2018 M&A Firepower Report:
Life Sciences Deals and Data
What lessons does 2017 provide for setting your company’s transaction strategy in 2018?
In the wake of year-end US tax legislation, conditions are ripe for a surge in life sciences M&A as business leaders weigh strategic priorities for capital allocation decisions to generate inorganic growth. Despite relatively high target valuations, M&A remains essential for growth, especially as technology’s health care convergence threatens traditional business models.
Here are six essential questions to consider in formulating your 2018 M&A strategy:
The EY Firepower Index tracks a group of life sciences companies and their “firepower,” which EY defines as a company’s ability to do M&A based on the strength of its balance sheet.
Together, a company’s market capitalization, cash equivalents and debt capacity provide the “firepower” needed for deals. Thus, a company’s firepower increases when either its market capitalization or its cash and equivalents rise — or its debt falls.
For more details about the methodology and the assumptions underpinning the EY Firepower Index, please see the report Appendix.
- Do we build scale, diversify or expand our geographic reach? The core strategic alternatives for today’s biopharma and medtech companies haven’t changed, and companies will continue to rationalize portfolios to focus on their innovative cores — or diversify.
- Are we ready to buy? Waiting for attractive targets to become less expensive or for geopolitical uncertainties to resolve shifted dealmaking from M&A toward risk-sharing alliances and joint ventures in 2017, particularly in biopharma. As the implementation of US tax reform becomes a question of “when,” not “if,” can we afford to wait any longer to pursue transformative M&A?
- Does our business model deliver value, not just a drug or device? Successful companies will use M&A and partnerships to establish platforms of care to drive value for multiple stakeholders. And in the process, adapting their strategies to the increasing sway of payers, with a focus on diversifying away from commercial and policy risk, reacting to new competition in core markets or moving beyond the pill/device into services that help to differentiate their products.
- Will there be a return of mega-mergers? As incursions from technology behemoths threaten the health care status quo, traditional biopharma and medtech leaders may find mega-mergers more tempting as a means to protect profitability, maintain competitiveness in key therapeutic areas and build scale to confront new challenges in the supply chain. The transformative CVS/Aetna merger may exacerbate these challenges, as payers move to drive value through lower costs.
- Are we vulnerable? Yesterday’s acquirers may be tomorrow’s targets. Several large and acquisitive companies have seen their abilities to continue to consolidate threatened by slowing growth forecasts, weakened valuations and excessive debt. Companies more accustomed to hunting for acquisition targets may find themselves on the other side of the deal table.
- Will buoyant capital markets empower targets to remain independent? Small and mid-sized biopharma and medtechs have their own trade-offs to navigate: raising capital to advance promising and cutting-edge science is a realistic alternative to acquisition —for now.
The total volume and value of life sciences industry M&A fell nearly 20% in 2017, as positive policy developments around areas like corporate tax reform in the US and a favorable tax rate for repatriation of cash held overseas by US companies failed to materialize until year-end. Bucking these trends, medtech M&A value rose 50% in 2017, driven by therapeutic device companies seeking economies of scale in the face of increasing leverage from payers, helping to lift the value of aggregate M&A to more than US$200 billion (see Exhibit 1).
Life sciences M&A and divestitures during 2017 also featured a pronounced shift away from the typical epicenters of the biopharma sector and the United States. Biopharmaceutical acquisitions accounted for only roughly a quarter of all M&A value, as compared with almost 80% in 2016.
Strong emerging markets growth cited by several pharma companies during third quarter 2017 investor calls suggest an expectation for improved global growth. A more cautious view on the US pricing and market access outlook as well as policy uncertainty may have contributed to more cross-border M&A.
US deals represented only 30% of 2017 M&A value, trending down further from 39% in 2016 and 52% in 2015. But overall, deal drivers remained fairly consistent with prior years, as companies sought scale to help in their defense against rivals and payers and (particularly in biopharma) new assets to drive growth.
Betting on focused strategies
Few in the group of big pharma companies that we have been tracking in our index since the inaugural 2013 EY Firepower Index and Growth Gap Report have opted to further diversify (see Exhibit 2.)
While diversified pharmas can deliver smoother earnings and cash flow, they face the challenge of managing multiple businesses that each require different capabilities. In addition, investors continue to be skeptical of conglomerates’ value, advocating for higher margin (and higher risk) biopharma focus. Concentrating on innovative biopharmaceuticals may allow these companies to more quickly engage in large-scale M&A with similarly focused players, as there would be fewer non-core assets to dispose of post-closing. With its intrinsically higher risk profile, the focus model may increase the need for those deals as well.
Disruption’s shadow looms larger
As 2018 dawns it’s increasingly necessary for CEOs and boards to imagine the effect the tech giants’ firepower might have on the life sciences industry should any of them decide to deploy it. A group of just seven technology sector disruptors boasts more firepower than 50 life sciences leaders (see Exhibit 3). Over the past decade, our set of disruptors’ firepower has soared five-fold to nearly US$1.7 trillion.
And this firepower could soon be focused on the life sciences supply chain, with its high-volume generic drug manufacturers, diagnostic laboratories, distributors/wholesalers, pharmacy benefit managers and retail pharmacies each ripe for potential disruption. (Owning a leading company in the generics space — which accounts for about 85% of all US drug volume according to the QuintilesIMS May 2017 report — could put 10% or more prescriptions filled in the US in the hands of a distribution-savvy technology player.)
Potential disruption could take several forms. But any entry into the life sciences supply chain could result in a reduction in profitability for incumbents as margins get squeezed along any link in the chain. Might this be welcome news for biopharma or medtech companies?
Stage set for M&A surge
The emergence of customer-centric care platforms, a key strategic driver of the CVS/Aetna merger, may spark a new and vigorous round of consolidation among manufacturers, payers and intermediaries, such as UnitedHealthcare’s US$4.9 billion acquisition in December of DaVita Medical Group, DaVita Inc.’s chain of medical groups and physician networks.
The underlying dynamics already support larger-scale consolidation within life sciences, and in biopharma in particular, where the market remains highly fragmented. Indeed, the top five companies in the trillion-dollar global pharmaceutical market — Pfizer, Novartis, Roche, Sanofi and Johnson & Johnson’s Janssen — each have no greater than 5% market share (see Exhibit 4.)
We expect that in 2018 the total value of life sciences M&A should once again surpass US$200 billion, as the fundamental drivers of competition and pricing pressure in core therapeutic battlefields intensify, as the downstream effects of US tax reform materialize and as new sources of capital from outside the traditional centers of life sciences M&A increasingly join the fray.
This summary is excerpted from our full report, 2018 M&A Firepower Report: Life Sciences deals and data. See also other related EY articles and papers:
- EY Life Sciences 2017 Data Book: Insights and our analysis of pharma, medtech and biotech financing, financial performance and deal activity in 2017
- Global Capital Confidence Barometer – Life Sciences | 17th Edition: EY’s twice-a-year survey of senior life sciences executives to identify trends in M&A and guage corporate confidence in the economic outlook
- EY M&A Outlook and Firepower Report 2017: will payer leverage and post-election optimism shift deal-making into high gear?