By John Pennett, Partner in Charge, EisnerAmper Life Sciences and Technology Group
Entrepreneurship is at an all-time high, and life science IPOs have been in the news every day for almost two years.
Entrepreneurs are advised to build their companies for the long-term horizon (a necessary factor in building a credible IPO roadshow). That means building the company for sustainable success as a stand-alone entity. Yet for every successful IPO, there are twice as many M&A transactions. Why is that?
Why M&A Activity Is Robust
First, despite the many benefits offered by the JOBS Act, the IPO process remains cumbersome and expensive for entrepreneurial companies. Sure, confidential filing, testing the waters, and reduced disclosures help to expedite the process; but IPOs are still a four to eight month ordeal, with no guarantee of success.
In fact, the past few months have seen several biotech and device IPOs pulled back and several dozen requiring significant insider participation to get the IPO across the finish line.
Sustaining the stock price and preparing for the next financing are full time jobs for CEOs. Yet the markets remain frothy, and the IPO queue is full of candidates.
Second, Big Pharma and big device companies are pulling the entire market into the frenzy, driven by the strategic need to acquire innovative and specialized portfolio products, as well as the “bigger is better” mantra. For instance, in one of the larger recent deals, Novartis and GSK traded $20 billion in assets to shore up strategic areas and exit non-strategic areas in the face of declining healthcare spend and competition from generics.
Big Pharma, largely absent from M&A deals over the past few years, spent nearly US$90 billion on M&A in 2014 – taking advantage of their cash-rich balance sheets and low interest rates. Overall, biopharma M&A exceeded US$200 billion in 2014 — well over twice the average annual deal volume seen in the last decade. Being focused on core technologies and therapeutic categories has led to several major M&A transactions and spin-outs by big pharma. In the medical device space, the major players continue to consolidate innovative companies, as scale is the premier force in that segment.
Lastly, shareholder activism is also having some impact on the markets. Spurred by shareholders, several companies executed divestitures in 2013-14, yielding superior returns for investors. Perhaps challenging the corporate strategy status-quo is healthy, as well, as it encourages management to re-formulate their long-term strategies.
Companies are preparing earlier in their corporate life cycle by engaging in pre-deal readiness assessments to ensure they have a thorough understanding of their markets, products, and the competitive landscape. Among the many tasks in a pre-deal readiness assessment, the following are particularly noteworthy:
- Complete a thorough analysis and support for all instruments in the Capitalization Table
- Ensure accounting principles used, internal controls, and IT systems are appropriate and well documented
- Review tax attributes of various transactions, structures, and arrangements to determine if income, sales, or other tax risks exist
- Consider Human Resource policies and business practices, including analysis of the need for “stay programs” for key members of the workforce
- Analyze the competitive landscape, including market share support and new entrants and technologies being introduced into the market place
This exercise can identify critical business risks, including barriers to growth, regulatory changes, cybersecurity threats, and supply-chain risks. Early identification of issues allows companies to get their house in order and prepare business intelligence analyses, which therefore can enhance or preserve significant value in the negotiation room.
In the middle-market, having their audits complete, having respectable internal controls, and clear command and controls of the “numbers” and cap table is critical (both in terms of time and value). But most important is that the target can clearly define its revenue streams and related costs – both current and future expectations.
M&A: 2015 And Beyond
Given a robust economy and ready cash reserves, we expect 2015 to be filled with highly competitive M&A activity in the life science industry. We anticipate a continued rise in deal premiums.
Big biotechs and specialty pharmas have the capacity and need to do major acquisitions that will provide a meaningful impact. We expect to see aggressive targeting of assets within the therapeutic categories where dominance is crucial.
That said, there is a relative scarcity of quality targets that can offer a meaningful impact to the company’s overall valuation. We also expect to see the continued shedding of non-core assets and businesses by the big players.
Mid-cap companies are realizing that, by rounding out their portfolios with additional products, their overall franchise value will increase and allow them to be a more attractive target.
We are also seeing newly formed entities acquiring non-core products from Big Pharma and Big Biotech, attracting funding and aggressively building specialty franchises. These non-core products are in the specialty/generic markets, as well as innovative products.
As there have been several successes in the specialty/generic markets, the competition for such products is becoming more intense and therefore driving up valuations. Given the large number of displaced senior executives from Big Pharma companies resulting from corporate restructuring after M&A deals or due to product/innovative downsizing, there is deep expertise on the portfolios and markets served. Coupled with significant investment dollars looking for quality opportunities, a robust market has formed.
All in all, we see continued strong M&A marketplace, with companies’ growing appetite for transformational deals, a stable U.S. economy, increased focus on entrepreneurship, and easy access to favorable financings.