Pharmaceutical Mergers And Acquisitions: Will They Drive Growth?
As someone who works in the pharmaceutical industry as well as an investor, I was curious as to the net result of all the mega mergers and acquisitions occurring within large pharma. Examples of such mergers and acquisitions could fill multiple blogs but I thought I would point out a brief history of a few industry leaders that were chosen at random.
In 2006, AstraZeneca acquired Cambridge Antibody Technology followed by the purchase of MedImmune in 2007. Sanofi-Aventis was formed in 2004 when Sanofi-Synthélabo acquired Aventis. Pfizer is now the amalgamation of Pfizer plus Warner–Lambert (2000), Pharmacia (2003), and Wyeth (2009). In 2009 Merck acquired Schering-Plough. In 2009 Roche fully acquired the remaining stake in Genentech. Clearly, mergers and acquisitions are occurring all the time and seemingly represent “usual” business as opposed to the exception. Ever since, there has been a virtual explosion of M&A activity of various flavors and motives including large company acquiring small company, small company grabbing large company, merging for assets, acquiring for tax benefits. Various models are also being employed such as the J&J approach of maintaining the name and culture of the their procured businesses but under their umbrella and the recent example of Novartis who purchased not GSK in its entirety, but only their oncology business.
Regardless of their form, the question still remains: have mergers and acquisitions delivered more products and thus more shareholder value, for large pharma? Additionally, how should the value that is being created be assessed and from which viewpoint? Let me start with probably the easiest-long term benchmark to measure, the number of newly approved drugs by the FDA.
More Approved Drugs
Between 1996 and 2000, the FDA approved on average, 41 new molecular entities and biologic license applications per year. Over the next five years (2005 to 2010), the number was averaging 22 per year – a nearly 50 percent drop. Last year the number of new approvals did increase but it is far from clear that mergers and acquisitions are driving the development of more products in large pharma. One critic, in a 2012 article in Forbes Magazine, opined that just the opposite has in fact occurred; large mergers may indeed be stifling innovation. Danzon et al. (2007) analyzed the effect of mergers in pharma/biotech on various measures of performance. He concluded that mergers result in slower growth and a reduction in operating profit. This was echoed by another study in which Ornaghi (2006) examined post-merger performance in the industry, but focused on productivity. Three years following a merger there is a decline in both R&D spending and productivity as measured by patents.
Based on the evidence, the argument that larger mergers and acquisitions result in more approved drugs or innovation is far from compelling.
Mergers are often promoted by very senior management as a way to increase shareholder value by reducing costs and duplication. In certain cases mergers are specifically designed to fill gaps in a product portfolio. However, irrespective of the merger’s objective, the net result should be increased shareholder value over the long term.
I was interested in evaluating how much the collective stock prices have changed for the big pharma companies given the mergers which have taken place, so I performed a retrospective analysis. Five large pharma companies were selected at random, AstraZeneca, Sanofi, Pfizer,
Merck, and Roche, all of which had been involved in large mergers over the past decade and in certain cases multiple mergers. I chose the period from 4/21/06 to 4/23/12. While these are arbitrary dates they represent a period long enough where I would expect to see return given the mergers which had taken place. Furthermore, the period starts before the market crash in 2008 and includes the recent recovery. The results of my analysis are as follows. If I purchased one share from each company on 4/21/06 the combined value would have been $196.86. As of 4/23/12 the combined value of the same group of five stocks would be $188.46. So I would have essentially lost ($8.40) on my investment. There are dividends involved but the story is not really about stock appreciation.
The logical question to ask is how these five stocks compare to the broader industry over the same six year period. I looked at an electronically traded fund (ETF) with a symbol of XBI that represent 40 plus biotechnology stocks. Since XBI follows an equal-weight methodology, smaller component holdings have an equal say in the portfolio’s overall performance, compared to large-cap holdings. On 4/21/06 XBI was trading for $47.82. As of 4/23/12 the ETF basket of stocks was valued at $79.08. Had I invested in this EFT I would have made $31.26 per share or 65% as opposed to losing -4% with my basket of five large pharma stocks. Clearly, the five large cap merger stocks have underperformed a broad based ETF of over 40 companies over the same period. This leads me to question whether large mergers and acquisitions by large pharma regardless of the company, deliver stock appreciation. This is not meant to be a definitive inquiry but it does raise a basic question about the supposed value created by mega mergers in pharma.
Therefore, if it does not lead to more products or increased shareholder value, what is the value of these mega mergers?
Alliances a More Promising Alternative
One of most extensively published studies examining the performance of alliances was performed by Danzon et al. (2005). This report notes that products developed through an alliance tend to have a higher probability of success, at least for phases 2 and 3, and especially when the licensee is a large pharmaceutical firm. Another study, Arora et al. (2007) observed the role of licensing and alliances from 3000 R&D projects in pre-clinical and clinical trials in the United States. One of their chief findings is that licensing improves the probability of success.
In contrast to the results of studies focused on mergers and acquisitions, those investigating alliances found positive effects on R&D performance. They indicate that development experience is generally associated with higher success probabilities, especially in later R&D stages.
I leave it to the reader to consider whether alliances and product licensing are a more prudent task to take for large pharma. You can also learn about a process we have developed for identifying strategic partners by requesting our white paper. I welcome your thoughts.