The future of M&A in the pharmaceutical industry: promoting or stifling innovation?
By Prof dr Walter Van Dyck and Prof dr Leo Neels; Vlerick Healthcare Management Centre
Source: Finance Monthly (June 2014)
In the research-intensive pharmaceutical industry, two rationales for M&A prevail. First, deals may be intended to provide access to target companies’ markets or innovative treatments R&D programs and, second, economies of scale could boost cost-efficiency. Both rationales lead to increased valuation of the merged company. The $119 billion takeover approach by Pfizer, the largest drug maker in the world, was resisted by AstraZeneca, another pharmaceutical giant and crown jewel of the UK-based life sciences industry at an offer representing a 45% premium over its share price before Pfizer made its move public. What went wrong and do we see a fundamental trend towards more or maybe different M&A activity in the pharmaceutical industry?
One of the reasons for the bid seems to have been that AstraZeneca’s innovative R&D program in cancer immunotherapy was jealously regarded by Pfizer. Meanwhile, in the past AstraZeneca was criticized for underperformance with regard to the cost-benefit-ratio of its R&D expenditure. Undoubtedly, quite a number of other aspects may have interfered – not the least Pfizer’s announced ambition to lower its corporate tax basis. In the turmoil of the failed take over-bid it is probably too early to write the history. The rejection of the high bid by AstraZeneca’s management reveals a strong confidence it can steer an independent course pursuing disruptive and captive therapeutic markets toward higher company valuation. That is clearly the position of AZ, that now carries the burden of proof vis-à-vis its shareholders.
With biomedical research becoming more and more complex, M&A activity could, in theory, provide the much needed critical mass for conducting innovative drug R&D programs. A recent study indicated a typical drug innovation programme to last 13 years yielding a capitalized cost of $1.8 billion[i]. Including early front-end research and sales & marketing it is accepted to be in the range of $3 to $5 billion. Most of this budget is required for the clinical development stages closest to market launch and for subsequent marketing in global markets. In these clinical phases, drug candidates are being tested across the globe, in trials that recruit more focused groups of patients, but with a growing number of patients involved as well. On top, these trials require efficient teams of experienced medical, regulatory , data management and other scientists. But what does practice tell us? Does M&A outperform organic growth building this critical mass? Very recently, John Plender was highly critical in the Financial Times, mentioning the Pfizer syndrome’ of ‘uncreative’ destruction spending $240 billion on three big acquisitions in the past 15 years leading to its present modest market cap of $185 billion[ii]. The critical analysis may partially rest on a feeling of British pride, but he does have a point that the decade of debt-funding that is required by the long and complex drug development process is hardly aligned with quarterly reports for investor relationship management.
Asset swaps are the latest fashion in big pharma M&A to build critical mass and more is probably to come in an industry that may have carried too broad therapy portfolios in the past. Swap-based M&A’s allow a drug company to focus on its forte, which provides them the depth of know-how required to tackle the huge scientific complexity involved. And of course, it makes markets more oligopolistic, reducing competition in these post-merger markets. The recent GSK – Novartis M&A swap deal in which the former traded its oncology business for the latter’s vaccine business to each become world-leading in their therapeutic area is a case in point. And they are not alone in their quest for increased focus and critical mass. Bristol-Myers Squibb sold its diabetes drugs business to AstraZeneca, which considers selling its neuroscience and infectious diseases franchises[iii]. Furthermore, the industry has already focused by drug companies having recently sold of their animal health divisions or by creating their own generic product companies. To the latter, the rumor is out that Pfizer could separate as early as 2017 its generic and innovative drug businesses[iv].
M&A involving innovative drug programs can only be successful if both bidding and target company have a clear joint interest and strategy. In the failed Pfizer – AstraZeneca bid the latter target company estimated that the planned merger would lead to the typical job cuts, loss of accumulated expertise and an ensuing negative impact on research and development productivity of the merged company. In contrast, instead of being used at least in the perception of the target company as a blunt weapon to buy critical mass and access to a disruptive and captive market, an M&A-based asset-swap solution is clearly in the interest of both parties. It enhances both their critical masses in their respective strategic strongholds.
Critics may claim that the resulting industry concentration will eventually stifle innovation while leaving no more room for competition, hampering diversity, leading to loss of creativity. At least the Novartis post-swap case shows this does not have to be true. Although already being one of the biggest oncology companies in the world the deal will allow them to better hunt for advanced combination therapies required to deal with the extreme complexity characterizing this scientific field of cancer research. Mixing and matching both companies’ background intellectual property (IP) increases the potential for breakthrough therapies well ahead of competition. Needless to say that this joint foreground IP generation will only happen in a climate of trust in the post-merger company, probably hard to be found after a hostile take-over.
We do follow the critics’ reasoning in the front-end of the targeted medicines research process where nowadays the onus is on academia and small biotech to come up with biomarkers and discover early drug leads. Given the previously mentioned long lead times and high capital needs to develop and market a drug following its discovery, this remains the exclusive territory of the large biopharmaceutical firms having the critical mass required to develop and market drug-based therapies. We believe that competition for ideas and hence innovation promotion is assured in the emerging biopharmaceutical industry structure; an open innovation-based ecosystem composed of a large amount of small creative, often university-connected biotech and medtech companies being connected to a limited number of large biopharma players. Having invested in the absorptive capacity to evaluate and select innovative ideas, the latter set up co-development collaborative arrangements leading to at least the option to in-license drug leads, scale them up and bring them to captive global patient markets.
Given the high risks involved and the still very long time to market in pre-seed and seed stages front-end biotechs limit their growth risks by engaging early in collaborative deals or M&A activity with holders of complementary assets. In Oncology, one of the largest and fastest growing therapeutic areas in terms of drug development 73% of drug candidates fail in clinical Phase II, even when partnering. In the last two decades only 8% of drugs tested reached US or EU markets[v]. To hedge for this risk, Swiss-based Roche acquired Genentech for $4.8 billion in 2008 but kept it at arms-length distance probably for fear of stifling innovation. M&A in the front-end does also happen amongst players of comparable small size but possessing complementary assets. The joint interest is in the creation of a merged company providing access to each other’s complementary capabilities offering a faster and safer growth path to becoming a fully integrated biotech company, known as FIBCO. As an example, typically one biotech company possessing a disruptive technology merges with a comparable size biotech that has already launched a product and hence has regulatory and product development know-how to successfully launch and market a product. Or, in an era of targeted medicines a small-sized therapeutic agent-based biotech may merge with a diagnostics-based biotech to eventually market a personalized drug-based solution.
Summarizing, in the back-end of the biopharmaceutical ecosystem the M&A rationale is based on providing critical mass through increased focus and ensuing de-prioritization. In the front-end it is used as a method of growth through complementarity. So, the robust M&A-activity in the life sciences sector could be an indicator of the fact that different tectonic plates are simultaneously moving in different directions. Admittedly, straight take over-bids have been around in the pharmaceutical sector since long, but nowadays we saw the biggest pharmaceutical company in the world fail in an attempt to repeat the known scheme. We also saw more sophisticated acquisitions, suggesting a more fine-tuned M&A approach based on rationales that are contingent upon the location in the biopharmaceutical ecosystem. Hence, M&A as a concept used by the pharmaceutical company of the next generation, if well applied will not stifle but promote innovation much needed by society.
[i] Paul, S. M., Mytelka, D. S., Dunwiddie, C. T., Persinger, C. C., Munos, B. H., Lindborg, S. R., et al. (2010). How to improve R&D productivity: The pharmaceutical industry’s grand challenge. Nature Reviews Drug Discovery,
[ii] Plender, John (May 13, 2014) ‘Politicians have the treatment for Pfizer syndrome’,
[iii] Mullard, A. (2014). Large drug firms narrow their therapeutic interests. The Lancet, 383(May 31), 1873.
[iv] Mullard (2014), ibid.
[v] Thomson Reuters (2013) RECAP Therapeutic Areas Insights: Oncology Deal Making & Development Trends 2008-2012