Firepower and growth gap report 2015: Focus, scale and growth drive explosive M&A
Record biopharma M&A exceeded US$200 billion in 2014, well over twice the average annual deal volume seen in the last decade, as companies used deal making to satisfy the strategic imperatives of adding focus, scale and/or growth. A convergence of forces fueled the fireworks, including increasing equity valuations, historically low interest rates and prodigious firepower.
Big pharmas, largely absent over the past few years, played a bigger role in 2014’s pyrotechnics, spending nearly US$90 billion on M&A to close — or attempt to close — “growth gaps.” (See box for definition.)
However, the lion’s share of big pharma deals that transpired were primarily sales and purchases of operating divisions. (Had two transformative acquisitions — Pfizer’s bid for AstraZeneca and AbbVie’s take-out of Shire — moved forward, big pharma’s growth gaps would have narrowed.) Importantly, the intra-pharma transactions that occurred were well received by the market. As a result, valuations rose and boosted firepower.
In prior editions of this report we predicted that specialty pharmas would be bigger acquirers thanks partly to the tax-efficient strategies at their disposal. We also noted the tremendous growth trajectories of big biotechs, which collectively have continued to introduce innovative products.
In 2014, we saw both those forces in action, bolstering the firepower of specialty pharmas by 42% and big biotechs by 30%. However, while big pharmas continue to have the most firepower (in absolute dollars), in aggregate, their firepower increased only a modest 12% year-over-year. As a result, their share of total firepower fell for the fourth straight year to a new low of 66%.
As the exhibit below shows, superior growth has delivered superior returns. Over the past five years, biotechs and specialty pharmas delivered cumulative growth that was more than five times that of big pharma and provided total shareholder returns of 257% and 332%, respectively. In the same five-year period, big pharma’s total shareholder returns increased 116%, which was roughly in line with the major averages and made the sub-sector a safe haven during the recent financial down-turn.
However, looking ahead to 2017, big pharma’s projected annual growth rate remains anemic, at just over 1%. Through that year, the big biotechs and specialty pharmas in our data set are projected to enjoy double-digit growth while the majority of the big pharmas we track continue to underperform the industry in terms of revenue growth. Their growth gap is estimated to be US$100 billion in 2017.
As market valuations for target companies continue to increase, big pharmas with significant growth gaps must reinvigorate their deal-making strategies, leveraging divestitures, bolt-on acquisitions and more creative structures to build comprehensive franchises in therapeutic areas where they are, or can be, market leaders.
The outlook for 2015
We expect 2015 to be a year of robust and highly competitive M&A activity in the biopharma industry, marked by a continued rise in deal premiums. This will be challenging, especially for some big pharma firms still in need of acquisitions to meet market growth expectations.
As M&A competition across the sector continues, big biotechs and specialty pharmas now have the capacity to do the kinds of major acquisitions that were mostly within the grasp of only big pharmas just a few years ago. There is now a scarcity of targets that can offer a meaningful impact on closing revenue growth gaps.
We also anticipate that “focus” will remain the operative word in deal making in 2015, as companies concentrate resources in core markets where they can achieve a sustainable competitive advantage. The moves made by many big pharma companies in 2014 to divest their non-core assets and create more strategically-focused businesses have bolstered their firepower to compete for attractive acquisition targets.
However, companies must reinvigorate and expand their deal-making strategies in order to become market leaders. Nevertheless, companies enter 2015 with bolder aspirations and a continued emphasis on therapeutic focus and/or adding scale.
The four factors likely to impact M&A in 2015 and beyond are:
- Growth still matters: Continued stronger shareholder returns from biotech and specialty pharma, combined with overall market growth projections, are expected to put additional pressure on the many big pharmas with growth gaps to do deals in 2015.
- Higher premiums likely to persist: Greater competition for high quality growth assets due to the strong buying power of both specialty pharma companies and big biotechs means high valuations for target companies will continue into 2015.
- More focused deal-making likely: Given the high premiums expected for attractive assets in 2015, transformational M&A will be an option only for a select few. As a result, big pharma companies may continue pruning portfolios, while pursuing bolt-on acquisitions, to develop – or maintain – critical mass in key areas.
- Shareholder activism on the rise: Shareholder activism is increasing at a time when several companies that announced divestitures in 2013-14 generated superior returns for investors.