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The Great M&A Gamble

To European pharma, fighting to stay ahead of the game, a merger could be a risky but logical next step to greatness

The investment community loves to deal in absolutes, it is the nature of the game. The way in which rumours and speculation within the market materialise, European pharma chief executives could be forgiven for thinking that they've been cast as players in a multibillion Ä game of Monopoly.

First of all, they have to decide in which therapeutic areas they would like to build their chain of lucrative, money spinning hotels. The oncology and cholesterol markets may be the Park Lane and Mayfair of the sector, but they require a very sizeable investment, and must withstand the ferocious competition.

Perhaps it's better to plump for a niche rare disease market where the outlay is less and the regulatory barriers are lower. Even once they have decided in which areas to invest, they have to regularly keep passing 'Go' (in this case getting a product approved) to sustain their company's momentum.

Unfortunately, in this day and age, passing 'Go' is becoming an altogether more difficult task. Of course, organic growth should never be ruled out; effective lifecycle management and squeezing the most out of the assets already at a CEO's disposal could enable them to throw a few healthy doubles on the dice. Yet, even if they manage to avoid a row of green houses built up by generic firms threatening to manufacture cheaper versions of their top-selling diabetes blockbuster, they may land on the 'Chance' spot and find themselves having to cancel phase III clinical development work on their experimental obesity pill due to safety issues. Then there's always the possibility of really hitting rock bottom and landing on 'Go to jail'. One of their most successful products on the market is instantly withdrawn and they face years of costly litigation.

It's always handy for a CEO to have a 'Get out of jail free' card on him, if only to convince his investors that he still means business and is on course to pass 'Go' with consummate ease within the next few rolls of the dice. It may not be the road to salvation, but at least it could get the company back on the right track. In these lean times, a 'Get out of jail free' card is likely to be a merger or an acquisition (M&A).

Getting out of jail free
Back in the real world, the fact that the pharma industry is facing myriad challenges is no secret. Declining pipelines, increased costs behind developing and commercialising products, and downward pricing pressures make for a somewhat harsh European climate and, for the blue chip firms at least, are likely to be significant drivers of consolidation.

While companies insist that the rationale behind the decision to embark on M&A activity is extremely complex, for some observers the reasons are all too painfully obvious.

If you look at the big cap pharma M&A activity, it's almost always when there's a big gap because of patent expiration, so I'd be inclined to say that many mergers are borne out of fear, says Denise Anderson, European pharma analyst at Kepler Equities. Of course, when you look at companies' press releases they never admit that having to fill the pipeline gaps is the real reason; instead they talk about synergies in marketing and research.

Anderson's view sums up one distinct school of thought on blue chip pharmaceutical M&A activity. It expounds the theory that the larger pharma mergers, such as Sanofi-SynthÈlabo's takeover of Aventis in 2004 and Pfizer's swallowing of Pharmacia two years previously, are a response to anticipated patent expiries and gaps in the product pipeline, and that rather than addressing the issue of developing new drugs to fill these gaps, firms have tended to buy their way out of trouble. In short, the 'Get out of jail free card' analogy still rings true.

Second school of thought
On the other hand, there is another line of thought that sees M&A activity as a much more strategic move, borne out of opportunity. Companies may embark on a horizontal acquisition to fill unused production and marketing capacity, and to achieve further economies of scale to reduce costs. The merger of Glaxo Wellcome and SmithKline Beecham was a good example of two firms combining to squeeze out cost-savings through personnel resources, facilities and factories to keep the bottom line growing.

Yet, beneath the prominent mega-mergers that dominate media pages are a swathe of smaller `bite-size' transactions looking for specific pieces of capability, such as licensing deals and strategic marketing alliances, which are making firms leaner and fitter. One noticeable trend, especially for big pharma, is the divestiture of non-core divisions such as over-the-counter (OTC) units. In other words, with the correct amount of due diligence, a merger could well be the perfect roll of the dice.

I don't think merger activity is a reaction created by fear so much as the desire to stay ahead of the game, says independent pharma consultant, Ross Williamson. Pharma is adapting reasonably well to the new harsher environment - they are getting leaner in their operations, they are reducing their costs of production and they are getting smarter with their use of salesforces.

He explains that rather than the headline M&A activity model that predominates in market discussions, companies are in fact adopting a number of different models to build critical mass.

If you look at everyone from the majors like GlaxoSmithKline (GSK) through to some of the smaller mid-size firms, they are making discreet acquisitions to get their hands on revenue streams, either around discovery technology or through licensing deals with an option to purchase, he says.

One strategy behind mergers may be buying time, but I think there has to be more than that, says Mark Ravera, MD of Strategic Pharma Consulting in the US. Companies also have to see the longer term benefits of combining two pipelines or boosting their total R&D effort from the two sides coming together. Especially for the bigger firms, a merger is so disruptive to the internal operations of the company, no good will come out of seeing it as a short-term, reactive move.

Striking the right deal
Pharma's propensity to strike a deal is reflected in the most recent market figures. Last year's PricewaterhouseCoopers' (PwC) pharma M&A report, Pharma Insights, revealed that there were 1,808 transactions globally in 2004, a rise of 20 per cent over 2003. Notably, four of the top five deals were European. At $60bn, the sanofi-aventis deal was way ahead in terms of value, with the next largest European deal being Bayer's acquisition of Roche's OTC business. While in Eastern Europe, the deal activity rate fell in 2004, in Western Europe the growth rate was 11 per cent. Obviously, pharma is not afraid to strike a deal, but is it carrying out the proper due diligence before it puts pen to paper?

Neal Ransome, European pharmaceutical sector leader at PwC, says that it is not enough for a merger deal to just look good on paper, and that companies can lose value if their post-acquisition integration strategy is not up to scratch.

There is a danger that firms are so focused on the drama of signing the deal that they fail to think much about what they will do afterwards, he says. The smart companies are the ones that spend a lot of time planning the integration well before day one. Companies that, after two years, haven't made the tough decisions on what they keep and what they divest have probably left it much too late.

Williamson agrees, saying that a merger is a very time consuming process for any business and companies going into one have to be certain it is the right move, as well as possess a clear plan about how to make it work and drive out the benefits.

You need a model of how you will operate the company before you start, he says. If you can't articulate that in terms of people, processes and systems, then you will never do it as quickly and easily as you would wish.

With its two most recent mergers, Pfizer is perhaps the best example of how extensive forward planning can reap huge benefits. When it acquired Warner Lambert and Pharmacia, in both cases Pfizer appeared to have it all mapped out in advance.

On the days the deals were finalised, they knew exactly who was going to be in charge of every group, every division and every office, so that on their first official days of combined operations they were ready to go, enthuses Ravera. That doesn't happen every time - some of the other larger mergers, such as Novartis (1996) and GSK (2000), took a little more time; they took a bit longer to organise the lower levels.

The fast-paced media world in which we live means that the next big story about a possible European M&A move is never far away. Only three months into the current year and already Serono and AstraZeneca (AZ) have been subjects of takeover speculation. In the case of Serono, Novartis was talked up as an almost cast-iron bidder much to the umbrage of chief executive, Daniel Vasella, who actually called for financial regulators to look into the role that hedge funds and the media had played in ramping up speculation that his company was about to swallow the rival Swiss biotech. Rumours and stories about potential mergers can spread around the investment market quicker than an Australian bushfire, but while they often cause short-term share price volatility, they are usually short on solid facts.

As Anderson notes, the swathe of recent large-scale pharma mergers has had one lasting repercussion: there is now a real dearth of viable options for European big pharma companies looking to consolidate.

Look at what Novartis has done, it tried to go after Roche; that didn't work. It tried to go after Aventis; that didn't work, she says. It's certainly not going to go after sanofi-aventis, so that leaves GSK and AZ as the only two possibilities and transatlantic M&A in the blue chips is very rare.

There will always be stories flying around and Novartis itself has said that it continues to look at all possibilities, but looking at the options, there aren't that many left.

There still remains a faint possibility that a US-based firm will decide to look at European options, but history would appear to bet against it. Even Pfizer's 2002 acquisition of Pharmacia, which had Scandinavian headquarters, was essentially a US merger, seeing as its primary stock listing was in the US. The majority of US firms already have a strong affiliate presence on European shores so would not be looking solely to acquire to extend European capabilities.

Between the big pharma players, it's not so much about gaining a European or US position, it's more about finding synergies in pipelines, therapeutic areas and marketed drugs on a global basis, comments Ravera.

WHAT the future holds in store
While the media waits for the next pharma mega-merger to fill their column inches, European companies will continue to adapt to their surroundings, and there could well be some significant mid-tier deals as companies look to move on to the next stage.

It is very difficult to predict what the future will hold in terms of big pharma activity, but the consensus is that if we are going to see a big European deal in the near future, it will most probably involve Novartis.

Out of all the European firms, I'd say Novartis is the most likely to make a move and I wouldn't rule one out in North America, says Williamson. If you want to compete with Pfizer for global distribution, Bristol-Myers Squibb would be a decent target. Looking further down the line, in 24-36 months' time I could envisage a post-Jean Pierre Garnier GSK making an acquisition.

While the investors and the media will continue to deliberate on who will be buying whom, pharma firms will carry on selling their products while weighing up the options before deciding to roll the M&A dice. Whatever happens in the future, one thing is for certain: the talk is never going to stop.

The Author
Gareth Carpenter is assistant editor on Pharmaceutical Marketing Europe and Pharmaceutical Marketing magazines

2nd September 2008

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