Big Pharma On the Hunt for Profit

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Big Pharma On the Hunt for Profit

Big Pharma On the Hunt for Profit

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With a record $724 billion worth of mergers and acquisitions (M&A) in the pharmaceutical sector, 2015 would be a truly difficult year to duplicate – much less follow.

Especially since much of that M&A activity was conducted by specialty pharmaceutical companies, whose business model is now in disrepute after the fall of Valeant Pharmaceuticals International Inc. (VRX).

That model involved serial acquisitions of companies possessing the rights to niche drugs, and then skyrocketing the price of those drugs.

This leaves just the pharmaceutical giants in the M&A game. And they seem most willing to play, despite the collapse of the $160 billion merger between Pfizer Inc. (PFE) and Allergan Plc. (AGN).

The Need for Speed

Just look at what happened on April 28, when three deals – totaling $45 billion – were announced. The assets included Abbott Laboratories (ABT), Abbvie (ABBV), and Sanofi S.A. (SNY).

Big pharma companies like Pfizer, Merck and Co. (MRK) and others are looking to find growth anywhere they see a glimpse of profit.

These wily acquisitions, however, are bound to push U.S. politicians to clamp down on price hikes, which was once a fairly easy way for big pharma to increase earnings. But without moderation, the general public is balking at paying higher prices for drugs that were once more affordable.

This leaves pharmaceutical companies scrambling for a new way to maximize their sales without further aggravating the powers-that-be. And it’s looking like the beaten-down biotechnology sector is the perfect avenue.

For instance, in May, Pfizer bought the small biotech firm Anacor Pharmaceuticals (ANAC) for $5.2 billion. Anacor is developing an eczema drug that Pfizer believes could lead to peak annual sales of more than $2 billion.

Low interest rates are also aiding the big pharma companies in their hunt for profit, because it is still relatively easy to borrow money at practically nothing to fund purchases.

In fact, the Financial Times reports that the major pharma companies have already accrued more than $50 billion in debt since the start of 2016. That is the second-highest sum in two decades!

It would appear that the big pharmaceutical companies are loading up on ammo to pursue those smaller biotechnology companies – like Pfizer’s deal.

Precision M&A

The difference from then until now is that large pharma companies have become a lot more focused.

Most large pharmaceutical companies are pursuing what Joe Jiminez, CEO of Novartis AG (NVS), calls “precision” M&A.

Jiminez explains that this kind of deal-making is a drastic change from the mega-mergers of the past, which often left the newly-merged company with nothing more than a collection of assets and cultures that really didn’t fit well together.

But now, instead of having exposure to a wide swath of therapies, most big pharma firms are focusing on just a few segments – vaccines, for example.

Vaccines are a growing business, with viruses like Zika in the headlines. There are only the “big four” left in the vaccine business: the aforementioned Pfizer, Merck, Sanofi and GlaxoSmithkline Plc. (GSK).

This means that drug companies will likely be facing less than a handful of other competitors in a specialty market, rather the wild free-for-all of the past where many companies competed against one other in nearly every disease category.

Of course, there are always exceptions.

Johnson & Johnson

In the case of big pharma, the exception is Johnson & Johnson (JNJ), which still follows a conglomerate approach to the healthcare industry. JNJ is the world’s largest healthcare company, with three main divisions – consumer products, pharmaceuticals and medical devices.

It has come under increasing pressure from activist investors like Artisan Partners Limited Partnership, which wants it to split those sectors into three separate companies.

JNJ has, for the most part, sat out the M&A spree of the past couple years. But I expect the company to make a splash this year with acquisitions for its pharmaceuticals division.

With much of its over-$18 billion in cash “trapped” overseas, and with the Brexit knocking down U.K. and European assets, I would not be surprised to see even the conservative Johnson & Johnson go on a shopping spree in the U.K. – a country which has a lot of promising biotech firms.

It needs the growth perhaps more so than even the other big pharmaceutical companies.

With drug pricing under pressure from multiple sources, expect big pharma – even JNJ – to remain on the hunt for small, fast-growing biotech companies.

Good investing,

Tim Maverick

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By Tim Maverick