Clifford Chance’s Benjamin Sibbett and Daryl Fairbairn discuss the nature of M&A in the industry—today and tomorrow.
CCBJ: What are the market trends in the life sciences M&A space?
Daryl Fairbairn: Most M&A in the life sciences sector is executed by strategic buyers – more than 80 percent of the deals last year. They are focused on aligning their product portfolios with their strategic objectives, looking at technological developments to grow and expand into new markets, consolidation in highly fragmented markets, and strategic moves to adjust to pricing pressures. In terms of targets, we see three common themes continuing: first, an increasing tolerance for risk as buyers look to clinical stage companies or assets focused on biologics applications with products for treating unmet needs in rare disease and cancer indications; second, healthcare services including CMOs, CROs and companies incorporating the Internet of Things and Big Data into their business plans; and third, growing cross-border legal and commercial complexity. As far as the market environment is concerned, M&A in the sector is expected to be much busier in the coming year given surplus cash and pent-up demand that awaited certainty on tax reform in the United States.
What kinds of smaller companies are buyers interested in?
Fairbairn: The focus is increasingly turning to biologics products. Buyers are interested in early stage biologics companies because their products address significant unmet needs for specialty products directed to rare diseases. Part of the value proposition is that these products offer less price erosion when the patents expire and higher technical and regulatory standards that offer better leverage in pricing negotiations and guard against competition. In view of the significant revenue pressures on large pharma companies, biologics present an interesting option due to a longer-term revenue promise. The buyers here are typically strategic players.
Benjamin Sibbett: I think Daryl's comment about strategic buyers is right. While these types of investments are often interesting to venture capitalists as well, mainstream private equity buyout firms tend to be hesitant to invest in this type of business unless there is a proven revenue stream. One of the key reasons for them is that their acquisition model is frequently heavily reliant on debt, so they need a proven revenue stream to service that debt while they build out the platforms, enhance the cash flows and potentially enter into new lines of business. They tend to be more interested in CMOs or CROs and other services companies. That's a very different model than the strategics, which are typically far more patient, buy-and-hold types of acquirers.
Fairbairn: One other comment: If you look at the top 20 markets globally for pharmaceutical and medical device products, eight are in emerging countries that have a growing middle class, with growing demand for better healthcare delivery and better patient outcomes. And these countries are pushing very hard to develop and grow their base technology. Consider biosimilars: China reportedly has more biosimilars projects under development than any other country. These markets are hungry for advanced therapies and technologies, and we expect to continue to see more and more buyers looking at European and U.S. targets in order to bring the technologies home and grow these industries outside more established markets.
What are some of the important technologies that are coming to the fore?
Fairbairn: On the biologics side, there's a particular form of cancer therapy referred to as CAR-T-cell therapy, which was first approved by the U.S. FDA just a few months back. CAR-T is a method where a patient's own blood cells are withdrawn and modified to be “weaponized,” effectively using the immune system to specifically recognize and kill cancer cells. The hope is that with a single treatment you can eliminate the cancer entirely. That's a promise that the industry's been working on for a long time, and now it is closer to becoming a reality. Gene therapy is also a technology that has been of interest for a very long time – and we now have the first FDA-approved gene therapy drug. And there is a good deal of interest in gene-editing technologies like CRISPR.
Outside of basic biology, other technologies that are significantly impacting the healthcare sector come from computing developments and the use of Big Data. These developments are revolutionizing what can be done in personalized medicine, treatment and business models and in healthcare insurance. And when you couple that with the Internet of Things, with wearable devices that can report back to the physician, for example, it’s a game changer. We expect to see more types of participants in the M&A space beyond the traditional Big Pharma and big device companies, because the applications are so broad, and they don't necessarily require the same massive R&D investments required for traditional pharma or device products.
Sibbett: I think that's exactly right. We are seeing many investors in the healthcare space looking for ways to get access to and commercialize data. Data can be a powerful driver of patient outcomes. Patients can get a more personalized service delivered, which can improve their lives and reduce the cost associated with patient care, including with respect to insurance. But data can also be monetized to drive financial returns. And the rapid development, over the last decade, of technology that helps access, store, manipulate, analyze and repackage data for commercial use is of great interest to strategic and financial investors alike. This focus on data and technology tends to be more on the services side of the industry, and less on the “science side,” if you will.
Are regulatory developments affecting M&A in the industry?
Sibbett: M&A practitioners were generally hopeful that with a new Republican administration, the regulatory environment around M&A would relax a bit. I think people have been surprised that this doesn't seem to be happening as expected. There's still a pretty robust enforcement appetite within the Department of Justice and the Federal Trade Commission, which look at competition concerns in connection with M&A transactions. And we're seeing a more activist approach on foreign investment in the United States. In fact, late last year, legislation was introduced to modernize the CFIUS (Committee on Foreign Investment in the United States) review process and expand CFIUS's mandate. The healthcare sector has not historically been thought of as an area of focus for CFIUS. But with the emergence of Big Data and the development of technology, we would expect foreign investment in the sector potentially to start drawing greater interest.
Fairbairn: There are a number of other regulatory developments around the world as well. China has been overhauling its rules toto simplify M&A transactions. One important change has been to make it possible for companies to rely, in certain circumstances, on clinical data from other countries when seeking approval to market a drug in China. It remains to be seen how these changes will be implemented, but the expectation is they it will improve the business environment for all kinds of corporate transactions, including M&A. Our clients in these industries have also been looking closely at the implementation of GDPR in the European Union, and, on the devices side, they've been looking at the potential impacts of the new medical device regulations in the European Union on their global M&A transactions.
With cross-border deals, what strategic considerations do buyers and investors need to think about?
Sibbett: You can never assume that another country is similar to your home country. The FDA equivalent in Europe resembles the U.S. FDA in some ways but is fundamentally different in others. In addition, data privacy generally is far more relaxed in the United States than in Europe, though that is starting to change. Even the way in which deals get done differs from country to country. If you're Big Pharma and you're already operating in 90 countries, you'll have a good sense of this. But if you're smaller or more domestically focused and are looking further afield for compelling investment targets, you might get tripped up by assuming that things operate all over the world as they do in your home market. This scenario can really handicap you when you are competing for targets in unfamiliar markets – and can even destroy value that you anticipate getting out of a particular investment – if you aren't aware of and therefore don't build into your business plans and financial models the effects of unfamiliar regulation.
Looking ahead, where do you see the greatest potential for M&A activity in this sector?
Sibbett: I think the recent announcement by Amazon, JPMorgan and Berkshire Hathaway is telling, and also in line with some of the data and technology factors on which we've been focused. These companies are formally coming together to look at ways to take costs out of the healthcare system and to simplify and add greater transparency to the entire process. Technology and data will be key tools in their effort. These companies have enormous resources and are so frustrated by the U.S. healthcare system that they are venturing outside of their core areas of expertise. Planning is in the early stages, but they are unlikely to do it alone – they aren’t healthcare companies. We expect that they may start buying and selling, and that they'll start partnering, to pull together the portfolio of assets they need to accomplish their objectives.
What will future deals look like – mega deals, cooperative arrangements? What are you anticipating?
Fairbairn: We expect to see continuing interest in innovative strategic-partnering arrangements, as well as mega deals. Growth companies need money so they can move their products through the various clinical stages. They can't raise enough from venture capital or on the markets, so they will need to partner at some point. The question is how can Big Pharma structure partnership arrangements that enable it to acquire a partner when things are going well? And how can it maximize the likelihood that R&D is leading to better patient outcomes?
Sibbett: Venture capital indeed has a role to play, but, as Daryl suggests, there is a limit. The venture capital investment is often just that: money. That's very helpful in the early stages of development, but less so later, when you start thinking about how to commercialize a product and develop it on a broader scale. Big Pharma brings not only money but also expertise, infrastructure and decades of experience commercializing products and operating in different markets. So that type of activity will continue – Big Pharma acquiring or otherwise partnering with smaller growth-oriented companies through licensing or other R&D-type arrangements. Mega-deals aren't going away either, as Daryl suggests, and innovative, patent-protected products will continue to attract greater premiums than generics. And if it isn't clear already, we also expect high levels of activity around data and technology to continue.
Benjamin Sibbett is a partner at Clifford Chance. His work encompasses a range of domestic and cross-border M&A transactions, and he has a strong record in healthcare, media and information services deals. Reach him at [email protected].
Daryl Fairbairn is counsel at Clifford Chance. He focuses on representing life sciences and technology companies in a broad range of cross-border intellectual property-driven transactions. Reach him at [email protected].
Published June 1, 2018.