Big Pharma’s deal-making zeal could be on the wane

A rout in pharmaceutical and biotech stocks has altered the equation for chief executives thinking about big-ticket mergers and acquisitions.

On one hand, target companies are much cheaper than they were: roughly $130 billion has been wiped off the Nasdaq biotech index since Hillary Clinton, the Democratic presidential front-runner, pledged to crack down on high drug prices.

But it would be a brave chief executive who engaged in transformational deal-making when investors are so nervous about health care stocks. Since the start of 2014, the industry has been gripped by an M&A frenzy — more than $850 billion of transactions have been announced, but there are signs investors may be turning sour on deals.

In the past three months, more than half of health care companies that have proposed an acquisition worth $1 billion or more have been punished with a next-day decline in their share price, according to an FT analysis.

Bankers and lawyers who advise on pharmaceutical deals are now starting to quietly ask whether the M&A juggernaut is slowing down. Despite this, four big groups are still said to be on the prowl for deals: Johnson & Johnson, the largest of the US drugmakers; Pfizer, the number two; Irish-domiciled Allergan; and Gilead, a leading US biotech group.

“You’re going to continue seeing the mid-sized deals, especially in the $10 billion range. But, as for transformational deals, I think there is really only one, maybe two, left in this cycle,” says one banker who advises several large pharma companies.

1. Johnson & Johnson

Johnson & Johnson has sat on the sidelines of the recent flurry of deal-making, but it has been more open than most in signalling it is still on the hunt.

Despite announcing a $10 billion share buy-back alongside its third-quarter earnings — often a sign that a company has given up on large deals — the company insisted it was “actively pursuing” ways of deploying its $17 billion of net cash and was open to acquisitions of “any scale”.

Earlier this year, the group tried to buy Pharmacyclics, the maker of a blood cancer drug, but missed out in a three-way auction that resulted in the company being sold to AbbVie for $21 billion. J&J has a long-standing partnership with Pharmacyclics and receives a share of sales of Imbruvica, its top selling drug.

However, one person who advised J&J on that deal said the company was “institutionally conservative” when it came to large acquisitions and had been unwilling to bid as much as AbbVie.

US biotech valuations are roughly one-fifth lower than they were a month ago, so J&J might find some targets it considers to be better value. But its chief financial officer, Dominic Caruso, suggested the company would be more open to deals outside of the US, where it has amassed a significant portion of its cash reserves. He said there would be “more to come on that at a later date”.

2. Pfizer

Ever since Pfizer, abandoned its $118 billion pursuit of AstraZeneca, its Anglo-Swedish rival, last year, investors have been wondering what is next for the world’s second largest drugmaker.

That deal would have enabled the group to shift its domicile to the UK, cutting its corporate tax bill and making it more competitive against rivals that have already made similar moves. But a crackdown on “tax inversions” by the Obama administration has made such deals trickier.

In February, Pfizer bought Hospira, a US-based maker of generic drugs, for $17 billion, a deal that some investors saw as an attempt to “fatten up” its established products division before splitting the group into two companies: one that owns older medicines and another focused on discovering innovative new drugs.

Ian Read, Pfizer’s chief executive, has hinted that the company is looking for another target, most likely a company that would add heft to the innovative side of the business ahead of such a split. Pfizer also bid unsuccessfully for Pharmacyclics, and, according to a person familiar with the company, has held late stage talks with several companies before pulling out over price.

Pfizer has been burnt in the past with deals that destroyed value, but chief executive Ian Read may find targets more appealing after the recent sell-off.

Some shareholders say the company has recently dialled back talk of splitting up in 2017 and instead appears to be focused on inversions again.

At a recent investor dinner, Read said if Pfizer were to move its domicile, he would prefer for the deal to close before the end of 2016, because tax reform might move back on to the agenda when a new US Congress is elected in 2017, according to an account of the meeting by Mark Schoenebaum, an analyst at Evercore ISI.

Despite the inversion crackdown, Pfizer could still pull off such a deal, as long as its shareholders ended up with less than 60 per cent of the combined company. One of the few targets that would fit this equation is Allergan, the maker of Botox, which is domiciled in Ireland and paid an effective tax rate of 4.8 per cent last year versus 25.5 per cent for Pfizer.

3. Allergan

So far, Allergan has been a hunter rather than a target in the M&A game. In the last three years it has completed a string of acquisitions, as it shifted from an $8 billion maker of copycat medicines to a specialist in branded drugs with a market cap of $110 billion.

The group, which was called Actavis until taking the name of its 2014 purchase, is again on the hunt for deals, armed with the proceeds of the $41 billion sale of its generic drugs unit in August. Chief executive Brent Saunders says the rout in pharma shares could help.

“I think over time, if it stays like this, then it should benefit a cash buyer,” he says. “But the market could still bounce back — the real issue is how sustainable is the decline, and does it put us in a good position.”

One large investor in Allergan has suggested that Amgen, one of the four large-cap biotech companies, could be a target, though Saunders has so far completed only friendly deals. Its market capitalisation of $106 billion might make it a stretch for Allergan.

But Dan Loeb, the activist investor who owns a small stake in the company has suggested Amgen should split itself in two; one of the two resulting companies might be easier to digest.

Fred Hassan, the former chief executive of Schering Plough, recently joined the board of Amgen, the investor pointed out. Hassan was a mentor to Saunders earlier in his career and is credited with “discovering” the executive.

4. Gilead

Gilead is often held up as the biggest success story of biotech. It has overtaken some of the biggest names in the industry, such as GlaxoSmithKline and AstraZeneca, in terms of market capitalisation.

The company’s $11 billion purchase in 2012 of Pharmasset, the maker of a cure for hepatitis C, was one of the highest-return deals in the drug industry’s history. The medicine it acquired, Sovaldi, and its successor, Harvoni, pulled in revenues of almost $10 billion in the first half of the year alone — thanks in part to a price tag of $1,000 a day — all but covering Gilead’s initial outlay.

Turning a life-threatening illness into one that is in effect cured after a 12-week course of treatment is a huge achievement, but it poses a conundrum for investors: eventually Gilead will run out of patients to treat. Some analysts say the second quarter represented the high water mark for sales of its hepatitis C drugs.

Having spent much of the past year damping down talk of M&A, Gilead has shifted emphasis and is now openly discussing deals, according to two large shareholders. “They really have changed their tune,” says one.

The group has raised $10bn of debt. Added to its roughly $15 billion net cash position, that gives it $25 billion to spend on a target. In a recent survey of investors conducted by Evercore ISI, respondents identified Vertex and Incyte, biotech groups that have a market capitalisation of $25 billion and $18 billion respectively, as potential targets.

But one adviser familiar with Gilead’s thinking says its executives were quite taken with the $7 billion acquisition of Receptos by Celgene, and that they are more likely to focus their energies on companies in this price range.