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May 28, 2012

M&A Likely to Continue Growing Along with Deal Premiums and Multiples

Slow comeback of IPO market will keep companies looking for opportunities to be acquired.

M&A Likely to Continue Growing Along with Deal Premiums and Multiples

As of May 21, only five companies sold their first stock in 2012, compared with eight companies this time last year. [© Sergey Dashkevich - Fotolia.com]

  • The long-dormant biopharma IPO market continues to take a few steps forward then a few steps back. Half of the eight companies that filed S-1 registration statements this year have done so since April. This month alone, Kythera Biopharmaceuticals disclosed plans to raise about $86 million, while OncoMed Pharmaceuticals has set its sights on a $115 million IPO.

    However, as of May 21, only five companies sold their first stock in 2012, compared with eight companies this time last year. All but one came to market after dropping their share price below their initial range; the exception was Verastem, which began trading January 27 at the $10 midpoint of its $9–11 range. Rib-X Pharmaceuticals postponed its IPO on May 9, a day after halving its share price from the $12–14 range, shaving $10 million from its original $75 million offering.

    Since April, stocks have largely disappointed investors hoping to build on first-quarter gains. Shares of the most-hyped IPO in recent memory, Facebook, closed their first trading day flat and their second at a loss.

    The bad news for the IPO market should mean good news for biopharma M&As in 2012, and for the most part it does. However, premiums or revenue multiples paid per deal vary significantly, with big companies increasingly willing to pay a big price for an increased presence in selected areas, notably specialty pharma and diagnostics.

  • What’s the Big Deal?

    In its $1.26 billion acquisition of Ardea Biosciences last month, for example, AstraZeneca agreed to pay $32 a share, or a 54% premium over Ardea’s share price the day before the deal was reported. That’s well above the average 44% premium Burrill & Co. calculated for M&A deals announced in April. Viewed against the stock’s premerger 52-week high of $28.29 as of April 27, 2011, the deal represents a 13% premium. Ardea still fared better than most M&A targets in April, according to Burrill, which noted that purchase prices averaged nearly 19% below the 52-week high on the trading price of the shares of the targets.

    The AstraZeneca-Ardea deal is one example of how much big pharma is willing to shell out major moolah for acquisition targets it thinks will fill holes in pipelines or product offerings. A few days later, on May 2, Novartis’ Sandoz unit paid $1.525 billion, all cash, for privately held generic dermatology drug developer Fougera Pharmaceuticals. The purchase price is 3.55 times the target’s 2011 revenue of $429 million. Sandoz and Fougera estimate that the combined company will generate $620 million a year in sales and will be the top generic dermatology medicine company in the world.

    Those multiples are on the low end of recent big deals, particularly diagnostics-driven deals. On May 17, Agilent announced a $2.2 billion all-cash deal for Dako. The price Agilent will pay—the largest acquisition in its history—is almost 6.5 times Dako’s 2010 revenue of $340 million and 5.9 times the $373 million that Agilent predicts Dako will generate in 2013.

    Watson Pharmaceuticals announced last month it will spend €4.25 billion (roughly $5.6 billion) plus another €250 million (about $320.3 million) in milestone payments for privately held Actavis. It expects the merger to create the world’s third-largest generic drug company with annual anticipated revenue of $8 billion this year.

    The milestone payment would be carried out in contingent value rights of up to 5.5 million shares of Watson common stock next year, at $60 per share. That sounds good, except that Watson shares closed at $69.69 the day the Actavis deal was announced and reached as high as $77.73.

    However, two of the most talked about unsuccessful deals this year reflect what happens when pharma giants skimp on their offers. Last month, Human Genome Sciences rejected GlaxoSmithKline’s $2.6 billion offer. Investors felt snubbed despite GSK’s 81% premium on HGS’ share price, at $13 per share, because it was less than half the 52-week high of $29.60 reached on April 27, 2011. HGS appears to have acted wisely since its share price on May 21 closed at $13.99.

    Also offering less than what investors wanted was Roche, which made hostile takeover offers of $5.7 billion, or $44.50 per share, for Illumina on January 27, then a sweeter $6.7 billion bid at $51 per share on March 29. While Roche trumpeted its 64% then 88% premium over Illumina’s closing price of $27.17 before the rumor mill started churning about the deal, the offer for Illumina was well below its 52-week high of $77.88 reached on July 6, 2011. As of May 21, Illumina was trading at $43.85.

  • Impact of IPO Health

    Payments tied to milestones are increasingly the norm in M&A deals, especially those not involving a highly competitive biopharma category. “Buyers want sellers to share some of the risk of uncertain events,” Jonathan Leff, a partner and managing director with Warburg Pincus, told GEN. “Especially when the IPO markets/financing markets are uncertain, the sellers are willing to take contingent value as part of the sales transaction.

    “And I expect that to be the reality for the foreseeable future, probably for as long as any of us are going to be in this business,” Leff added. “It’s the reality and it’s the right way to do these transactions in principle.”

    It’s fine and dandy for buyers, who can cut their up-front price the more uncertainty they see in a deal. And target companies have few other viable options; they cannot easily raise traditional venture capital, and the IPO market has yet to fully recover.

    Those options aren’t likely to return any time soon. The chilly biopharma investment market will take years to thaw even if Congress expands the types of medicines eligible for faster reviews and approvals. This month Standard & Poor did, however, cite the prospect of faster FDA decisions as a factor in its optimism about exchange-traded funds that include biotech stocks. A more likely factor is the other one cited by S&P, namely the prospect of continued near-term M&A activity as other means to an exit for investors continue to lag.

    As Roche-Illumina and GSK-HSG show, however, not all deals go through. The deals that succeed are those that fulfill the cliché of “win-win,” with a twist: Buyers fill a need and are willing to pay a premium that—at least for this year—can be expected to keep growing, while investors of target companies accept the premium if for no other reason than because all the other options look worse.

    What is your forecast for mergers and acquisitions this year?


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