3 minute read 21 Jun 2019
Scientist experimenting in lab

How acquisitions and divestitures create value in life sciences companies

By

Arda Ural, PhD

EY Operational Transaction Services Life Sciences Leader, Transaction Advisory Services

Co-author of numerous whitepapers and a frequent speaker about biopharmaceutical strategy at industry conferences. Married father of two.

3 minute read 21 Jun 2019

Combining strategic M&A and divestitures improves capital efficiency in life sciences companies.

The heightened level of transaction activity by life sciences companies since 2014 continues in 2019 unhampered by high valuations, geopolitical concerns, or the added regulatory scrutiny imposed in late 2018 for cross-border, inbound investments.

Most companies are pursuing bolt-on acquisitions, allowing them to expand into high-growth adjacencies, access emerging technologies and participate in the ongoing wave of external innovation. At the same time, robust divestiture activity continues and assets carved out of life sciences companies’ portfolios provide a stream of supply for buyers. Private equity (PE) firms are actively pursuing those assets, mainly in the medical technology and services subsectors.

Amid this deal activity, the key question C-suite executives need to answer is whether buy- and/or sell-side transactions contribute to capital efficiency, an important measure for a company’s financial health and a key to increasing investors’ confidence.

Our analysis shows that companies that utilize a combination of acquisitions and divestitures deploy capital more efficiently than those that only buy or only sell, or do neither.

Refer to the end of the article for methodology.

Venn diagram life sciences companies acquisitions divestitures capital efficiency

Buying and selling together boosts capital efficiency

We found that companies that either bought or sold have an average annualized ROCE of 8.8%, while companies that did not transact at all have a ROCE of 5.5%. This gives a 60% advantage to companies with an active corporate development and portfolio management process.

Life sciences ROCE increased with acquisitions and divestitures

Breaking the dealmaking companies into those that acquired, those that divested and those that did both reveals that those that both buy and sell fare the best, with a ROCE of 9.2%, compared with 8.8% for the acquire-only cohort and 7.5% for the divest-only cohort.

It is important to highlight that engaging in any type of buy or sell activity individually also compares favorably to the do-nothing (N) cohort’s 5.5% outcome.

Establishing portfolio optimization rigor

This analysis is consistent with the findings of our prior research, Is your growth strategy a big deal?, which indicates that acquisitions, especially those considered as a bolt-on, create shareholder value and increase capital efficiency. Similarly, a second study we published, Creating capital efficiency and shareholder value through divestment, indicates that divestitures lead to improved capital efficiencies. This current analysis underscores that transacting per se is a value-generating activity that the C-suite should consider as an effective tool in its corporate finance toolkit. It further raises the stakes for successful planning and execution of these buy- or sell-side transactions to fulfill the investment hypothesis.

A leading practice for C-suites is to have an established mechanism and the discipline to actively reshape their companies for innovation and resilience as part of the annual portfolio planning process. Rationalizing portfolios by shedding non-accretive assets enhances the capital efficiency of the life sciences company.

The notion that companies that both acquire as well as divest deliver higher shareholder returns is a philosophy that we strongly believe in because it shows that you have a thoughtful and strategic approach to managing your portfolio.
Marianne De Backer
Global Vice President, M&A Operations, Divestitures and IDV BD, Johnson & Johnson

Similarly, inorganic growth should always be a key part of the innovation process and capital-growth agenda. Having an active sensing mechanism to detect high-growth technologies on the deal radar, and the leadership with the courage to press the go button for the right technologies at the right time, increases the operational and financial health of life sciences companies, and creates shareholder value. Life sciences C-suites should be encouraged by these findings and be more proactive with portfolio optimization strategy and execution.

  • A key performance indicator of corporate health is how efficiently life sciences companies utilize capital as measured in return on capital employed (ROCE). This analysis focuses on how companies using transactions as a growth stimulator perform when compared with others that do not, and whether buying assets, selling assets or doing both are more effective in achieving capital efficiencies.

    We analyzed approximately 5,500 buy- and sell-side transactions in the life sciences sector from January 2009 through March 2019. Subsectors included: pharma, biotech, medtech, life sciences tools, animal health, health care distributors and health care suppliers.

    In total, there were 122 companies, with 52 headquartered in the US (43%) and 70 outside of the US (57%).  Subsequently, we have analysed four cohorts of companies to compare their capital efficiency as measured in ROCE in this 10-year period.

    Note: ROCE calculated as EBIT*(1–tax rate)/average total capital, where total capital includes total common equity, total preferred equity, total debt and minority interest.

Summary

EY conducted research based on more than 5,000 life sciences buy- and sell-side transactions that closed between 2009 and 2019. Our analysis shows that companies that utilize a combination of acquisitions and divestitures deploy capital more efficiently than those that only buy or only sell, or do neither.

About this article

By

Arda Ural, PhD

EY Operational Transaction Services Life Sciences Leader, Transaction Advisory Services

Co-author of numerous whitepapers and a frequent speaker about biopharmaceutical strategy at industry conferences. Married father of two.