Clean Bill of Health
The Deal
by Thomas Zadvydas
Updated 02:07 PM, Dec-10-2010 ET
M&A activity has recovered from a two-year decline, and the healthcare industry is a driving force of the revival.
There have been 1,037 healthcare mergers announced year to date, according to a November M&A report from William Blair & Co. LLC, topped only by the computer and electronics (1,993) and business services (1,287) sectors.
The industry’s prominent return to the auction tables is a result of several conspiring factors. For starters, drastic healthcare reform in the U.S., coupled with uncertainty for much of the year about potential changes in the country’s tax code, have cast a pall over the biotechnology and pharmaceutical industries, pushing many companies to seek deals in order to adapt to an amorphous landscape. At the same time, looming patent expirations for compounds are driving many companies to go hunting for targets to fill holes in their pipeline. All of this is happening in a market still recovering from the worst economic downturn since the 1930s, leaving valuations restrained and obscured.
“We continue to see a lot of consolidation; you’re seeing big companies like Amgen Inc., Pfizer Inc., Johnson & Johnson to be actively looking in the market,” says Jones Day life sciences partner Jonn Beeson.
One driving factor is the pending loss of patent exclusivity on key drugs for many pharmaceutical companies. IMS Health Inc., which collects marketing data for the pharmaceutical and healthcare industries, says that more than three dozen drugs that produce about $137 billion in annual revenue are expected by 2013 to fall off the patent cliff, an apocalyptic term the industry uses to describe the coming end to the brand-name exclusivity that laws across the world grant their medications.
Pfizer is one big pharmaceutical company grappling with this issue.
“Everybody knows Lipitor is one of Pfizer’s biggest products. It’s a blockbuster [drug] and they’re losing patent protection soon,” says Gregg Blake, a managing partner at healthcare investment bank Brocair Partners LLC. “They’re buying King Pharmaceuticals Inc. in order to bring in a bunch of new products and also diversify a little. King has a drug delivery business with injectibles and also an animal health business.”
Lipitor, which generated $13 billion in sales in 2009, falls off the patent cliff at the end of November 2011. Blake explains that sales of a drug can crater by as much as 90% in a year after a patent is lost and generic alternatives enter the market.
Pfizer announced an agreement on Oct. 12 to buy Bristol, Tenn.-based King Pharmaceuticals for $3.6 billion cash. About one week later, on Oct. 20, the New York pharma bought a 40% stake in Brazil’s Laboratório Teuto Brasileiro SA for $240 million in an effort to expand its presence in both an emerging economy and the generic drugs market. Meanwhile, Pfizer has also placed its Capsugel hard capsules unit on the auction block, a move that could portend other noncore divestitures by the conglomerate, analysts say.
“They’ve made a big strategic move into generics over the last 20 years,” says Blake of Pfizer. “A lot of other big pharmaceutical companies are diversifying that way too.”
Adding drugs new to the market, or even drugs in the late stages of development, through acquisitions also allows pharmaceutical companies to sidestep the long and arduous process of developing drugs from scratch, a costly undertaking that can take years, with no guarantee that the drug will ever reach the market, let alone become a financial success.
“At the end of the day, pharmaceutical companies are finding that it is cheaper to buy than to just research,” says Alden Philbrick, chief executive of Oxford Finance Corp.
Gregory B. Brown, a managing director at Cowen Healthcare Royalty Partners, a healthcare private equity firm affiliated with Cowen Group Inc., agrees, adding that many pharmaceutical companies face increasing shareholder pressure to find cheaper, safer, alternatives.
“It’s an industry that has been acculturated or accustomed to taking capital that’s generated from product revenue and plowing it back into research, but shareholders today are saying, ‘Wait a minute, there may be a better way,’ ” Brown says, referring to the increase in M&A.
Expanding drug offerings via M&A to appease shareholders is no sure bet, of course. Consider the plight of San Diego-based Cypress Bioscience Inc., which in September put itself up for sale after rejecting a sweetened $4.25 per share bid from shareholder Ramius Value & Opportunity Acquisition LLC. The affiliate of New York hedge fund Ramius LLC, a 9.9% shareholder, on July 19 offered $4 per share, then a 60% premium over Cypress’ share price, complaining that management had destroyed the drugmaker’s shareholder value. Specifically, Ramius deemed Cypress’ purchase of Proprius Pharmaceuticals Inc. “a complete failure,” one that cost the company $40 million while generating less than $600,000 in revenue. Lagging drug production at Cypress was also a concern of Ramius. Two days before rejecting the hedge fund’s first bid, Cypress said it would discontinue its co-promotion of the Savella drug with partner Forest Laboratories Inc. (Ramius raised its bid for Cypress to $5.50 per share on Friday.)