Merging toward a Full Pipeline

For many years, pharmaceutical and biotechnology companies didn't have a burning desire to consolidate. Fledgling biotech firms were inwardly focused, trying to establish themselves and raise equity. Pharmaceutical companies were enjoying strong sales growth and full product pipelines, and mergers and acquisitions were few and far between. But in today's increasingly challenging marketplace, few companies in these sectors can afford to ignore the potential benefits of melding with like-minded entities.

In search of strategic and financial synergies, biotechnology and drug companies have sporadically launched rounds of consolidation over the past several years. And 2003 was no exception. Last year, overall mergers and acquisitions (M&A) rose in total value over 2002 in both the pharmaceutical and biotechnology industries.

Peter Young, president of the investment banking firm Young & Partners, reports that the number of pharmaceutical sector deals retreated from a record high of 46 in 2002 to 36 in 2003. Young's analysis only includes completed deals valued at more than $25 million.

The total dollar amount of pharmaceutical M&A surged to $66 billion in 2003. This compares with $26 billion in 2002 and is the third highest dollar total since 1989, Young reports. Most of that total, however, derives from the $60.1 billion acquisition of Pharmacia by Pfizer in April 2003. A collection of much smaller deals made up the remainder of the total.

The increase in M&A activity can be attributed to drugmakers' struggle to deal with market pressures as patents for blockbuster drugs expire, generic drug sales grow, R&D costs escalate, and a wide variety of threats to ethical drug pricing rage globally. By combining operations, companies in this maturing industry hope to achieve cost and marketing synergies, develop more potent sales forces, boost R&D, and cultivate a more lucrative commercial product mix.

"Unfortunately, a number of the mergers continue to happen from weakness, not strength," Young says, "and often are not improving either R&D product pipelines or costs beyond short-term cost savings."

A NOTABLE EXCEPTION may be the string of acquisitions completed by Pfizer recently. In 2000, it acquired Warner-Lambert and gained control of the $7 billion-per-year drug Lipitor. And last year's purchase of Pharmacia expands Pfizer's global pharmaceutical market share, broadens its product base, and bolsters its R&D capacity.

"With Pharmacia, we are bringing together two strong and complementary product portfolios that combined will give us unprecedented therapeutic reach," Karen Katen, president of Pfizer's global pharmaceutical business, said at the close of the deal. "The depth and experience of the Pfizer sales force is a distinct competitive advantage for sustaining growth, and we'll use that to increase the already strong positions of Pharmacia in oncology, endocrinology, and ophthalmology." What's more, Pfizer expects to achieve merger-related cost savings of $2.5 billion in 2005.

Despite the consolidation that has occurred since 1999, the pharmaceutical market remains fragmented, Young points out. "There have been only modest changes in market share." Today, the leading firm--Pfizer--enjoys 9.4% of the market. That's not much more than the 7.6% of the market that Merck controlled in 1998 when it was the number one company, he says.

At the same time, "the rankings of competitors have changed dramatically. In addition, with the exception of Pfizer, all other major pharmaceutical companies now have a smaller share of the pie." For example, Merck controlled only 4.7% of the market in 2002. And Aventis, which was the second leading company in 1998 with 6.7% of the market, slipped to eighth place in 2002 with only 3.9%.

As was the case in 2002, U.S. drug companies dominated the acquisition of U.S. pharmaceutical assets last year, initiating 12 of the 22 deals completed, according to Young & Partners' figures.

In Europe, on the other hand, M&A volume declined sharply in 2003. Only seven M&A deals closed in Europe in 2003, compared with 20 in 2002 and six in 2001, according to Young. U.S. pharma companies led four of last year's European deals, while local firms handled the other three.

In Asia, M&A activity rose to six deals in 2003, compared with four last year and two annually for the four years prior. Asian buyers were behind four of the six transactions.

"Asian M&A activity has typically been modest, because Japanese companies were facing cultural and structural impediments to mergers," Young notes. "More recently, however, companies in Japan are beginning to sell off their pharma assets or merge them with Japanese, European, and U.S. companies." Just two weeks ago, in fact, the Japanese drugmakers Yamanouchi Pharmaceutical and Fujisawa Pharmaceutical announced a $7.8 billion plan to combine into the second largest Japanese drugmaker after Takeda Chemical Industries (C&EN, March 1, page 12).

In 2003, most of the Asian transactions were small, Young observes, with the exception of Merck's acquisition of the part of Banyu Pharmaceuticals that it did not already own. "The Japanese recognize that they are falling behind in terms of scale and competitiveness," Young says. "They are struggling to find ways to either maintain their position or sell out."

Two of the most exciting health care sectors for M&A activity in 2003 were medical devices and diagnostics, says Neal J. Ransome, European pharmaceutical sector leader for PricewaterhouseCoopers (PwC) corporate finance. The rate of consolidation of both of these sectors accelerated in 2003, particularly in Europe, he notes.

LEADING THE CHARGE was General Electric, which closed on the $2.0 billion acquisition of Finnish devices company Instrumentarium and announced the $9.4 billion acquisition of U.K.-based diagnostics firm Amersham. The Amersham move is expected to enable GE to accelerate the development of molecular imaging and personalized medicine.

To boost R&D productivity and compete with a growing legion of merged competitors, drug companies will be forced to scrounge for their own merger partners or resort to hostile takeover attempts. Recently, for example, French pharmaceuticals maker Sanofi-Synthélabo opted to make an unfriendly bid for its larger French-German rival Aventis (C&EN, Feb. 2, page 6). "Sanofi-Synthélabo feels they are getting pushed more into the background and strategically they have to do something," Young says. "So Aventis is the target." With Aventis under its wing, Sanofi says it would jump from being the world's 13th largest drugmaker to the third largest, and number one in Europe.

In general, pharmaceutical companies are now more vulnerable to takeover attempts by other drug firms than they have been in the past. Historically, profit-to-earnings ratios have been too high to attract bidders, but those ratios are on the decline, Young notes. As a result, companies will be able to take "a proactive stance to pharmaceutical mergers and acquisitions, something that is important as the number of available merger partners dwindles."

In addition to buying their rivals, pharmaceutical producers will continue to have an appetite for biopharmaceutical firms that can help them "gain access to exciting new technologies or drugs being developed," PwC's Ransome says. Most attractive will be companies with products on the market or in late-stage development "rather than technology platform companies."

In April, for example, Johnson & Johnson bought Scios, a biotech company developing novel treatments for cardiovascular and inflammatory disease. The company's disease-based technology combines protein biology with computational and medicinal chemistry to identify targets and design small-molecule compounds.

And observers believe that similar deals are on the horizon. "The only way for big pharma to plump up its pipelines is to partner with or acquire its more innovative brethren," says G. Steven Burrill, chief executive officer of the merchant bank Burrill & Co. He points to examples such as Pfizer's $1.3 billion acquisition last month of Esperion Therapeutics, a biotech company focused on high-density-lipoprotein targeted therapies for the treatment of cardiovascular disease.

Another example of big pharma buying biotech innovation is Eli Lilly's $400 million acquisition of Applied Molecular Evolution, which is a leader in applying directed molecular evolution to biopharmaceutical production.

But biotech acquisitions are not the only antidote to big drug firms' R&D productivity problems, Burrill notes. Increasingly, drugmakers have found that they can acquire most of what they need through partnerships, which are much more efficient and cost-effective. "Why would a company want to buy a firm if it can strip away all the value simply by 'renting' it?" In many instances, he says, partnering will be "the behavior of choice" for drug companies that want to access innovation, and "we'll see the number of those deals rise dramatically."

Despite the partnering trend, the number of biotechnology M&A deals completed in 2003 soared to 29, according to Young & Partners figures. The deal total is higher than any of the previous 14 years, Young notes. And the total dollar amount invested in M&A rose to $10.3 billion--the highest level since 1999, the year that Agouron, Genentech, and Centocor were acquired.

Young attributes last year's M&A increase not only to pharmaceutical companies' desire for new products but also to biotech firms' need to combine product portfolios and development efforts and conserve cash. The merger of Biogen and IDEC Pharmaceuticals in November reflects the latter trend. "The combination has resulted in a fusion of complementary strengths in therapeutic focus, research and development capabilities, manufacturing expertise, global infrastructure, and financial position," according to a statement by the new company, Biogen Idec.

The Biogen Idec deal, valued at $5.7 billion, was much larger than most biotech M&A in 2003. In fact, only that merger and J&J's $2.4 billion acquisition of Scios were valued at more than $1 billion.

Biotech M&A of U.S. companies by U.S. companies jumped from only six in 2002 to 21 in 2003, according to Young & Partners estimates. In Europe, the volume of biotech M&A deals fell in 2003 but still reflected improvement over the dormant years prior to 2001.

Consolidation activity in the biotech sector will increase in Europe in 2004, Ransome predicts. "As share prices continue to recover, it starts to make it easier for quoted companies to do deals," he says. "The private equity fund-raising market is also starting to improve, and there are faint glimmers of recovery for the initial public offering market, although not helped by the post-IPO share-price performance of some recent new launches in the U.S."

Ransome expects that the improved liquidity in the biotech sector will be a stimulant to M&A, although Europe will follow a few months behind the U.S. markets. He predicts that consolidation in the biopharmaceuticals area will continue "at a slightly accelerated pace" in 2004.

Indeed, biotech is "a little more in favor with investors now," Young says. After being severely punished for poor stock performance from 2000 to 2002, biotech companies recovered last year, he observes. "Biotechnology executives are more hopeful right now," Young says. "They feel there is an improvement with regard to their ability to attract funding and get some traction with their pharma compatriots."

In the near future, Young expects to see "a much heavier tie-in between the biotech and the pharma companies. But before pharma will buy them or put major funds into them, the biotech companies will have to be further along" in the product development cycle than in the past.

And biotech and pharmaceutical companies are also likely to link up with their own kind in the coming months. Burrill predicts that "one or two 'marquee level' biotech mergers, along the lines of IDEC and Biogen, could happen in 2004, as larger cap biotechs compete directly with big pharma." And, he adds, "the year will bring continued consolidation among big pharmaceutical companies, as well as more partnerships--both forged out of desperation to find more innovation."