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.