By Allan L. Shaw, a five-time public company CFO (e.g., Serono & Syndax) and has served on five public boards, which included the chairing of two audit and two compensation committees.
“It was not too long ago that the surge valuations of multibillion-dollar biotech deals were negatively received by the capital markets.”
In an environment where the pace of M&A and partnering deals has been nothing short of frenetic due to the industry’s desire for growth, it is necessary to look externally for catalysts. The feeding frenzy we bear witness to is a manifestation of the competitive nature of this pursuit: Where “time is the enemy, and the opportunity is now,” companies scour the landscape to identify opportunities that leverage core technologies/ competencies to drive growth, create value for stakeholders, and create new treatment options for patients. Given this trend, is there an imperative for strategic M&A and collaborations to succeed? If so, how is growth sustained in an increasingly competitive environment filled with expensive crusades from those companies with acquisitive ambitions?
Before tackling these questions, consider the irony of how quickly market sentiment can change perception of strategic transactions. It was not too long ago that the surge valuations of multibillion-dollar biotech deals were negatively received by the capital markets. For example, several years ago Gilead’s stock price tanked after the Pharmasset acquisition announcement. In contrast, Celgene’s recent acquisition of Receptos was greeted enthusiastically with a soaring share price that reflected a rare NPV (net present value) positive deal. This shift in perception underscores the market’s acceptance of the value-creating potential of such transactions; the fact that Gilead recovered the $11 billion price tag within one year of launching Solvadi/Harvoni has made this pill much easier to swallow.
The land grab phenomenon (discussed in detail in my article last month) has created a casino mentality in the capital markets, driving effective premiums to new heights (assuming the “real unaffected stock price can be determined” during bio-mania) while underestimating the considerations and work associated with mitigating the risks of picking the wrong horse. Put another way, this speculation is no different than the wagering that occurs in competitive sports, except in this case, every day is the Kentucky Derby, though with a lower probability of success. In a highly liquid environment with deals being consummated at a record pace and everybody being a target, it is easy to see how the industry has evolved into a spectator sport, being fueled by an-eat-or-be-eaten business-development mentality as investors cheer on companies.
The soaring valuations reflect the confluence of competitive dynamics: the insatiable demand for innovative assets relative to supply, investor expectations for the next big deal — and last but not least — a very liquid market. This dynamic leaves would-be purchasers no other choice than to pony up ever-larger checks and assume increased risk in order to gain access/exposure to exciting, innovative medicines/technologies. Consequently, the size of these bets is escalating in the face of eye-popping valuations, underpinned by scientific and regulatory risks with binary outcomes.
Given the increasing stakes, I thought it would be worthwhile to highlight some best practices that enable successful outcomes, whether you’re in the hunt or deciding which jockeys to wager on. In my opinion, several fundamental ingredients to facilitate favorable outcomes are:
- crystal-clear focus on your needs/goals
- deep understanding of how to leverage your core expertise
- flexibility (e.g., structure, terms, consideration)
It is also important to remember that one size does not fit all, and there should be careful consideration of the alternative business-development strategies available in the toolbox to achieve desired goals. For instance, in some circumstances, buying a company outright is not always effective and efficient capital deployment. This is true particularly in acquisitions predicated by a lead asset whereby the acquirer is paying for assets they do not subscribe value to (e.g., rest of the target’s portfolio). To better illustrate, when you want a steak, do you buy the cow? Collaborations, in contrast to M&A, offer many advantages over an outright acquisition (particularly with respect to precommercial assets). For example, collaborations combine the strengths of larger companies (e.g., global commercial reach and manufacturing capabilities) with the agility and entrepreneurial thinking of smaller companies. Such alliances play an important role in enabling capital/ time-efficient development that complement and enhance core capabilities while allowing for developmental synergies. Of course, development-stage collaborations often serve as precursors to a merger — akin to dating before marriage. If pursued in a targeted manner, this strategy can provide significant pipeline leverage and diversification by cost-effectively increasing the number of shots on goal while diffusing risk (e.g., structuring deals that correlate payments to success-based milestones). Given the insatiable appetite for deals, the competitive environment is requiring much more flexibility on deal terms for would-be buyers desiring access to innovative technologies. The recent Celgene/Juno collaboration is a recent example of this emerging pay-to-play trend for access to groundbreaking experimental therapies, as evidenced by the deal’s significant upfront cash and shift in risk.
The alternative approaches to business development are not mutually exclusive, and given the multitude of considerations and the need for flexibility and creativity, openness to a hybrid approach of innovative alliances, partnerships, and acquisitions may provide the most cost-effective framework. While there are no guarantees of success, executing a business development strategy that harmonizes priorities (or the needs that leverage strengths) is critical to minimizing risks, unlocking value, and creating synergies. To better illustrate this guiding principle, I offer a closer look at some of the strategic objectives associated with successful transactions:
- Draw upon scientific expertise — identify the best science in the world for the stated objective, and determine the most cost-effective solution to bring it in-house.
- Capitalize on development capabilities to reduce cost and lead time. Accelerate the discovery and development of new therapies. Deploy efficient developmental/ life cycle management strategy to expedite time to market, which is particularly critical in an increasingly competitive commercial environment.
- Leverage your therapeutic footprint (including preexisting clinical and commercial expertise) to maximize asset value via enhanced execution. Accelerate commercial evolution and provide further substance and breadth to the product portfolio while reducing execution risk.
- Focus on categories/drugs with high unmet needs in areas not typically prone to innovation to expedite approval with the goal of providing new treatment options to patients.
While this expedition is not for the faint of heart, given the inherent risks and escalating price tags, it is a market reality and needs to be rationalized as a cost of doing business. With that said, developing successful strategies/ approaches that minimize assumed risks will ultimately separate the winners from the losers. Like any adventure, one needs to rely on their compass: Stay true to your strategic vision while remaining grounded to the fluid competitive landscape. Perhaps it is not random that three of the hottest classes of drugs in the past two years all have competitors coming to market in tandem with the lead drug. That is, Gilead has competition already from AbbVie, with J&J and Merck still working on competitive drugs in hepatitis C; two PCSK9 monoclonal antibodies will be approved simultaneously, with a third in the mix when all report clinical cardiac reduction trial data in a year or two. The latter results will determine if these drugs sell billions; and, of course, there are two PD-1 antagonists already on the market (from BMS and Merck), each at a cost of $150,000 annually. Accordingly, one winning strategy is to find out what is hot and find a similar technology to develop, prior to me-too status. Or is this pandering to fashion?
Finally, quibbling about valuations may very well represent rounding errors in the face of success, particularly in a well-constructed portfolio approach to external collaboration. This is best exemplified by two highly acclaimed (retrospectively) transformative transactions: Gilead’s aforementioned $11 billion acquisition of Pharmasset and BMS’ $2.1 billion purchase of Medarex, where both carried purchase price premiums of approximately 90 percent. The latter catalyzed BMS’ evolution, driven by its immuno-oncology Yervoy/Opdivo assets, which are leading an exciting new therapeutic category. Furthermore, this example speaks directly to the merits of a portfolio approach to business development; the incredible success of the Medarex acquisition more than compensated for the outright failure of BMS’ $2.5-billion acquisition of Inhibitex. Bottom line: no pain, no gain, no glory. In this sport, it is either pay to play or cheer from the sidelines.