EY M&A Outlook and Firepower Report 2017
Payer pressure is growing across a wide spectrum of the health care sector. Price increases have been blunted by election-year rhetoric and competition in key global pharmaceutical markets. Continued portfolio rationalization, a professed preference for bolt-on deals, and lower target company valuations continue to sharpen global appetites for acquisitions into 2017. A distinct firepower advantage combined with suddenly friendly political and tax climates in the US should allow big pharma to seize the M&A agenda.
The growth gap is the difference in the sales growth of a biopharma company or biopharma sub-sector relative to overall drug market sales. It is based on IMS Health’s global drug market forecast and analysts’ estimates of company sales.
The EY Firepower Index measures 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” for deals. Thus, a company’s firepower increases when either its market capitalization or its cash and equivalents rise — or its debt falls. Access more details about the methodology and the assumptions underpinning the EY Firepower Index.
More than any other time in the past several years, big pharma companies have the firepower advantage necessary to execute on the acquisitions they require to bolster revenue and drug pipelines. And more than any other time in the past several years, those deals are necessary.
Big pharma and biotech’s race for inorganic growth has intensified as payers continue to push back on price increases for older drugs and dampen the growth trajectory of newer therapies. M&A has averaged above US$200 billion over the past three years – impressive heights which we deemed the “new normal” in last year’s report. Even so, 2017 could be a banner year for dealmaking, well exceeding this level as industry and political forces converge.
Although 2016 marks the first time in several years that big pharma’s growth gap has not materially expanded, a significant gap remains. In fact, while big pharma has returned to growth in 2016, its growth rate is just shy of the overall market.
Evidence of payers’ impact was easy to find in 2016. As companies struggle to boost market share in diabetes, for example — a market already accustomed to contracting with payers — pricing has eroded more quickly than expected across multiple diabetes drug classes.
Biosimilars, now established in emerging market countries, are poised to capture share and are pressuring margins in developed markets as well. And market forecasters may only now be beginning to discount biosimilars’ potential impact on payer pressure, which may eventually accelerate market erosion in classes with several competitors vying for share.
Finding the drug price “white space” can hedge against payers’ ability to limit growth, but may require pharma to pursue higher-risk, global market opportunities. This quest may also drive future M&A as companies compete for the best assets in key therapeutic areas where drug sales currently represent a smaller portion of total related health care costs.
Who’s buying (and selling) what?
Heading into 2017, we expect dealmakers to return to the table in earnest. From 2014-16, yearly M&A totals averaged around US$200 billion, but as a group, big pharma has spent on average only 10% of its firepower each year. The strategic drivers and deal conditions are set. In a global poll by EY in mid-October, we saw early signs of this uptick: 43% of life sciences executives claimed to have five or more deals in the works, as opposed to just 6% in our mid-April poll.
Biotech and big pharma valuations fell steadily throughout the year — before the post-election bounce — as drug pricing concerns gained momentum. The last time biopharma valuations experienced such acute declines was during the 2008 financial crisis. This pronounced downturn was quickly followed by a handful of 2009 megadeals, so there’s a precedent for big pharma ramping up dealmaking in 2017 and potentially dominating M&A share for several years.
Falling equity valuations and debt raised to fuel previous years’ M&A have resulted in a roughly 20% industry-wide firepower decline. Specialty pharma firepower and big biotech firepower account for about half the decline.
Big pharma now nearly equals its largest share of industry firepower in four years. Despite the overall decline, capital allocation priorities favor continued M&A among industry’s largest players.
Most big pharma and some big biotechs have forecast growth through 2020 below the IMS-projected 4% global revenue growth rate for the sector. Pricing pressure on new therapies has impeded recovery from the industry-wide patent cliff that began several years ago. Companies with growth gaps and shrinking firepower are in the most challenging positions.
Firepower unleashed — record M&A in 2017?
The marketplace reaction to biopharma companies’ third quarter earnings calls suggests investors did not fully appreciate the industry’s pricing problems. As the probability of revenue shortfalls increases across the industry, even companies with ostensibly solid growth prospects may pursue M&A to guard against downside scenarios.
There had been pent-up demand for deals in a holding pattern going into the US presidential election, but the deal chatter in the waning weeks of 2016 indicate much firepower could soon be unleashed in 2017 based on these drivers:
- The payer growth gap has become a reality
- Finding growth in traditional strongholds is becoming increasingly difficult
- Plenty of firepower remains unspent
- US political climate becomes more favorable
- Waning ex-US advantages
Certain companies may alternatively or in parallel pursue further diversification away from the pharma core business. Non-core businesses may be the road less traveled for most of pharma, but they are projected to account for around US$150 billion in sales in 2016 out of a total of US$500 billion. We expect transactions in most, if not all, subsectors in 2017.
Divestitures, therapeutic battlefield consolidation and activity in remaining unmet therapeutic needs might easily yield another year of US$200 billion in deal volume, even without such favorable M&A conditions. But unprecedented payer pressure, a deal tailwind from macro forces, and an unusually full M&A pipeline, is likely to push biopharma dealmaking to new heights in 2017.