For the last half decade, life sciences companies have taken a wait-and-see approach to dealmaking. They’ve been stockpiling their so-called firepower, which according to EY, is defined as, “the ability to do M&A based on the strength of a company’s balance sheet, including its market capitalization, cash equivalents and debt capacity.” Instead, they’re spending it on tiny deals rather than megamergers.
In 2018, life sciences companies stashed over USD $1.2 trillion in firepower. However, they only deployed 16 percent on acquisitions. As EY points out in its 2019 EY M&A Firepower report, that 16 percent is a sharp drop-off from five years prior, when companies used 27 percent of their firepower on M&A.
Additionally, the total aggregate deal value of $200 billion a year that life sciences players were predicted to conduct in the past five years is still $90 billion less than the average M&A total value from 2014 to 2016.
According to Deloitte’s 2019 Global life sciences outlook a new generation of startups and tech giants have emerged, “disrupting the status quo and threatening pharma’s legacy culture.” All around them, their world is being eaten by new, hungrier, and more focused entrants.
To tout a well-trodden example, Amazon announced plans to acquire PillPack for $1 billion in June 2018, kicking down the door for consumer-focused companies to disrupt the industry. Hong Kong-based Alibaba Health, shifted its weight from selling health products online to the health services side of things, leveraging a network of more than 24,000 physicians, pharmacists, and nutritionists to conduct one million consultations per day.
And then there are the smaller incumbents. “While pharma giants are investing in gene-based therapeutic solutions, more than 250 startups are already developing these therapies and building them around the patient,” write the report’s authors. “These startups could merge and form a whole new breed of company with a very different culture around innovation and life sciences.”
This begs the question: how are the big players in the global life sciences sphere being affected by hanging on the sidelines? “At the moment, there is little evidence that life sciences companies have suffered meaningful valuation declines by adopting a wait-and-see approach as it relates to accessing digital or other disruptive capabilities,” say the authors of EY’s Firepower report. “However, there is growing evidence that companies are overly focused on short-term growth metrics, potentially at the expense of longer-term and sustained value creation.”
Deterrents to Dealmaking in the Life Sciences
EY surveyed business executives from 22 life sciences companies with headquarters in the US, Europe, and Japan. These companies have combined annual revenues of more than US $300 billion, representing a cross-section of the medtech, biotech, and pharma segments. So what were the factors deterring dealmaking?
Respondents pointed to high prices/valuations deterring deals, which is an accurate assessment according to EY, given that the average valuations of biotech targets have shot up 78 percent since 2014. Respondents also mentioned geopolitical/trade uncertainties. “Rising valuations, meanwhile, have driven industry firepower to its current levels,” write the authors. “But they have also inflated the price tags for likely acquisition targets, making them prohibitively costly at current deal multiples.”
Meanwhile, a half decade of market liquidity has flooded startups with capital, insulating them from the pressure of acquisition. Of those surveyed, 42 percent say they plan to ramp up dealmaking in the near-term, with a focus on “small- to medium-sized acquisitions valued at up to US $10 billion.” A negligible three percent of respondents are looking to megamergers and digital acquisitions.
Focusing on Portfolio Optimization
Taking a page out of the startup’s playbook, it’s time for big life sciences firms to get focused. According to the EY survey, that’s precisely what they plan to do. 71 percent of respondents say product-focused innovations and optimizing their portfolio is the way forward. And EY’s analysis agrees.
According to the data, companies with focused portfolios outperformed their less focused counterparts, reporting “average five-year historical compound annual growth rates that were seven times higher than their less focused peers.”
“These data are an important counterargument to the claim that megamergers are the logical and easiest path to improved performance,” write the authors. “Indeed, the analysis suggests that the industry’s current focus on bolt-ons and portfolio optimization is not only rational but the best possible use of M&A dollars.”
In a sense, it’s a positive prognosis. As tech giants make missteps trying to delve into the regulatory-dense market and startups hammer out the details on how best to leverage data and emerging technologies, the life sciences giants have benefited from their perch on the sidelines.
But now’s the time to act. And who knows, maybe that banner year is right around the corner? It just may take a lot more deals to get there.