Uncertain markets lead to de-risked approach for pharma M&A deals

This article is provided to FT.com readers by BioPharm Insight—a news service focused on providing insight into the most price sensitive issues in the global pharmaceutical market. www.biopharminsight.com

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Large pharma have begun to take a more de-risked approach to M&A transactions because of the increased complexity of both the regulatory and reimbursement environment, according to industry bankers and sources interviewed by Biopharm Insight.

The life sciences business model is undergoing a period of systemic change, propelled by upcoming regulatory transparency requirements such the Physician Payment Sunshine Act (PPSA), pipeline pressures, intense competitive activity, as well as pricing scrutiny and global economic trends, according to Angela Miccoli, president, North America of Cegedim Relationship Management Americas, a healthcare information technology provider. The PPSA is expected to go into effect on 1 January 2013, where pharmaceutical companies will have to disclose payments made to physicians.

One major impact of these changes, in terms of life sciences M&A, is that current deals have more structure to them. Unless the process is highly competitive, a majority of the compensation for a deal has been in clinical and commercial milestones, said Jonathan Silverstein, a partner at Orbimed Advisors, and previously director of life sciences investment banking at Sumitomo Bank. This allows the acquirer more flexibility to walk away from a transaction if the outlook for a specific compound changes, he added.

Recently, Novartis (NYSE:NVS) walked away from privately-held Protez with only USD 100m paid upfront and Eli Lilly (NYSE:LLY) cut ties with Alnara before a majority of the payments were due, said Silverstein. In the public markets, Sanofi had contingent value rights built into the deal which bridged the value gap with Genzyme so it only paid for the specific value creation, he explained.

George Milstein, a healthcare banker at Cowen & Co., said almost every transaction nowadays has a contingent value associated with the deal. This is partly due to the challenging clinical and regulatory environment. There have been four to five commercial launches in the last 12-18 months, where expectations were fairly high, he said.

Dendreon’s (NASDAQ:DNDN) prostate cancer vaccine Provenge did not meet market expectations within its first 12 months. “Large pharma is now saying, we want strong clinical data, regulatory approval, and we also want to see if it’s a commercially viable drug,” said Jaime Burnes, managing director in the healthcare investment banking group at Cowen & Co.

Late-stage assets garner more attention

The focus is on late-stage assets, and companies are now beginning to seek input from potential takeout partners much earlier in the process, Burnes said. Input from large pharma around how to design the Phase III trial is important. “At the end of the day, if large pharma is not on board with design of Phase III trial, they need to redo the trial [if they want to get the deal done],” he said. “Everyone wants companies with Phase II and III assets,” he added.

The largest voice on the deal team is beginning to be marketing, said Milstein.

“From the bidder perspective, they want to get the job done the first time, and are willing to pay more for a clinical trial that’s done correctly,” said Les Funtleyder, portfolio manager of the Miller Tabak HealthCare Transformation Fund.

The challenging financing environment has forced some companies to evaluate all strategic alternatives. Private companies, which are largely VC-backed, are having difficulties raising capital. Their mandate at the board level is pursue a dual-path strategy, namely an IPO or sell-side mandate to maximize outcomes, said Burnes. The bar has been raised significantly for takeover candidates, Burnes added.

Any drug in development needs to show a clear efficacy advantage, before large pharma is willing to take a “hard look,” said Burnes. If a drug only shows marginal efficacy, it’s not going to justify developing a large commercial infrastructure around it, and potentially have it not reimbursed, he said.

Orphan indications avoid traditional risks

Orphan drugs are less risky, since these drugs do not require a huge sales force to come to profitability, said Grant Miller, managing director and head of equity capital markets at Cowen. In prostate cancer -- where Dendreon is competing -- there’s a lot happening, he said.

Two of the better performing biotechnology stocks have been Alexion (NASDAQ:ALXN) and Biomarin (NASDAQ:BMRN), both in the orphan drug space, Silverstein noted. Both companies have outperformed the sector by a large margin, he said. With orphan drugs, far less expenditure is required for clinical, regulatory and commercialization costs, he said, since companies can run smaller trials, hire a smaller sales force and charge higher prices.

Pfizer (NYSE:PFE) and GlaxoSmithKline (NYSE:GSK) have both created a rare disease division, Silverstein said, adding that four other large pharma companies are considering following this trend. Large pharma is now less concerned about having their name associated with high priced drugs, if they are delivering high value to patients, he said.

Prostate cancer and HCV notable indications of interest

Norway-based Algeta and US-based Exelixis and Medivation are also developing prostate cancer drugs, Miller said. The dynamics around that therapeutic area are changing considerably, and there’s a lot of market attention that may very well lead to deal activity, he said.

Other therapeutic areas that have shown interesting market activity include hepatitis C (HCV), where there is currently a lot of activity. “Vertex (NASDAQ:VRTX) and Pharmasset (NASDAQ:VRUS) are on the winner side, based on their success in the markets,” Miller said. A lot of attention is being paid to them, because how dynamic the therapeutic area is becoming, he added.

Roche recently acquired US-based Anadys (NASDAQ:ANDS) for USD 230m to increase its pipeline of experimental HCV drugs.

In-house model at large pharma in flux

Secondly, pharma is getting leaner on their own R&D and looking externally for pipeline candidates, Silverstein said. When Pfizer announced it will cut USD 1.5-2bn of its R&D expenditure this February, its stock subsequently traded up 5.5%, he noted. Investors want R&D engines to be leaner and for pharma business development teams to become more opportunistic, he said. “To give them an edge in competitive M&A, most of the major pharmaceutical companies have initiated corporate venture funds,” Silverstein said.

Companies are increasingly thinking about other acquisition or in-licensing opportunities after a first acquisition that made sense to build a platform around that asset, said Burnes. Endo Pharmaceuticals (NASDAQ:ENDP) acquired HealthTronics to make a foray into urology, and then made a second acquisition in that space with American Medical Systems for USD 2.9bn.

“We’re also seeing companies cutting non-core areas and re-focusing,” Burnes noted.

Massachusetts-based Biogen-Idec (NASDAQ:BIIB) is one company that decided to divest its non-core assets and refocus on core therapeutic areas. Now the company is looking for acquisitions in central nervous system disorders, and other core areas of focus, Burnes said.

A Biogen-Idec spokesperson said the company divested its oncology assets. Its core areas include multiple sclerosis and other neurodegenerative diseases, such as Lou Gehrig’s disease, ALS, Parkinson’s and Alzheimer’s disease. The company also has a focus in immunology and hemophilia, he said.

“It’s easier for a M&A team and pharmaceutical company to justify an acquisition opportunity that has a technology platform embedded in it,” said Burnes. The rationale is that it de-risks the asset, since it’s not just a drug that they’re buying that has binary risk. “With a tech platform, that makes it sell easier to sell to the board,” he said.

Seattle Genetics (NASDAQ:SGEN), a perennial takeover target, has its shares burdened by a massive number of licensing deals, an industry banker said. However, the company has an attractive technology platform, he said.

Regeneron (NASDAQ:REGN) is also always rumored to be a takeout candidate, but the company is fairly expensive. People want to see the unencumbered part of the pipeline, Burnes said.

The industry banker agreed that while Regeneron has solid science, a lot of the value has been partnered away. The company is partnered with Bayer for ophthalmology drug Eylea and Sanofi with its VEGF compound. “You’d have to have great belief in the unpartnered compounds [to do a] deal,” the banker said.

“Public investors are not rewarding pharma for big deals, and they’re moving towards a de-risked model. They’re not getting rewarded for taking these big risks,” said Funtleyder.

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