Pfizer+AZ: Will Mega-Merger Mania Return?

Today the talking point, of course, is the bid by Pfizer for AstraZeneca (AZ)  and whether this is good or bad for pharmaceutical companies, biotechs, R&D, employees, jobs and patients. One thing is for sure and that is the concept that pharma mega-mergers are a thing of the past has just been blown to pieces! So why should we see the return of the pharma mega-merger, what are the drivers and its implications?

My view is that this bid is just an elaborate extension of what pharma has been doing for the past five years, buying biotech companies and their assets to boost their pipelines. AstraZeneca’s patent cliff meant that it’s real value remains in it’s R&D. As I said in Saturday’s FT (3rd May 2014) “The environment has changed. The reasons ‘megamergers’ happened before are different from today. Pfizer’s bid for Warner Lambert was for a product already on the market. This time it is about access to the R&D pipeline.” 

The public financial markets tend to put lots of emphasis on earnings to the valuation of companies and little emphasis on their R&D pipeline. Pfizer’s move enables a strategic buyer, who wants to boost their R&D pipeline, an opportunity to acquire an undervalued publicly quoted company with a strong but undervalued R&D pipeline. AZ recognises this and has used the more conjectural based expected net present value (eNPV) valuation method to argue for a higher price, which at the time of writing appears to be working.

Yes, Pfizer will use its ‘off-shore’ cash pile to do the acquisition but that is just an extremely cheap source of capital to allow it to pay more for AZ. It is an extremely tax efficient use of that cash pile and it enables Pfizer to take the some additional risk on the acquisition. Although 68% of the last rejected offer was in the form of stock Pfizer is under pressure to move the cash component up so that AZ shareholders get more cash for their shares.

So what is the impact on other pharma companies and their employees? Well, as I write every major pharma company board has met or is about to meet to discuss their place in this new landscape and their own fate. If AZ is acquired the shape of the competitor landscape will have changed dramatically and they will feel that they have to respond. They are not going to sit there and ignore it, are they? So the next step will be a wave of mega-mergers probably reducing the number of large players up to one half their number in the next five years. A key driver will be a focus on building the strongest pipeline. Simply put, you can strengthen your pipeline through acquisition by keeping the best of the combined businesses and spinning out or axing the weaker candidates. Underlying this driver is the current definition of a weak drug candidate as this has changed dramatically as pharma has realised that clinical efficacy is simply not good enough. Pricing and reimbursement (P&R) and emergence of tougher bodies to regulate P&R have emerged to expose weak drug candidates in their existing pipelines.

Inevitably some of these mergers will be successful some not so successful. Rationalisation will mean that another wave of job losses will occur.

What will the impact be on the sector itself? I believe this will lead to further rationalisation of manufacturing and R&D and a greater role of out-sourcing to contractors. A trend that has been happening for some time and where we have had considerable experience. Indeed, one of our major pharma clients, where we acted as advisors, has just two days ago successfully sold one of its US manufacturing facilities to a US-based CMO. Pharma will continue to rely on biotech to be the key innovators and we should see a further rise in licensing and partnerships.

What about jobs? Some jobs will be lost forever. Individuals affected will either leave the sector completely, become entrepreneurs in new ventures or find jobs in the successful expanding parts of the sector, including in the stronger merged pharma companies.

Last, and by no means least, what about patients? In the end patients need access to drug therapies that are both effective and affordable. Both of these two elements are out of their control, they are dependent on a strong buoyant biotech sector to discover them, efficient well-capitalised pharmaceutical companies to take the risk to develop and commercialise them, and a private and public payer sector willing to pay for them. 

Can 2014 be better than 2013?

I predict that 2014 will be a year where the pharmaceutical industry will be stronger, however, both old and new investment challenges will continue to behold biotech companies.

Through the painful process of restructuring, together with a strong therapeutic focus on their late stage clinical pipeline, a number of pharmaceutical companies will emerge in 2014 in a much stronger position than they were just a few years ago. Pharma has learnt to be lean and focussed. The challenges have not gone away and repeated drug failure in Phase III for some still needs to be dealt with.  One of the questions for pharmaceutical companies in 2014 is how they should build their emerging market strategy. Establishing a robust presence in the BRICs is proving more of challenge than anticipated. Although there have been some acquisition opportunities most pharma companies currently rely heavily on organic growth within these territories where business and cultural practices can be quite different. Nevertheless I predict a leaner and stronger pharma industry in 2014.

In 2013 we had the heady boom in biotech IPO’s in the US together with a strong rise in biotech stocks. Although this was very welcome and long over due it leaves the biotech sector with big challenges in 2014. The key question of course is the sustainability of the IPO market. Will we run out of good IPO candidates leading to the trap of poorer quality companies attempting to go public? I fear ‘probably’! And how sustainable is the market price for those companies that floated in 2013? This is not trivial! Their performance in 2014 can hugely influence investment in the biotech sector world-wide. For biotech companies generally 2013 was an ‘OK’ year. Good companies got funding, albeit not at ideal levels, but there was a general feeling of mild optimism. The lack of VC funding remains a big challenge particularly at the earlier stages of drug development. However, more imaginative schemes, some governemnt backed are starting to emerge.  This together with the rise of corporate VC funds will improve funding in 2014. Nevertheless, I believe there is a huge opportunity for new funds which can exploit the very much changed biotech industry. The old VC funding model is dead and stronger more intellient models are starting to emerge. So with a maturer and more experienced biotech sector I remain optimistic for 2014.

With all its knocks over the past decade I believe we have built a stronger industry capable of delivering its promise to patients. 2014 will be a year that will bring that promise closer.

Biotech Bounces Back

On the 31st July of this year the Financial Times front page headline to its Companies and Markets section said “Biotechs give Wall St shot in arm as IPOs (Initial Public Offerings) soar”. For those in biotech it must have been heart warming to read as It hasn’t been easy for them over the past 6 years. To understand why this is so important to biotech and new drug development we have explore the history of biotech and its crucial role in drug discovery and development.

In the past, pharmaceutical companies invested hugely in their own R&D, driven by what they did best – discovering new drugs. Innovation is not just about genius at the lab bench but also being smart about how you can manage and create innovation. In the 1980’s things changed with the emergence of molecular biology and biotechnology that revolutionised drug discovery. The emerging biotech industry, backed by venture capitalists (VCs), developed and introduced new drugs on their own giving rise to a fledgling biotech industry in California and Massachusetts.

Since then the emergence and development of biotech companies worldwide continues, however, it is driven by VC sentiment that has fluctuated over the past 30 years. This fluctuation has been influenced by events both within the industry, as investors better understood the risks associated with drug development and by global economic events.

The risks of a drug making it to market from the first clinical trials in humans are high, in fact the chances of a novel drug or new molecular entity (NME) making it to approval are, on average, less than 10%. This means that biotech companies attempting drug development carry very high inherent risk. In the past 15 years this has meant that the biotech model has had to focus on two key models, 1) create a business with an innovative platform for drug discovery which gives you ‘more shots at goal’ and/or 2) only do the early low cost part of clinical trials and take the drug to proof of concept (POC) in humans (usually Clinical Phase IIa). The NME still carries the risk of getting to market, in fact the chances of getting a drug this far from POC is still only about 40% on average. If the biotech company is successful at getting a drug to POC, they then usually out-license the rights to the drug to pharmaceutical companies who will take the drug through further clinical trials and then to market approval often with clinical costs reaching hundreds of millions of dollars. For the right drugs pharmaceutical companies will often pay these biotech companies millions to hundreds of millions of dollars in upfront and milestone payments and then royalties based on sales. This is the attraction to investors who are prepared to take the risk.

Equally intrinsic to the biotech model is the ability for investors to exit either through a trade sale to a larger pharmaceutical company or through flotation on the stock market, an initial public offering (IPO).

Needless to say the recent financial crisis has not helped, risk aversion has shied investors away from biotech and even Limited Partners away from VCs involved in biotech. Furthermore a number of venture capital firms have not performed as well as anticipated in the past 10 years introducing another layer of doubt in the biotech investment model. So concerned have the pharmaceutical companies been by this that they have reacted to the lack of venture capital by creating their own corporate venture funds to co-invest alongside side traditional VCs. So when the financial crisis arose the IPO market disappeared and the VCs were left dependent on their investee companies being bought by larger Pharma companies.

Some in the industry thought that IPOs would never return for biotech and then the gate opened again this year biotech stock on NASDAQ soared to dizzy heights and at the end of October this year the NASDAQ Biotech Index had increased by nearly 50%. This has brought huge relief not only to investors but also to all those who care for bringing new treatments to patients who suffer terrible diseases.

Pharmaceutical companies, recognising in recent years that their own internal R&D is less productive, have started to reduce their own research efforts leading to huge lay offs and closure of their research centres and manufacturing world wide. They have moved their research into the areas of highest biotech innovation like California, Massachusetts and the UK. They have created smaller high tech focused research centres that can thrive within their local innovative clusters. This increased reliance on innovative biotech companies can only boost the sector even more. All this change can only be best for patients too.