Amgen and Genzyme saw their share values decline and finish in negative territory to close the year down 1.7 percent and 26 percent, respectively. Amgen’s shares took a hit in the final quarter after the US Federal Drugs Agency said it wanted more information on the potential osteoporosis treatment Prolia. Genzyme shares were impacted as manufacturing problems slowed sales of its drug Cerezyme used to treat Gaucher disease.
“On the plus side, several companies saw their share values increase dramatically,” added Burrill. “Leading the charge was Affymetrix whose share value almost doubled, benefiting both from an improvement in its quarterly sales performances and a general resurgence of interest in genomics and tools companies during 2009.”
“The spectre of personalised medicine is gaining traction thanks to Big Pharma adjusting their business models from discovering blockbuster drugs to developing targeted medicines. Advanced tools to uncover genetic information will be central to this new strategy,” says Burrill. “The drive to slash the cost of genomic sequencing to $1,000 has also focused attention on advances under way in next-generation sequencing, which is one of the reasons why the share values of companies such as Illumina, Life Technologies and Helicos BioSciences, who provide various sequencing tools, performed so well during the year.”
Helping pad these gains was the dramatic year-over-year share increases of companies such as Human Genome Sciences (1,370 percent), Compugen (1,000 percent), Athersys (821 percent) and Targacept (524 percent), whose share values were driven by positive clinical trials data and/or the signing of lucrative partnerships with pharmaceutical companies.
Burrill also points to corporate fundraising levels as a positive indicator for the sector in 2010. He says that despite the tough economic environment, the biotech industry in the US raised, through public and private financings and partnerships, over $55bn in 2009 – setting a new record. “Partnering was on a tear through much of the year with the industry raising almost $37bn in total deal values – a record for the industry. With $55bn raised, this will go down in history as our industry’s largest financing year, albeit during one of the most difficult financing environments ever,” says Burrill. “The message is: when companies have to raise capital, companies do, even when the cost of capital is unfavourable.”
“It also reflects the urgency that Big Pharma’s place on accessing biotech innovation as their ‘patent cliff’ gets ever closer,” says Burrill. “The number of deals inked in the year is unprecedented. What did come as a surprise to many was that they did not acquire biotech companies at the rate that was predicted,” he adds.
Pondering property owners
As a wave of patent expiries on major products approaches Big Pharma’s shores, industry observers are calling 2010 the year of the patent cliff. Companies will continue to look for partners and purchases, both big and small, to offset the looming decline in sales.
Among the drugs facing generic competition this year are Pfizer’s Alzheimer’s treatment Aricept, Merck’s hypertension medicine Cozaar, and Sanofi-Aventis’ breast cancer drug Taxotere. And by 2012, several firms will have lost protection on their most lucrative products, including Eli Lilly (Zyprexa), Bristol-Myers Squibb and Sanofi-Aventis (Plavix), and AstraZeneca (Seroquel). Most critically, Pfizer will face competition on Lipitor, the cholesterol-lowering drug that raked in nearly $13bn in 2008.
Companies are using a range of tactics to stem the pending revenue drain. Last year brought three high-profile deals meant to buttress portfolios and pipelines: Pfizer paid $68bn for Wyeth, Merck bought Schering-Plough for $41bn, and Roche forked over $47bn for the 44 percent of Genentech it did not already own.
Yet even with this latest round of merger and acquisition activity, no single firm commands more than eight percent of the global prescription drug market, notes Burrill. “That would generally indicate that we have a ways to go on consolidation,” he says. “There’s definitely a couple of large M&A events left in Big Pharma,” agrees Simon King, senior analyst at Datamonitor.
King points to two companies that sat out the merger frenzy of the past decade. Managers at Lilly and Bristol-Myers focused on smaller biotech acquisitions and swore they were not interested in bigger deals. However, they are now the smallest of the top-tier players, and King sees a potential shift in strategy going forward.
Throughout the year, big companies will continue to mine the pipelines of small biotechs to help sustain growth. In a positive twist for Big Pharma, the challenging funding environment for small firms will create some bargains.
Burrill notes that 2009 turned out to be the second-largest financing year in biotech history. Still, gloomy markets meant that small firms, unable to raise cash from stock offerings or venture capitalists, were forced to accept less favourable terms from partners or acquirers. In 2010, those harsh realities will persist. Also this year, drug companies will continue to look to emerging markets for growth, Datamonitor predicts. In addition to India and China, where many firms increased their stake in 2009, Latin America, Central and Eastern Europe, and Turkey are to be important acquisition locales for Big Pharma.
In December last year GlaxoSmithKline (GSK), the world’s leading vaccine producer, said that it plans to outpace its rivals in the race to emerging markets as revenue from traditional Western pharmaceutical markets continues to slow. Abbas Hussein, London-based GSK’s head of emerging markets, said that the company will pursue acquisitions and alliances in the region, although he cautioned that targets are scarce and prices being demanded by some businesses are unreasonable.
Hussein said that GSK is focusing on a combined pool of branded generics, vaccines and traditional patented medicines to beef up its exposure to emerging markets, which currently account for 13 percent of group sales. “I think it’s very, very reasonable to say that my ambition is that we will beat the market growth rate,” he told reporters ahead of an analyst and investor briefing.
Healthcare information group IMS Health has forecast 13 percent to 15 percent growth in pharmaceutical demand in emerging markets over the coming decade, compared with just one percent to three percent for mature markets. For example, China’s domestic vaccine production market is expected to expand quickly in the years ahead as investors look to capitalise on the nation’s healthcare reforms and enhanced public awareness about inoculations.
Analysts expect that the country’s vaccine sector will grow, up to 25 percent annually, according to a report from Zero2IPO, a Chinese venture-capital firm. In 2012, the size of the market will reach “8bn yuan”, the report says. Attracted by the growing vaccine market, “investors from home and abroad will be piling into China”, said Zheng Yufen, senior manager for healthcare at the investment banking division of Zero2IPO.
Talk of foreign investment in the country’s growing pharmaceutical industry has already spurred rallying of some companies’ share prices. For example, at the start of this year shares of China’s Sinopharm Group jumped on fund buying fuelled by hopes for more merger and acquisition deals as China’s largest pharmaceutical products distributor moves to expand its revenue base. “We have a very bullish view on the stock as the company is in one of China’s booming, high entry barrier industries. More M&A deals are expected as it grows through acquisitions,” says William Lo, analyst at Ample Finance Group. “Since it is the market leader in this low-risk distribution segment of the medical industry, we don’t expect to see any competition from rivals and that also fits the appetites of many investment funds,” Lo says.
Reforming China’s healthcare
China is the world’s largest vaccine manufacturer, and most of the companies in the sector are privately owned. The local vaccine market has enjoyed strong growth worldwide, but vaccine sales accounted for only less than one percent in the nation’s healthcare industry, according to figures from CITIC Securities. “That number is comparatively low considering China’s large population base,” said Zheng.
Ongoing healthcare reform is giving the vaccine sector a boost because the Chinese government is expected to spend 26bn yuan on improving public healthcare services before the end of 2011. According to Zero2IPO, the gross profit rate for vaccine companies on average is 70 percent. But challenges do exist. “Compared with their foreign counterparts, Chinese vaccine makers lag behind in innovation and management,” Wang said.
Nationwide, China has over 40 vaccine manufacturers. Other than state-owned companies like Shanghai-listed Tiantan Biological Products and US-listed Sinovac Biotech, many of China’s vaccine makers are private and still small in size. “Money is their biggest concern when they plan to expand,” said Zheng.
Drug companies are battling to win a large piece of the pie as they look for substitute revenue in the face of increased competition for patented drugs in the US and Western Europe. Drug sales in emerging markets are expected to double by 2015 from the current $81bn thanks to a number of factors, including a high birthrate and a swiftly increasing middle class. “By 2020 you are looking at emerging markets in size being equivalent to the US market and the major five in Europe,” says GSK’s Hussein.
In 2009, a batch of international pharmaceutical firms entered the vaccine sector through mergers and acquisitions. In late 2009, Novartis International, the world’s sixth largest pharmaceutical company said it agreed to acquire an 85 percent stake in a Zhejiang-based private vaccine producer. And last year GSK wrapped up two deals in China to establish vaccine manufacturing joint ventures with two local firms committed to researching and developing vaccines in various categories. “We have great confidence in China,” says the firm.
Increasing GSK’s reach in the region would provide a key “third leg” to its existing US and European businesses, he added. Hussein said that GSK remained alive to acquisitions and tie-ups in the region following its purchase of assets from Bristol-Myers Squibb Co., Belgium’s UCB SA, and alliances with South Africa’s Aspen Pharmacare Holdings Ltd and India’s Dr Reddy’s Laboratories Ltd.
Hussein said that alliances were a “great way to go as you are sharing the risk, and it makes good financial sense,” while acknowledging they can be more complicated than a straightforward acquisition. GSK expects operating margins in the region to remain at current levels of around 35 percent of sales. But he adds that GSK is unwilling to pay over the odds for any potential deals. “I think the pace will continue,” says Hussein. “On the other hand, I think it’s fair to say there are very scarce targets and some of the valuations of the promoters are very unreasonable.”
Predictions for 2010
G Steven Burrill, CEO of Burrill & Company, a San Francisco-based merchant bank specialising in funding for life sciences companies, outlines his thoughts on what is likely to happen in the pharmaceuticals sector over the coming year.
Biotech consolidation to continue
The large universe of small public companies and private companies looking for venture capital will still face challenges as they try to find ways to extend their runway and stretch out their remaining funds. Expect to see further consolidation in 2010 although at a slower pace that we saw in 2009.
Capital
Over $15bn will be raised by US biotechs; partnering/M&A will again trump financings and in total $35bn will be raised. The industry’s market cap will grow from its present level of $350bn to $400bn, despite significant consolidation and attrition as valuation is lost through M&As. There will be significant funding available for public companies through secondary financings and registered direct offerings, especially after they report good news.
Partnering
To deal with their impending patent cliffs, Big Pharma will continue to keep a robust pace of partnering deals. Both Big Pharma and Big Biotech will compete for companies with advanced product pipelines, as well as important land grabs of technology. There will also be new players competing for technologies – such as major medical devices, instrumentation and healthcare IT companies, and even generics companies will be acquirers. The traditional sector lines of pharma, biotech, devices, diagnostics, healthcare IT, services, and generics/biosimilars will blur as we see converging technologies (and companies) responding to new market opportunities that present themselves as we move a system focused on treating sickness to one that seeks to maintain wellness.
Mergers & Acquisitions
Big Pharma consolidation will continue as these companies position themselves for the new market realities and competitive pressures from the generics world. Pharma will also start to adapt from a vertically integrated business model to one that reflects virtual integration. Companies will build dedicated business product units with their own management structures and decision making processes.
Healthcare reform
President Obama’s State-of-the-Union address in January reported on his new healthcare reform bill. The reform would stimulate ways to move the system from one based on cost to one based on value. Providers will look for ways to reduce costs by improving healthcare delivery and rewarding behaviour that promote healthier lifestyles. But most of the impact of this healthcare reform bill will be on reforming the insurance industry and who pays for a largely dysfunctional system. Healthcare reform II will begin immediately, trying to fix what still remains as a broken system.
