Right ingredients for a successful M&A - Essay Example

?right Ingredients for a successful M&A Perspectives from the Pharmaceuticals Industry right ingredients for a successful m&a Perspectives from the Pharmaceutical Industry Author’s Name Author’s University Summer 2011 Introduction Since many years, M&A has become a dominant growth strategy for companies all over the world. Pharma Industry has always been a front-runner in engaging in M&A with over 1,345 deals in the last 10 years with the total value of $694 billion (FiercePharma, 2010). This report studies the advent of M&A in Pharma Industry, the key drivers of M&A in the industry and factors that lead to the success of an M&A deal. M&A in Pharmaceutical Industry Historically, the pharmaceutical industry has been one of the most profitable industries, with returns on revenues often exceeding 17% (Bartlett? 2004). The industry is highly fragmented with thousands of big and small companies fighting for their share in the market. However, market leaders such as Pfizer (8.7%), GSK (6.3%), Sanofi-Aventis (5.5%) and Novartis (5%) form a part of Big Pharma innovative companies that thrive on developing and marketing innovative drugs in the market (Datamonitor, 2004). This industry has been in news due to its high M&A activities particularly characterized both by significant consolidation of large pharma firms as well as the vertical disintegration of the R&D process. The impact of M&A activity is evident from the fact that in 1987 the 10 largest firms accounted for about 12 percent of worldwide sales, whereas in 2002 the 10 largest firms accounted for over 50% of total sales (Patricia M. Danzon, 2003) with a M&A deal value exceeding $514 bn. The following table (Ornaghi, 2009) lists the important mergers and acquisitions taking place in the pharma industry. While mergers and acquisitions (M&A) have tended to occur in waves (Pharma Buzz), there have also been other kind of alliances withing the industry such as joint-ventures, co-marketing partnerships and alliances and licensing deals. With the advent of biotechnology in medicine, the biotech pharma has been a key contributor to the M&A deals in late 21st century. The following chart (Kyle, 2008) shows the number and value of biotech out-licensing deals from the year 1997-2006. Factors such as shifting market dynamics from US to Emerging Markets, rising healthcare demand due to ageing population, regulatory and government changes due to economic environment and patent expiration of blockbuster drugs and the failure of R&D have led companies to restructure, grow inorganically and contain costs. Rationale behind M&A in Pharma There are a number of reasons behind which organizations merge or aquire each other, the most presiding one is accelerating growth. Pharma industry has some unique growth drivers that lead the companies to grow inorganically rather in the conventional way. The key drivers of M&A growth in the pharmaceutical industries are: 1. R&D Productivity: The pharmaceutical industry is research-intensive industry, with an average R&D to sales ratio as high as 18%, compared to 4% for US manufacturing industry overall (Pharmaceutical Researchers and Manufacturers of America, 2011). The R&D process is expensive costing $1.3bn in average (Grabowski, 2007) time-consuming (12-15 years) and highly risky in their outcomes. Hence, by joining the research expertise of the two companies, M&As can profoundly improve the research performance of the firms involved. 2. Pipeline growth: An important investing criterion in pharma firms is evaluating company’s drug pipeline. Inspite of the exorbitant R&D spend, drug pipelines of companies are quite barren, especially the late?stage pipelines. Hence it is imperative for the Pharma companies to look outside in order to fill their pipelines. 3. Search for Blockbusters: Blockbusters, defined as brands with annual sales in excess of $1 billion, continue to drive growth. Pharma companies constantly search for blockbuster drug molecules such as Eli Lily’s Prozac or Pfizer’s Lipitor to boast their top lines. 4. Patent Expiries and Generics Competition: The period for which the patented drug can be masrketed is effectively 4-5 years after which the patent owning company loses its exclusivity to market and sell the drug. Numerous generics companies then sell the drugs at reduced (1/10th) prices. The generics cliff for a blockbuster drug results in heavy losses (upto 40% of overall value) and have to be compensated with fast growth. 5. Geographical expansion: M&A is also a tool for pharma companies to have geographical footprints across the world quickly and cost effectively (Staton, 2011). 6. Therapy-led expansion: Pfizer’s Warner-Lambert acquisition, one of the history’s biggest pharma acquisitions, was purely driven by the need to acquire ‘Lipitor’, the anti-cholesterol blockbuster. M&A is also an answer to pharma companies who want to acquire companies that have niche leadership in a particular growing therapy or in a high-potential disease state (Watson Wyatt, 2009). 7. Economies of Scale: Economies of scales and cost-savings are generated due to M&A in production, sales and marketing. 8. Shareholder pressure: Besides external competition, the internal pressure from the board and shareholders to deliver and increase their wealth is also severe and is one of the drivers of M&A. The above points describe the need of M&A in pharmaceutical industry. Even though there is a high need and a rightful justification of M&A, not all deals lead to success. Between 1990 and 2000, there was a tenfold increase in the volume and value of pharma M&A deals, however only 17% of these deals contributed significant value and 50% actually eroded shareholder returns (Cap Gemini E&Y, 2003). Factors defining success in M&A deals A study from Deloitte Consulting (Deloitte, 2007) estimates that 50-80% of all M&A deals across all industries fail to live up their expectations. Particularly, 70% of these deals do not achieve the anticipated synergies while only 23% earn their spent cost of capital. The study also states that the productivity in the merging firms also drops by 50% and after a year 47% of new company’s executives are no longer there. These statistics indicate how risky and costly an M&A deal can prove to be for an organization. Upon studying different M&A deals (particularly in Pharma), these are the factors that come to light in distinguishing successful and unsuccessful M&A transactions: 1. Corporate Strategy Alignment: Understanding the clear strategic rationale behind the M&A deal is one of the important ingredient to the success of an M&A deal. In a study conducted on 1700 mergers (Harding, 2004) and feedback from 250 CEOs, it was found that less than one in three chief executive had a clear strategic rationale for indulging in M&A. Successful mergers or acquisitions consider their company’s growth strategy thoroughly and see if an M&A will actually add value to their portfolio or not. On the other hand, the reason of failure of many such deals is the lack or shortsightedness of the company’s vision and an over-emphasis on short-term legal and financial issues at the neglect of strategic direction of the company. 2. Due Diligence: Screening of Potential M&A targets: Another differentiating factor between successful and unsuccessful M&A cases is the due diligence undertaken in the screening of potential M&A targets. It is, in a way, an extension of the strategic alignment of the company. Once the strategy is clear, the executive understands the criterion for search of potential M&A targets very well. Peer-reviewed research (Angwin, 2001) indicates that effective due-diligence should be a comprehensive analysis of the target company’s entire business, not just an analysis of their cash flow and financial stability as is usually the case. Successful ventures suppliment qualitative research on the management team, with quantitative research on market trends. 3. Realistic Synergies Assessment: One of the biggest mistakes that firms make while deciding for a merger is to over-emphasize the “synergies” present in collaborating with another organization. Synergies here represent the cost savings and added revenues generated due to economies of scale, co-marketing deals etc. However, past research indicates (Henderson, 2000) that unsuccessful M&A breeds from diseconomies-of-scale imposed by managing an enormous and geographically decentralized models of work. 4. Pricing the M&A deal: The common trait in unsuccessful mergers is the over-priced and inflated evaluation of the selling company. An example (outside pharma industry) is the $7.5bn acquisition of NCR by AT&T. AT&T paid a preimum of 95%, lost $6.5bn on deal negotiations while the returns of the deal to company were -16% to AT&T shareholders (Kose John, 2008). 5. Post-merger Integration (PMI): The most important differentiating characteristic between successful and unsuccessful deals is how post-merger integration is conducted. The cultural clashes, unplanned integration choices and lack of communication plan leads to destruction of cost synergies and ultimately the failure of merger. (McKinsey, 2010) Following are few cases from the pharma industry that highlight doings and misdoings in an M&A transaction. GSK: In 1995, Glaxo achieved one of the most aggressive cost savings in the history of pharma M&A with its friendly 100 day takeover of Wellcome that was $14bn in value (Cap Gemini E&Y, 2002). Savings were delivered as shareholder value with a 400% increase in market cap in the 4 years following the merger. Again in 2000, Glaxo Wellcome combined with SmithKline Beecham in a $76bn merger that created 10.8% savings from the merger (much higher than the industry index). The success of these transactions is attributed to good strategic planning and very efficient PMI. Pfizer-Wyeth: Pfizer’s $68 billion acquisition of Wyeth represents Pfizer’s third mega-merger in only 9 years and the largest pharmaceutical merger of 2009. This acquisition is congruent with Pfizer’s traditional strategy of acquiring large firms to fill gaps in its portfolio and product line – the expiration of Lipitor’s patent in 2011, the lack of a promising pipeline, industrial environment challenges and a change in strategy. Pfizer blockbuster products generated $27 billion in revenues in 2008 (56% of total revenues) (Pfizer, 2009). However, the firm anticipated a huge dent in their revenue stream (25.67% of total sales) by the loss of exclusivity of their flagship product Lipitor in 2011 leading to estimated loss of $7.8 Bn. Pfizer had experienced similar revenue declines following the loss of patents on other blockbusters, Zoloft’s patent expiration in 2006 cost the firm $2 billion in annual sales, a hole plugged with the 2003 acquisition of Pharmacia and new drugs from the firm’s pipeline. Pfizer also did not have any significant blockbuster drugs in its pipeline capable of filling the Lipitor hole. The estimated amount of synegies is $4bn. The 15% premium paid to the shareholders of Wyeth did not justify value destruction by negative development in Pfizer’s stock price (Catenion, 2011). The issues with the merger are different organization cultures, over-ambitious synergies and presence of negative synergies in the deal. Every M&A deals are easier done on paper than in practice. Hence, Integration strategy of a merger is most important factor in the failure and success of integration. Following are actions that I would follow to lead successful integration of two pharmaceutical companies: 1. Divesture of Animal health businesses: Since most of the businesses of Pfizer and Wyeth were not overlapping with each other, there was not much expectation of regulatory bottlenecks prior to and during Pfizer-Wyeth integration. However, since both companies own animal health businesses, Pfizer is bound to divest its veterinary product lines. 2. Cost Synergies and Redundancies: Since there are estimated synergies of $4 billion in cost containment, it is necessary to milk these synergies as soon as the merger is finalized. Pfizer would have to cut all redundant positions, manufacturing plants and distribution channels to save money. It is also better to apply outside-in benchmarks to cost synergies. 3. Effective communication: Effective and transparent communication to all levels of employees is necessary to contain chaos during post-merger situations. By preparing effective deal teams specializing in integration from both companies is required to have seamless interactions between the two parties. I would also involve key line managers in the process of M&A well before the deal is saturated in order to take them in confidence and also to prepare everyone with the ground realities of the merger. Pfizer-Wyeth merger is also susceptible to various companies specific and M&A related risks. Some of the risks are mentioned below in the form of a table: Risks Mitigation/Control Measures Cultural Integration Risk Effective communication and effective project management, attention to critical business areas. Negative Synergies Risk Pre-Involvement of key business managers, calculation of negative synergies before announcement of bids Uncertainty regarding Management Effective communication and timely interactions between both sides at different levels of hierarchies. Leadership should be honest about the ongoing cost containment measures, absence of which affects productivity and talent turnover. Overestimating synergies Usually an asset pricing model is used to calculate synergies, however to ensure that synergies are not over-estimated, the buyer should be realistic about organization’s capacity and revenue growth projections of merged companies. Timing Managers should be realistic about timing of capturing synergies and should not project high cash flows at unrealistic percentages of growth in a relatively short period of time. References: Catenion. (2011). Strategic M&A Support for Pharmaceutical and Biotech Companies ? minimising the risk of “Winner’s Curse”. London: Catenion. Watson Wyatt. (2009). Managing M&A and market risk in the pharmaceutical industry. Watson Wyatt. Angwin, D. (2001). Mergers and Acquisitions across European Borders: National Perspectives on pre acquisition Due Diligence and the Use of Professional Advisers. . Journal of World Business , 36 (1), 32-57. Cap Gemini E&Y. (2003). Mergers & Acquisitions: The Consolidation Chase. Life Sciences Division, Cap Gemini E&Y. Cap Gemini E&Y. (2002). Perspectives on Life Sciences. Cap Gemini Ernst & Young. Datamonitor. (2004). Market Shares. In: Datamonitor Pharmaceuticals: Global Industry Overview. US: Datamonitor. 34-35. Deloitte. (2007). Capturing Sustainable Value: Post-merger integration in the paper industry. Deloitte. Donald L. Barlett and James B. Steele; Laura Karmatz and Barbara Kiviat. (2004). Why Drugs Cost So Much. Available: http://www.time.com/time/magazine/article/0,9171,993223,00.html . Last accessed 15th Apr 2011. FiercePharma. (2010, March 26). Pharma M&A: 10 years, 1,345 deals, $694B. Retrieved May 2, 2011, from FiercePharma: http://www.fiercepharma.com/story/pharma-m-10-years-1-345-deals-694b/2010-03-26 Grabowski, J. A. (2007). The Cost of Biopharmaceutical R&D: Is Biotech Different? Managerial and Decision Economics , 28, 469-479. Harding, D. a. (2004). Building Deals on Bedrock. Harvard Business Review , 82 (9), pp. 121-128. Henderson, R. (2000). Drug Industry Mergers Won’t Necessarily Benefit R&D. Research Technology Management , 43 (4), 10-11. Kyle, H. G. (2008). Mergers and alliances in pharmaceuticals: effects on innovation and R&D productivity. In K. P. Yurtoglu, The Economics of Corporate Governance and Mergers (p. 265). Cheltenham, UK: Edward Elgar Publishing,. Kose John, Y. L. (2008). It Takes Two to Tango: Overpayment and Value Destruction in M&A Deals. New York University Leonard N. Stern School of Business. McKinsey. (2010). A new generation of M&A: A McKinsey perspective on the opportunities. Mckinsey & Company. Ornaghi, C. (2009). Mergers and innovation in big pharma. International Journal of Industrial Organization , 27, 70-79. Patricia M. Danzon, A. E. (2003). Mergers and Acquisitions in the Pharmaceutical and Biotech Industries. Pennsylvania: The Wharton School, University of Pennsylvania. Pharma Buzz. (n.d.). Mergers and Acquisitions moving forward hand in hand. Retrieved May 2, 2011, from Pharma Buzz: http://www.pharmabuzz.org/cover_article.php?feature_id=14 Pharmaceutical Researchers and Manufacturers of America. (2011). Pharmaceutical Industry Profile 2011. Washington DC: PhRMA. Staton, T. (2011, February 22). M&A fills patent holes, fuels geographic expansion. Retrieved May 2, 2011, from FiercePharma: http://www.fiercepharma.com/story/ma-fills-patent-holes-fuels-geographic-expansion/2011-02-22 Read More