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19 June 2008
Who's Next?
Outlook for merger activity in
Specialty Pharmaceuticals
David M Steinberg
Research Analyst
(+1) 415 617-3296
david.m.steinberg@db.com
Edward Y Chung
Research Associate
(+1) 415 617-3301
edward.y.chung@db.com
Rosemary Wang, CFA
Research Associate
(+1) 415 617-4233
rosemary.wang@db.com
Fundamental, Industry, Thematic, Thought Leading
Deutsche Bank Company Research's Research Product Committee has deemed
this work F.I.T.T. for our clients seeking differentiated ideas. Here our specialty
pharmaceuticals team examines the forces that are shaping the busiest mergers &
acquisitions cycle ever in this sector.
Deutsche Bank Securities Inc.
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Investors should consider this report as only a single factor in making their investment decision.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
FITT Research
Sector Performance Versus S&P 500
75
80
85
90
95
100
105
110
115
6/14/07 7/27/07 9/10/07 10/22/07 12/04/07 1/17/08 3/03/08 4/15/08 5/28/08
Indexed to 100
S&P 500 DBSI Large Cap DBSI Mid Cap DBSI Small Cap
DBSI Large Cap
S&P 500
DBSI Mid Cap
DBSI Small Cap
Source: FactSet
DBSI Specialty Pharma Indices
. W/W YTD Y/Y
DBSI Large Cap (>$5B)* -1.2% -5.8% -9.8%
DBSI Mid Cap ($1B-$5B)* -3.9% -1.6% -4.1%
DBSI Small Cap (<$1B)* -4.6% -10.6% -1.4%
AMEX Pharma (DRG) -1.6% -15.3% -18.6%
NASDAQ Biotech (NBI) -2.2% -4.8% -3.4%
S&P 500 0.0% -7.4% -10.7%
* Indexed to 100 (beginning June 14, 2007)
Fundamental: a four year consolidation boom, by far the most active to date…
Since Specialty Pharmaceuticals gained critical mass in the mid-90s, there have
been several cycles of consolidation. The current merger cycle began in late 2003
and accelerated dramatically between 2005-2007, which we anticipated in our
inaugural “Who’s Next?” report published three years ago. This cycle has
overwhelmingly surpassed all other consolidation periods—even including the
1999-2001 “bubble” period. From 2005 to 2007, there were 59 announced
transactions, averaging nearly $1.6 billion in value.
Industry: …driven by competition and a search for longer product life cycles
Both generic drug companies and branded specialty marketers have been very
active participants in the current merger era. Most branded companies are seeking
products with longer life cycles—largely reflecting either near-term generic threats
or a feared slowdown in key revenue drivers. Intense competition and rising
globalization has fueled more active consolidation among generic drug companies
in the past couple of years. Not surprisingly, drug delivery companies are not
being acquired as rapidly of late, as this sub-sector continues to lose luster within
the pharmaceutical industry.
Thematic: pace of mergers should remain robust—if markets stabilize
The key fundamentals underpinning the ongoing merger cycle—largely built on
strategic acquisitions—remain firmly in place. That said, during 1H08, the pace of
mergers did not slow down—but the average size certainly did, largely due to the
weakness in healthcare equities. If markets stabilize, we expect continued activity.
Thought Leading: where the activity is likely to occur
We continue to explore three broad consolidation themes: branded specialty
marketers seeking longer product life cycles; generic companies seeking
complementary assets or critical mass; and the presence of Big Pharma—perhaps
acquiring at least one larger Specialty Pharma player and possibly even a larger
generic company. Purchases of private companies seeking an alternative to
increasingly discriminating IPO financing are also likely to continue.
We identify 24 potential acquisition candidates
We broadly define three classifications of acquisition candidates: profitable
companies, developmental-stage companies, and special situations – and identify
24 potential candidates in this report. Given the recent increase in buyout activity,
we also identify several companies that fit leveraged/managed buyout criteria.
Table of Contents
Executive summary ........................................................................... 3
Outlook: we identify three broad consolidation themes ...........................................................3
Valuation ..................................................................................................................................4
Risks ........................................................................................................................................4
The four year M&A boom – will it continue? .................................. 5
Recent consolidation cycles......................................................................................................5
2005 – 2007: The mergers & acquisitions “boom” era ............................................................7
Three recurring consolidation themes.....................................................................................11
Specialty Pharma: seeking to increase/maintain growth.........................................................11
Generic drugs: consolidation in response to intense competition ..........................................12
Big Pharma may be looking at Specialty Pharma ....................................................................13
Where was the consolidation focused?..................................................................................14
Distinguishing features of the current M&A cycle ..................................................................15
Common attributes of transactions in Specialty Pharma ........................................................17
Trends in premiums offered for acquisition targets ................................................................19
Three years later, how did our forecast pan out?....................................................................20
Crunching the numbers: the “sweet spot” for our proposed takeout candidates..................22
A number of potential consolidation candidates.....................................................................25
Case studies A: Generic drug consolidation ................................. 29
Consolidation in response to intense competition ..................................................................29
Mylan-Merck KGaA generics: a high price to pay for global diversification.............................29
Teva-Sicor: a sizable and highly complementary business......................................................31
Barr-Duramed: generic buying quality branded assets and complementary generics ............33
Mylan-King: right rationale—wrong companies ......................................................................34
Case studies B: Big Pharma buying Specialty Pharma................. 37
Attempting to mitigate the impact of generic erosion on key franchises ...............................37
GlaxoSmithKline–Reliant: liquidity for venture investors; jury is still out for GSK ....................37
J&J-Alza: rare “blockbuster” deal involving Big Pharma.........................................................39
Case studies C: Branded marketers; Various M&A strategies .... 41
Diversification, critical mass, and longer life cycle products...................................................41
Shire–Transkaryotic Therapies: strategic success for Shire; mixed outcome for TKT .............41
Cephalon’s strategic acquisitions............................................................................................42
Cephalon–CIMA: largely a defensive move to protect a key franchise ...................................43
Cephalon–Anesta: outstanding – for both companies.............................................................45
Cephalon–Salmedix: another savvy acquisition.......................................................................47
Case studies D: Small cap companies mergers ............................ 49
Seeking relevance and/or survival ...........................................................................................49
Noven–JDS: attractive exit strategy for JDS investors; highly dilutive to Noven ....................49
QLT–Atrix: diversification, critical mass and relevance ...........................................................51
Appendix A....................................................................................... 53
Appendix B....................................................................................... 54
Executive summary
Outlook: we identify three broad consolidation themes
We begin this report by examining recent consolidation cycles—1999-2001 (the high P/E era)
and 2001-2003 (the “inward-looking” era). After this two-year lull, M&A activity gradually
accelerated during 2004 and turned into a virtual consolidation “boom” starting in early 2005.
And, since the beginning of 2008, the pace of transactions has largely kept on tempo with
the 2005 to 2007 “boom” phase, despite the very significant recent disruption in the credit
markets and corresponding turbulence in the equity markets. However, we have observed a
sharp decrease in the number of sizeable transactions.
We believe that the key drivers necessary to stimulate broad merger and acquisitions activity
that emerged in 2004 still largely remain intact, and if equity markets stabilize—the
fundamentals are in place for continued robust consolidation activity. And, concurrently,
larger transactions should re-commence, in our opinion. On the other hand, if “bear” market
conditions continue to prevail over the next few years, then purchases of smaller, less wellcapitalized
companies with few viable strategic or financial options will likely accelerate.
We continue to see three broad recurring themes in this most recent consolidation phase:
Branded specialty companies seeking to 1) increase/attain critical mass; or 2) diversify
away from slowing product lines, with a central focus on purchasing companies with
longer life cycle products (e.g., long patent lives).
Generic companies 1) purchasing other generic manufacturers typically to fill a void in
product lines, technology base, or geographical presence or; 2) purchasing other generic
companies for “defensive” purposes (e.g., API supply, rationalization), or: 3) while
occurring with less frequency, occasionally acquiring branded specialty companies (or
products) to move up the “value chain.”
“Big Pharma” 1) more frequently acquiring small technology-based or moleculeenhancing
drug delivery companies to create high value pipeline products and 2) less
frequently, buying large specialty pharmaceutical companies to expand their product
offerings and fill revenue gaps from patent expirations on key drugs. In addition, a
possible emerging theme could be 3) the acquisition of generic businesses.
Several distinguishing characteristics of this M&A cycle remain intact: 1) Cash-rich,
“product poor” companies have been trying to replace what they could not otherwise
generate from their own internal R&D via strategic acquisitions. 2) An increasing number of
cash-based transactions, as many acquirers have built sizeable cash balances. 3) With the
discriminating IPO market of the past four years, which has been shut down for the past six
months, M&A has increasingly become a popular exit strategy for capital-constrained private
companies in the sector. 4) Emerging concerns over reduced future pricing flexibility in the
U.S. suggest Europe and other international territories may be a growing source of
geographic diversification. 5) The purchases of closely held companies as a means to provide
liquidity to a concentrated shareholder base.
In addition, we have recently observed the emergence of two additional distinguishing
features of the current M&A cycle, including: 6) the purchase of US-based firms by foreign
pharmaceutical companies, largely corresponding to a decline in the relative value of the US
dollar, and 7) an increase in leveraged buyout activity of specialty pharmaceutical companies,
particularly during the height of the credit market “boom” in 2006-2007.
We also review the M&A activity has occurred among companies featured on the M&A
target list published in our inaugural “Who’s Next?” June 2005 report. Among 36
potential consolidators and acquisition targets that we identified, 14 have been involved in
merger transactions over the past three years. And six of the 24 companies we highlighted
as potential acquisition candidates have already been purchased. Moreover, our retrospective
analysis suggests that there is a higher probability of acquisitions occurring in profitable, midcap
Specialty Pharma companies, as five of the 11 companies with market valuations
between $750 million and $5 billion that we previously highlighted in this category were
purchased during the aforementioned period.
We broadly segregate our list of acquisition candidates into four classes:
Profitable companies: Among profitable, generic companies, we highlight Barr,
Watson, Impax, KV Pharmaceutical and Germany-based STADA, among others. As for
profitable, mid-to-larger capitalized branded names, we would highlight Allergan, Shire
and Perrigo, among others. In the profitable, smaller capitalization arena, we cite Eurand
and Medicis, among others.
Developmental-stage companies: Nearly profitable developmental stage companies
that have attractive late-stage pipeline assets include Savient and Barrier. We also cite
potential take-outs of companies that have a longer horizon to profitability, including
Cadence and Auxilium, among others.
Special situations: A lucrative product partnership with a potential acquirer is a key
here. We highlight Cypress Biosciences (Forest Labs) and XenoPort (GSK), among
others. We also note there are fewer likely buyers for these candidates because of their
partnerships.
Note: we are not advising investors to purchase shares in any particular company for the sole
purpose of a take-out. Please see Figure 19 (page 58) for our fundamental recommendations
where applicable, which are supported by our most recently published company reports.
Potential consolidators: If history is any guide, we highlight Teva, Novartis/Sandoz and Barr
as key potential generic acquirers to watch, Allergan, Cephalon and Shire among specialty
pharmaceutical companies; and Johnson & Johnson, Pfizer and GlaxoSmithKline among
large-capitalized companies.
Valuation
For profitable branded specialty pharma companies, our valuation analysis is typically based
on applying a terminal P/E multiple—in a range from in-line to a premium to estimated
earnings growth rates, determined by a given company’s growth prospects – to forward oneyear
earnings. For generic companies, our valuation analysis is also based on applying a
terminal P/E multiple—in a range from a discount to in line with estimated earnings growth
rates – to forward one-year earnings.
Risks
Risks to our fundamental price targets principally relate to slowing or unexpected changes in
prescription trends for key growth drivers and unanticipated setbacks with developmentalstage
product candidates.
Risks to a continuation of the ongoing M&A cycle include: 1) declining or highly volatile equity
markets, 2) a more stringent regulatory environment as well as 3) a further deterioration in
credit markets, among other factors.
The four year M&A boom –
will it continue?
Recent consolidation cycles
1999-2001—the high P/E era
In the 24-month period from mid-1999 through mid-2001, the specialty pharmaceutical sector
(an amalgamation of branded niche marketing organizations, drug-delivery technology
companies, and generic drug manufacturers – see Appendix A) witnessed a then-record level
of merger and acquisition (M&A) activity. The announced aggregate value was $26.3 billion,
based on a total of 14 M&A transactions or $1.9 billion per transaction (excluding the very
large $12.3 billion Johnson & Johnson/Alza deal, it would be $1.0 billion per transaction).
This activity, not surprisingly, coincided with historically lofty valuations for:
Companies in the sector, which had an average forward 12-month P/E multiple of 48.2x
in October 2000 versus an average multiple of 28.2x over the past 10 years, and for
U.S. equities generally, which had a forward 12-month P/E multiple of 26.3x (S&P500
Index) in October 2000 versus an average multiple of 20.7x over the past 10 years.
Some of these transactions were strategic (e.g., Johnson & Johnson-Alza, Shire
Pharmaceuticals-Roberts Pharmaceuticals) or were opportunities to buy undervalued assets
that could be turned around (e.g., Teva-Copley). However, many transactions, in retrospect,
were nothing more than companies with over-inflated shares buying short-term growth to
“make numbers” (e.g., Biovail-PharmaPass, King Pharmaceuticals-Jones Pharma, Elan-Dura).
This practice, of course, was common in many other industries during this period.
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