With this abundance of capital and the global economy continuing to expand, life sciences companies must make capital allocation decisions that will drive long-term growth. Long-term thinking should be an area in which life sciences companies have an advantage over other sectors.
The very nature of product development, with its rigorous testing regimen, regulatory hurdles and systematic decisions about whether to advance a product to the next phase means that successful life sciences companies need to regularly evaluate long-term investment decisions. Yet in a recent EY survey of more than 500 CFOs, nearly half (46%) of the 90 life sciences respondents say their companies do not have a formal, systematic approach to capital allocation.
Of those life sciences CFOs who do have a formal capital allocation process, only 55% say that their process is directly linked to the overall strategic plan (versus 63% for all respondents). Similarly, 31% say their companies can quickly pivot and assess new opportunities or reprioritize planned investments, compared with 40% of all respondents.
Adopting a formal, data-rich approach to capital allocation may enable life sciences companies to rethink the timing and magnitude of their share repurchases and increase investment in focused R&D programs and innovative third-party technologies through acquisitions, joint ventures or partnerships.
In the recent EY Capital Allocation survey we pose three questions life sciences CEOs and CFOs need to be able to answer:
- Can we react quickly enough to opportunities and threats?
- Are we making objective, unbiased decisions?
- Are we returning cash to shareholders at the right time, and in the right way?
Objectively evaluate share repurchases
Life sciences companies are among the highest share repurchasers. An EY analysis of public data shows that from the 2008 financial crisis to the present share repurchases have been accelerating at the 45 largest life sciences companies at a time when valuations have increased significantly.
While there was a decrease in repurchases in 2017 at a time of significant uncertainty related to the outcome of tax reform in the US, once the Tax Cuts and Jobs Act was passed, life sciences companies resumed their high levels of share repurchases, many using cash from overseas.
We believe a company should repurchase shares if it has excess cash and its intrinsic value exceeds its market value. But in 2018, life sciences companies set a record for share repurchases even as life sciences stocks were trading at their all-time highs. Meanwhile, according to the survey, only 7% of life sciences companies indicate they repurchase shares because they feel their stock is undervalued.