But investors should not be put off by this contraction. Larger companies will continue to look for strategic acquisitions, which will provide additional returns for investors.
Recently, many of the large deals have either been driven by ‘specialty pharmaceutical’ companies, which aimed to drive all their growth from acquisition, or from large pharmaceutical companies looking for more favourable corporate taxation regimes.
These tactical deals caused a large spike in M&A volumes over the last few years, effectively outpacing more strategic deals which are implemented to provide long-term growth. Large pharmaceutical and biotechnology firms mainly acquire smaller rivals to access innovative new drugs which have significant sales potential.
The volume of these strategic deals has remained constant over the last decade, irrespective of the current economic cycle. However, the premium paid for these deals depends on the benefits of the acquisition and is typically between 30% and 60%.
This constant demand for innovative technology from larger rivals underpins biotechnology valuations and can be the source of additional return for investors. For example, since last September ZS Pharma, Anacor, Dyax and Medivation have all either been acquired or currently in a bidding process.
From a biotechnology firm’s perspective, acquisition by a large firm is often attractive. Not only does it give them the necessary cash to fund future development but also allows access to high-quality clinical development and marketing teams. The expertise of these teams will ensure a drug can reach its full potential.
Appetite for acquisition does not mean that larger firms have given up on their own R&D capabilities. In the past, pharmaceutical companies solely focused on developing new drugs in-house. But over time firms recognised a well-resourced R&D department was no guarantee they would discover the best-in-class drug. Product development is such a serendipitous process that it’s just as likely that a smaller firm will be successful.
While large pharmaceutical companies still fund R&D to give them a fighting chance of finding the next multi-billion blockbuster product, they also use this in-house expertise to determine if a rival has a better drug. There has been a shift in the culture: it’s not important where the drug was developed but it’s important to own the compound with the greatest clinical benefit and therefore maximise the potential value.
Furthermore, larger companies have quite specific criteria when looking to acquire biotechnology firms. The bid target should ideally have a “wholly-owned” asset with global rights. Most companies want the drug to be in late-stage clinical development, or already launched, to reduce the risk. Sometimes, however, firms are prepared to buy companies with earlier stage compounds.
Pharma companies also look for drugs that treat conditions which address serious medical needs and have major improvements over the current standard of care. This means less competition and stronger pricing power. There should also be solid patent protection as well as no immediate or obvious competition on the horizon.
Acquisitions will not just be confined to public companies but will extend into the privately-owned firms. Owning a selection of privately owned firms will allow the investor to make the most of large companies’ constant appetite for innovation.