IP, divestments, fragmentation and the future: M&A in life sciences

The current M&A market: an overview

The last 12 months have demonstrated a strong M&A trend particularly in the US and China. We have also seen the emergence of cross-sector deals especially driven by tech-backed investors (eg Amazon and Google) making acquisitions.

Many of these deals have been powered by the emergence and increased sophistication of technology in the sector and the ongoing entry of consumer-focused digital companies into the market.

Businesses are looking to find new sources of growth in an increasingly patient-centric and digitally enabled world where traditional business models are being challenged. Overlaid with this is a focus on restructuring of portfolios and divestments, driven by specialisations in a fragmented therapeutic marketplace.

However, this is in the context of a changing commercial landscape, plus political uncertainty especially here in the UK (including from Brexit and the resulting economic impact) and in the US (given the rise in protectionist trade policies).

Added to this, we have had five years of unprecedented market liquidity with many start-ups (especially biotech companies developing curative or genetic therapies) being now so well capitalised that they are under no immediate pressure to be acquired.

The IP differentiator

The divergence in M&A activity in patented products by contrast to the generics pharmaceutical sector is marked. The increased level of M&A activity in the latter has been driven by the relative lack of intellectual property rights in the products which these companies market.

Accordingly, the need to create alternative barriers to competition by creating economies of scale and a more comprehensive offering in their chosen area of therapeutic focus is creating M&A momentum.

This is by contrast to the life sciences sector, which is underpinned by intellectual property rights and, in particular, the ability of a company, as a result of its intellectual property assets (in the broadest sense), to prevent others from competing with its products.

The massive investment required to bring a product to market simply would not be worth pursuing if a period of exclusivity (or at least restricted market access) was not available, so to an extent all deals in the life sciences sector are driven by intellectual property.

Much of the acquisition strategy of the life sciences majors has been around targeted acquisitions of companies with intellectual property assets and product pipelines (or alternatively portfolios of such assets) that align with their strategic areas of therapeutic focus.

Restructuring of portfolios and divestments

Divestments play a vital part in rebalancing portfolios – they allow companies to exit de-prioritised areas so that they can devote more attention to core areas. Recent figures suggest that many life sciences companies have plans to divest a substantial part of their businesses.

For example, GSK intends to split into 2 companies within 2 years – one focused on consumer health, and one focused on developing and commercialising innovative drugs.

What's driving this? It is a combination of factors:

• The importance of specialisation in fragmented therapeutic marketplace.
• The classic business model changing as the medical community and patients demand more cost effective and efficient care that takes advantage of new digital platforms.
• Studies show that more focused business models typically out-perform less focused ones.

Aside from this, it can also be part of a wider M&A strategy to complement a rebalanced portfolio (eg Johnson & Johnson acquired a Japanese company focused on dermocosmetic and skincare products).

Alternatively (particularly given the M&A activity driven by generics pharmaceutical sector referred to above), it is precipitated out of anti-trust necessity following merger activity (eg post the Allergan generics business acquisition by Teva in 2015). Anti-trust regulators are becoming tougher and are imposing more conditions on M&A transactions.

Shareholder activism has also risen in prominence over the last few years, and investor pressure is often cited as a reason to divest.

Finally, diversified conglomerates and healthcare assets are optimising their portfolios (eg Siemens floated 15% stake in its medical imaging and diagnostics division).

Emergence of cross-sector deals

The lines between health and technology continue to merge. Many life sciences companies are facing significant challenges to their typical business models, particularly as a result of the recent and ongoing entry of consumer focused digital companies into healthcare.

These companies can use their connected devices data analytics skills and deep consumer relationships to further progress – for example, Apple's newest watch incorporates an electrical heart rate sensor which can take an ECG using an app which has FDA approval.

Alphabet Inc (part of Google) has continued investing in life sciences companies, and Amazon recently acquired Pillpack Inc (a pharmacy delivering medications in pre-sorted doses packaging, which holds pharmacy licences in all 50 states in US).

Institutional interest

Private equity investors have generally been reluctant to invest in the pharmaceutical sector and/or drug development, as it is a costly and lengthy endeavour (which conflicts with their typical hold period of three to five years) with a reasonably high level of risk by contrast to other sectors in which private equity typically invests.

However, several strong fundraising years mean that the funds have cash to spend, and are now considering the pharma space in a new light, whilst still considering the medtech/healthcare sectors as viable investment opportunities.

Looking forward

Divestitures and spin-outs will continue and market fragmentation will still drive deals. This fragmentation is apparent across multiple individual therapeutic areas especially oncology which is the largest and fastest growing therapeutic area, and continues to be a lynchpin of M&A activity.

M&A activity in life sciences and healthcare is likely to be more moderate in some senses, as the typical business model continues to be challenged by tech players in the market.

This might alter the drivers of success, with big data and analytics capabilities being the critical determining factors in the future, not whether a company has the biological and chemical knowhow to create novel drugs and devices.

A tighter focus on a company's core business, especially through purpose-driven divestment as the cornerstone of any M&A activity, will be something to always keep in mind. Portfolio reviews will also be a strategic priority and one of the best paths to sustained growth.

As the life sciences sector becomes ever more patient-centric and the market continues to overlap with technology, it will be those companies which can exploit that convergence that will be the most successful.