This year there have been two major strategic initiatives by big pharma companies: rationalisation of portfolios by trading business areas with one another to consolidate and strengthen market share in specific sectors; and M&A of large companies driven by the need to bolster sales and profits by synergy and tax savings.
During September, there were more restructuring and portfolio rationalisation announcements but some big pharma M&A deals are now looking less likely following tax changes announced by the US Treasury.
Company restructuring and portfolio rationalisation
Following restructuring by Pfizer, GSK, Novartis, Lilly and Merck & Co, Bayer has jumped on the portfolio rationalisation bandwagon with its decision to spin off as a separate listed company its Material Science division leaving the focus on Healthcare and Crop Science. The proceeds of the spin off due to be completed in the next 12 to 18 months have been estimated to be around $13bn similar to the $14.2bn being paid by Bayer for Merck & Co’s consumer health business. In September Bayer completed the divestment of its interventional device business to Boston Scientific for $400m. In the same way as Abbott spun off its pharma division in early 2013, so Baxter has announced it will spin off its pharma division into a listed company called Baxalta with sales of $6bn.
Both Bayer and Baxter have justified the decision as enabling the management of the spin out companies to be more autonomous and make their own investment decisions whilst having access to capital markets. The question is whether breaking up a conglomerate structure, as Bayer has done, is best for the company and its investors. In the financial community, the valuation of conglomerate companies is discounted compared to more focused companies because of the perceived lack of synergy between diversified businesses. So in theory by splitting a conglomerate into separate companies, the overall valuation should increase. In the case of Bayer there is probably very little synergy between pharmaceuticals and plastics so it was not surprising that the share price of Bayer increased by 6% following the announcement.
Merck KGaA is going in the opposite direction to Bayer and Baxter by consolidating its conglomerate structure. It has announced the purchase of Sigma Aldrich for $17bn representing a hefty 6.3x sales. The share price premium was 37% much less than the 53% being paid by Abbvie for Shire. The acquisition will increase Merck Millipore’s product range, sales and geographic coverage and also generate synergy savings of $0.3bn per year. Merck Group comprises biopharmaceutical (2013 sales $7.7bn), consumer health ($0.6bn), performance materials ($2.1bn) and laboratory supplies ($3.4bn + $2.7bn from Sigma Aldrich). While Merck may not wish to follow Bayer and spin off its performance materials division, there does not seem much point in retaining the consumer health division with less than 5% of sales, a low EBITDA margin and an insignificant player in the OTC market. Perhaps Merck KGaA will follow the strategy adopted by Merck & Co and divest its consumer health business?
Company acquisitions and tax inversions – the heat is on
This year is going to be a record year for M&A in the pharmaceutical industry with the overall value exceeding the peak year of 2009, assuming that the announced deals are completed and are not stopped by changes in US tax regulations! The tax inversion story whereby a US company buys out a smaller foreign company and then adopts its tax nationality, has been one of the major talking points behind some of the deals that we have reported this year in various Deal Watch issues. This is a US issue predominantly but something that is playing out across the headlines and carrying some considerable deal impact on European companies.
The situation has arisen as the current US tax laws mean that US companies pay US tax when they repatriate profits from other operating units across the world. This is unlike other tax jurisdictions which only charge tax on revenues which arise in that particular territory. Coupled with the fact that US corporate tax can be as much as 35% compared to other territories such as Ireland (12.5%) and the Netherlands (20-25%), it is obvious that there are clear financial incentives for companies to look for tax sparing deals and corporate structures to escape paying US tax.
This is not a recent nor uniquely pharma issue. Tax inversions were happening in the 1990s usually involving countries such as Bermuda e.g. Tyco in 1997 and has included insurance, manufacturing and resource companies. As a result in 2004 Congress enacted new legislation seeking to prevent tax inversions. Within a few years the tax advisers had found new financial structures to avoid the law and, following the financial crisis, tax inversions substantially increased particularly amongst pharmaceutical companies (see table below).
| Year | Acquirer | Target | New company tax domicile |
| 2010 | Valeant | Biovail | Canada |
| 2011 | Alkermes | Elan | Ireland |
| 2012 | Jazz | Azur | Ireland |
| 2013 | Liberty Global | Virgin Media | UK |
| 2013 | Actavis | Warner Chilcott | Ireland |
| 2013 | Perrigo | Elan | Ireland |
| 2014 | Endo | Paladin | Ireland |
| 2014 | Theravance Biopharma | Cayman Islands | |
| 2014 | Horizon | Vidarg | Ireland |
| Pending | Medtronic | Covidien | Ireland |
| Pending | Mylan | Abbott – generics | Netherlands |
| Pending | AbbVie | Shire | Jersey |
| Pending | Burger King | Tim Hortons | Canada |
However it was the recent bid made by Pfizer to acquire AstraZeneca which really brought matters to a head with the US government realising that steps needed to be taken to close this particular loophole.
With the political gridlock in Congress blocking or significantly delaying new legislation, the US Treasury announced on 22nd September new tax rules effective immediately to reduce the tax benefits of completed deals and make new inversions more difficult and less financially attractive. These include blocking loans to access overseas earnings without paying tax, preventing restructuring overseas units and hence accessing cash reserves tax free and the closure of the loophole which allows transfer of cash or property from an overseas subsidiary to a new parent.
These new measures will impact deals that have not yet closed such as Medtronic’s $43bn acquisition of Covidien and AbbVie’s $54bn acquisition of Shire; renegotiation and/or restructuring the deal may be required or the deal may be terminated. In the latter case, many deals contain sizeable break-up fees such as $850m in the case of Covidien/Medtronic. This non closure penalty would not fall due if the deal is vetoed by shareholders or if there is a change in law, but changes in tax guidelines may not be a specified exclusion. The effect of the announcement of the new tax guidelines has been a temporary decrease in the share prices of the US acquirers and an increase in the workload (and income) of US tax advisers looking for new loopholes.
If you can’t stand the heat…
While the uncertainty about tax inversion is causing some big pharma companies to sweat in the political limelight, others are staying cool by engaging in more run-of-the-mill company and asset (product) acquisition deals. The deals can be grouped into:
- Acquisition of biotech companies by big pharma to build pipeline and late stage products. The highest value deal this month was J&J’s acquisition of Alios for $1.75bn. Alios has an oral anti-viral in phase 2 for treatment of infant respiratory syncytial virus (RSV) which complements J&J’s early stage programmes in RSV. Similarly Daiichi Sankyo has supplemented its oncology pipeline by acquiring Ambit Biosciences for $400m. Ambit develops kinase inhibitors and has quizartinib in phase 3 for acute myeloid leukaemia.
- Acquisition of product assets or companies with marketed products by speciality and generic companies. KV Pharmaceuticals emerged from Chapter 11 bankruptcy in September 2013 with the new name Lumara Health and two divisions: maternal health for the orphan drug Makena; and women’s health for three other products. This structure was probably set up with the objective of maximising the sale value of the company. Perrigo who manufactures two of the three women’s health products is acquiring the products for $82m. The current annual sales multiple is 5.5, but the products had sales of $78m prior to production problems. Amag is buying the remaining company for up to $1.025bn. It contains Makena, a progesterone injection with US orphan status to reduce the risk of preterm birth with annual sales of $110m (+72%). The upfront payment of $675m represents 6 x sales and there are sales milestones totalling $350m. The potential maximum sales multiple of 9 for Makena reflects its high margin and growth rate. In contrast, the lower growth and margin Arixtra plus its authorised generic version in the US being bought by Mylan from Aspen for $400m has a sales multiple of 2.6.
- Acquisition of complementary and competitor companies. The acquisition of Civitas for $525m provides Acorda with a product for Parkinson’s disease in phase IIb that complements its CNS portfolio. The UK acquisition of the UK contract manufacturing company Aesica Pharmaceuticals which has 6 sites in Europe for $374m (1.2 x sales) complements the medical device manufacturing of Consort Medical. The contract manufacturing sector is in a state of flux with the acquisition of Patheon last year by DSM and Akorn’s acquisition of the ophthalmic manufacturer Excelvision in July this year. In India this month, Strides Arcolab has acquired another Indian generic and API supplier Shasun in an all stock deal worth $200m to add products to its portfolio. Glanbia based in Ireland has bolstered its US presence with the acquisition of Isopure the US sports nutrition product company for $150m (2 x sales).
Licensing rumbles along in the background with creative deals for the US
Big pharma M&A and rationalisation of portfolios may be the headline topic at the moment but licensing deals continue in the background. Often these deals are just as important to the licensee’s business as M&A and probably are a lot less costly than acquiring a licensor’s company. In recent months there seems to have been an increasing number of licensing deals with more flexible financial terms not just to deal with risk but also to change the reward structure at a later date. In addition many more deals include carve outs for specific countries and activities such as manufacturing and also include co-promotion.
The two highest value licensing deals this month are for oncology products in phase 3 and both have carve outs and other creative terms. Baxter is licensing Merrimack’s nanoliposomal injection of irinotecan which has orphan status in the US and the EU for metastatic pancreatic cancer, but does not have US rights. In contrast, AbbVie has US rights but is required to co-commercialise and equally share profits with Infinity who book the sales. Outside the US, AbbVie exclusively commercialise duvelisib but pay a heroic royalty of 23.5% to 30.5%. The royalties are high because Infinity has to share the proceeds with Mundipharma and Millenium. One can’t escape one’s past.
Another creative deal also with a US theme is the early stage deal between MyoKardia, a company based in California, and Sanofi. Myokardia will develop two HCM (hypertrophic cardiomyopathy) programmes where it retains US commercialisation rights and Sanofi has ex-US rights; and a third DCM (dilated cardiomyopathy) programme will be developed by Sanofi with global commercialisation rights. Sanofi has the right to co-promote new HCM indications in the US and MyoKardia can co-promote the DCM product in the US. It certainly would have been simpler, but probably more expensive, if Sanofi had acquired MyoKardia! That may still be on the cards as Sanofi has made an equity investment in MyoKardia as part of the upfront.
There are two other big pharma / biotech deals this month that appear to be more typical of traditional licensing deals. Boehringer Ingelheim has taken a licence to Curevac’s messenger RNA vaccine for one of its compounds and the Californian company, Sutro, has signed an early stage deal with Merck KGaA to license its antibody drug conjugate (ADC) technology. With the growth of antibody products, there is increasing interest in ADC technologies. Four years ago Genmab started working with Seattle Genetics’ ADC technology and has now signed a new deal using a Genmab antibody. The creative aspect of this deal is that Seattle has retained an option to increase the Genmab royalties to double digit levels in exchange for a reduction in milestone payments. The key unanswered question is when does the option expire? Expiry of the option is no longer an issue for TG Therapeutics now that it has exercised early its option with Rhizen to change their deal from a 50/50 joint venture to a global (excluding India) licence. The product, an oral PK13 delta inhibitor appears to have completed phase 2 the stage when most options would expire.
Finally it is interesting to see yet another big pharma / big pharma development and commercialisation collaboration. These have become increasingly popular as big pharma seeks to reduce risk by sharing costs and revenues particularly in uneconomic therapeutic areas, for example, antibiotics and in therapeutic areas such as degenerative neurological diseases where there is a high risk of development failure. AstraZeneca and Lilly have announced a joint development and commercialisation deal for AstraZeneca’s BACE inhibitor in phase I for Alzheimer’s disease. Lilly will lead the development effort and both companies will share costs and revenues with AstraZeneca getting $50m in 2015 and a further potential $450m in milestones. AstraZeneca estimated that the product has potential peak sales of $5bn and a 9% chance of success. This is why big pharma companies are working together. Perhaps “a problem shared is a problem halved?”