High levels of pharma M&A activity will almost certainly continue, driven by a number of  long-term trends, predicts James Baillieu

The pharmaceutical sector has seen a significant amount of deal activity in 2019. Although the volume of deals is on course to be lower than 2018 (when 1,348 were completed), there has been an increase in deal values this year, driven by a small number of blockbuster acquisitions such as Bristol-Myers Squibb’s purchase of Celgene for around $74 billion. Deals with a combined value of over $250 billion have already been announced, surpassing 2018’s total of $242 billion.

Deal activity in the pharma sector continues to be driven by a number of long-term trends. The development of new drugs requires high levels of investment but only carries a low probability of success. A model has effectively developed where smaller, innovative companies – often backed by venture capital financing – fund the initial and riskiest stages of drug development. Big pharma companies can then focus on acquiring the most promising assets by deploying their significant cash resources. They can also use their regulatory capabilities to help navigate the drug through late-stage clinical trials and, if successful, towards commercialisation.

This process enables big pharma to replenish its R&D pipelines as patents on highly profitable branded products expire, removing the right to manufacture and market them exclusively. It also helps companies drive economies of scale to mitigate pricing pressures from governments and other healthcare providers, as well as bulk up in high-growth areas, such as gene therapy and CAR-T.

This year, we’ve already seen the announcement of two blockbuster deals. In January, Bristol-Myers Squibb agreed to acquire Celgene, which will create a specialty biopharma company with a strong focus on oncology, inflammatory and immunologic disease and cardiovascular disease. More recently, AbbVie agreed to acquire Allergan, best known as the maker of Botox, for $63 billion. The move will help AbbVie fill the growing gap caused by falling sales of its blockbuster arthritis drug Humira (adalimumab), which has already lost patent protection in Europe and is set to lose patent protection in the US in 2023. Assuming both deals close, they will rank among the largest deals completed in recent years. Similarly, Takeda also completed its $62 billion-acquisition of Shire this year, which was first announced in May 2018.

Pharma companies are continuing to optimise their product portfolios, both by ‘bolting on’ additional products to ensure they have critical mass in key therapeutic areas and divesting non-core assets, perhaps because of a change in strategy or in order to pay down debt or fund other acquisitions.

Recent ‘bolt-on’ deals include Roche’s acquisition of gene therapy company Spark Therapeutics for $4.3 billion. Luxturna (voretigene neparvovec), Spark’s one-time gene therapy product for treating biallelic RPE65 mutation-associated retinal dystrophy, a rare form of inherited vision loss, has received regulatory approval in both the US and Europe. The treatment costs $850,000 in the US ($425,000 per eye), making Luxturna one of the most expensive drugs currently on the market. Similarly, Biogen acquired Nightstar Therapeutics, the clinical-stage gene therapy company focused on adeno-associated virus treatments for inherited retinal disorders for approximately $800 million, enabling Biogen to bolster its clinical pipeline of gene therapy candidates in ophthalmology.

Although not an acquisition, another significant deal was Gilead’s ten-year global research and development collaboration with Belgian pharma Galapagos. Under the terms of the deal, Gilead will make a $3.95 billion-upfront payment and a further $1.1 billion- equity investment in Galapagos, in a move that will give the US drugmaker access to a portfolio of Galapagos’ compounds, including six molecules currently in clinical trials, more than 20 preclinical programnes and a drug-discovery platform.

Big pharma companies have also been busy streamlining their portfolios by undertaking divestments. In order to win regulatory approval for their own tie-up, BMS and Celgene have announced the sale of Celgene’s Otezla (apremilast), a treatment for psoriasis and Behçet’s disease, to Amgen for $13.4 billion. Other recent divestments include Takeda selling its dry-eye drug Xiidra (lifitegrast) to Novartis for $3.4 billion (with potential additional payments of $1.9 billion if certain milestones are satisfied), enabling Takeda to cut debt after its acquisition of Shire while allowing Novartis to augment its ophthalmology portfolio.

In recent years, there has been an increasing use of more complex spin-offs or demergers to divest entire divisions, as opposed to individual products. Pfizer recently completed its joint venture with GlaxoSmithKline (GSK) to combine the firms’ respective consumer healthcare businesses, which brought under one roof household products such as GSK’s Panadol and Voltaren together with Pfizer’s Advil and Centrum. GSK has already announced that it intends to demerge the business in the next three years as a separate company listed on the London Stock Exchange. This will leave the slimmed down GSK focused on innovative drug development and vaccines but without the high volume (but lower margin) consumer healthcare business.

Similarly, Novartis also completed the spin-off of its Alcon eye care business as a separately listed company on the SIX Swiss Exchange and New York Stock Exchange, although it kept its ophthalmology pharmaceutical business (and indeed bolstered it with the acquisition of Xiidra).

Deal premiums in the life sciences sector have steadily increased in recent years, especially in ‘hot’ therapeutic areas like oncology and gene therapy. For example, Roche paid a premium of over 138% to secure its acquisition of Spark and fend off rival bidders. Significant deal premiums are now commonplace as the competition to snap up the most lucrative new drugs intensifies and bidders seek to deter potential counterbidders.

More often than not, the value of a proposed company depends on the subsequent success of its clinical pipeline. Consequently, it is common for buyers and sellers to have differing views about a company’s valuation. Dealmakers continue to use milestone payments in private transactions to bridge any ‘valuation gap’ and link the amount to be paid to the success of the target’s pipeline. Milestone payments are triggered upon completion of certain defined triggers, such as upon commencement of a clinical trial, successful completion of a clinical trial, receipt of regulatory approval, first commercial sale in a particular market or when sales hit certain financial thresholds.

In public deals, milestone payments are implemented using a ‘Contingent Value Right’ (or CVR) structure. A CVR is essentially a contractual instrument committing a buyer to pay additional consideration to a target company’s shareholders following the occurrence of certain specified triggers. Due to their complexity, CVRs are rarely used except in the largest deals. BMS’ acquisition of Celgene included a CVR entitling Celgene’s shareholders to receive an additional payment of $9 per share (in addition to the upfront consideration) in the event that the FDA subsequently approved three products (by certain agreed deadlines) that Celgene was developing prior to the acquisition was announced.

In the short term, it would not be surprising if deal volumes taper off given the political and economic headwinds around the world. However, given the long-term sector trends, high levels of pharma M&A activity in 2019 and beyond will almost certainly continue.

James Baillieu is a corporate life sciences partner in the London office of international law firm Bird & Bird.