Between 2005 and 2010, 60 biotech companies tracked by SVB Capital were acquired for $100 million or more. [© Ben Chams - Fotolia.com]
For years biotechnology and pharmaceutical giants panic-stricken at the thought of seeing their profits evaporate with the expiration of patent protection for their blockbuster drugs have pursued roughly the same strategy. They have scrambled to merge with or acquire smaller companies, typically research partners, using their R&D as the basis of new products that, they hope, can be brought to market faster than starting from scratch through their own research efforts.
The M&A parade has continued well into this year, with Thomson Reuters pegging the value of such deals in healthcare for 2011 to be about $84.8 billion worldwide, nearly double the $44.8 billion logged last year. The biggest deal so far this year was announced on February 16: sanofi-aventis (now sanofi) bought Genzyme for $20.1 billion. The second biggest was in May, with Takeda offering $13.6 billion for Nycomed.
There are signs that even big pharma may be tiring of big mergers, though, or at least rethinking their approach on how to put the pieces together. In March, Merck and sanofi announced they will keep separate their respective animal health businesses, rather than form a new joint venture that would have combined sanofi’s Merial with Merck & Co.’s Intervet/Schering-Plough.
Around the same time, Pfizer CEO Ian C. Read told research analyst Tim Anderson of Sanford C. Bernstein that it may spin off several of its businesses. Up for potential grabs are its consumer health and generic drug units. Such deals are expected to shrink its revenue base by up to 40%.
One possible reason for the shift in thinking: M&A deals haven’t worked out quite as well as expected. Between 2000 and 2010, close to a trillion dollars in value has been lost in the market capitalization of 17 of the industry’s most active acquirers, according to an analysis from Burrill & Company issued in April. The trillion dollars reflects the $430 billion spent on these in acquisitions plus the $530 billion in lost market value, from $1.57 trillion on December 31, 2000, to $1.04 trillion this past December 31, according to the life science merchant bank’s annual report on the industry, “Biotech 2011—Life Sciences: Looking Back to See Ahead.”
“Some of the market cap lost is just Wall Street’s disenchantment with whether or not there’s a survivable, sustainable business like there used to be in the glory days of the $10 billion to $15 billion franchise on a single blockbuster drug,” G. Steven Burrill, CEO of Burrill & Company, told GEN.
The nation’s best-selling drug, Lipitor, generated $7.2 billion in sales for Pfizer in 2010. That’s down $701 million, or 6%, from the previous year. And the number will get much worse this year since it is going off patent in November. Revenues for the drug are expected to shrink to between $1 billion to $2 billion, according to Burrill.
Why Buy Biotech?
Losing sales to the end of patent protection and competition from generic drugs isn’t the only reason big pharma has been playing the acquisition game. Many drug companies, he noted, simply have been unable to translate their costly internal R&D efforts into new blockbuster drugs. To make up for this lag in innovation, the companies are buying new products through M&As.
If you’re sitting in the boardroom of big pharma and doing anything to find alternatives, “acquisition is one of the most efficient ways to do that,” Burrill pointed out. “The question is, where can they find innovation outside the organization that can sustain them? How can they build more powerful sales and marketing forces and bring more drugs into the market?”
Biotechs have proven to be good targets for M&A deals. In 2009, Pfizer closed a $68 billion acquisition of Wyeth, and Roche took over the approximately half of Genentech it didn’t already own for $46.8 billion. The mergers have helped boost both companies, but while Pfizer’s market cap climbed to $163.87 billion post-acquisition, the Genentech-fortified Roche is at about $167.91 billion.
As big pharma tries to maintain a larger revenue base, he added, “they’re firing a lot of people in the middle and calling it profitability for a few years, and yes it will continue.” Those people in the middle include thousands of R&D professionals idled as research shifts to smaller biotechs; clinical professionals whose jobs have been outsourced to contract research organizations; and manufacturing staffers whose jobs have been outsourced overseas, especially to China and India.
Then there are sales professionals who now are no longer needed since the buying power for drugs has shifted away from thousands of small doctors’ offices to regional medical practices, healthcare systems, and payers ranging from HMOs to Medicare.
R&D in smaller companies, Burrill said, is more efficient than in larger ones because it can cost less than the average expense of developing a new drug, which is about $1.3 billion, according to the Tufts Center for the Study of Drug Development. Additionally, smaller firms can act faster to start drug development programs or stop those that show little promise.
“The scale difference allows innovation to be far more effective and cheaper in small companies,” he said. “It’s a good model if the biotechs continue to be great innovators, and in some cases, developers, and marketers.”
That may explain why some pharma giants have not simply absorbed some of the smaller biotechs they have acquired in recent years. Instead they have retained significant portions of their operational structures, as Eli Lilly has done with ImClone and Pfizer with Rinat Neuroscience.
Why Biotechs Want to Be Bought
Jonathan Norris, managing director with SVB Capital’s Venture Capital Relationship Management team, told GEN that smaller biotechs face a challenge that has increased the appeal of mergers and acquisitions in recent years—the tightening of venture capital funding following the recession. Between 2005 and 2010, 60 biotech companies tracked by SVB Capital were acquired for $100 million or more.
“One of the major issues facing venture-backed companies is that there’s a lack of reserve funding in these companies from the traditional venture investors to be able to drive companies through their pivotal Phase II or Phase III trials,” Norris said. “Many venture firms are faced with the issue that they didn’t get liquidity as early as they may have thought they were going to. They’re faced with too many companies that need to be financed and maybe not enough overall reserves to cover all the financing needs of those companies.”
Interestingly, the squeeze felt by venture capitalists struggling with obtaining liquidity explains why, since the recession, SVB Capital recorded a spike in structured M&A deals, where there is some up-front payment, but the majority of the transaction value is paid out upon completion of milestones advancing new drugs through trials.
For example, in 2009, 11 of 13 exit deals were structured; the rest involved all payments being made up front. By 2010, all-upfront deals disappeared, and all seven exit deals were structured. Most exit deals were all-upfront between 2005 (when just one of ten deals was structured) and 2008 (two of eight deals were structured).
“Venture firms have to make that tradeoff between an earlier exit that’s maybe not as attractive an exit they could get, but it’s a bird in the hand,” Norris said. “They’ll take a structured deal, which gives them a decent multiple up front, maybe a 1 or 2x, with milestones to be earned, rather than trying to fund the next big clinical trial and either not having enough funds to support that company and getting their ownership decreased, or funding that company and having the risk with those clinical trials. You’re going for an increased opportunity to exit but you also have the risk that that asset doesn’t work.”
The VC squeeze, the lengthening of trials and reviews for new drugs, and investor impatience also explain why investors took less time to exit biotechs last year (3.94 years) than any of the previous five years, where exit times hovered around five years, rising to 5.54 years in 2009. The average number of venture rounds of biotech companies with exits has yo-yoed in recent years, from three or so before the recession, to 2.5 in 2008, to 3.5 the following year, then back down to 2.6 rounds in 2010.
Another factor, according to Norris, was interest by acquirers of biotech companies in spinout opportunities, which typically are in later stages—either ready for Phase I or II. “The age of allowing smaller, more nimble venture-backed companies to be the feeder system has arrived,” Norris said.
“More than 50 percent of the exits since 2005 are by biotech companies with either preclinical or Phase I assets. And helping companies stock their early-stage pipeline allows the bigger players to work on their later-stage opportunities that have higher probability. It’s a good use of resources,” Norris noted.
According to SVB Capital’s “Startup Outlook 2011,” which focuses on early-stage companies in a variety of industries, 23% of biotech startups identified growth through M&A as an opportunity, the highest percentage of four technology sectors. However, M&A scored only fifth highest among opportunities for growth, following expansion into new markets, business conditions in existing markets, access to equity financing, and international expansion.
Those results appear to reflect that biotech startups, faced in this economy with a shriveling VC market and exits tied increasingly to milestones, are at least thinking of trying to grow their businesses before selling them off, in hopes of gaining leverage with would-be acquirers. And big pharma and big biotech show no signs of abandoning their model of recent years, which calls for replenishing their pipelines through acquisitions. So the wave of biotech and pharma M&As is likely to continue at least short-term, as long as the price is right.