Pharmaceutical companies are striking deals at a dizzying rate. The collective value of 2015’s deals is on pace to break the previous record, which was set only last year. Analysts and industry experts say this fervor is a product of shifts in the industry’s competitive landscape and executives’ acquired taste for more focused and streamlined business models, even at the world’s largest pharmaceutical companies.
In the latest round of negotiations, the Wall Street Journal reported Thursday that Pfizer Inc. and Allergan plc have begun talks about an acquisition that could be the industry’s largest in history given Allergan’s market cap of $113 billion. Allergan confirmed the companies were in “preliminary friendly discussions” in a statement posted to its website.
The announcement comes even while Allergan completes the sale of its generics unit to Teva Pharmaceutical Industries in a $40.5 billion deal announced just three months ago. Pfizer kicked off 2015 by announcing that it would buy Hospira Inc., which produces injectable drugs and biosimilars, for $17 billion. If this latest purchase is also completed, Pfizer will welcome brand name specialty drugs including anti-wrinkle Botox injections and Namenda for dementia to its already-expanding portfolio.
Such fondness for acquisitions reflects the rapid growth of deals taking place across the pharmaceutical industry this year. In the first half of 2015, pharmaceutical companies struck $211.7 billion worth of deals compared with $205.4 billion in the first half of 2014, which wound up being a record year in both the volume and value of agreements.
To some degree, this trend fuels itself. “I think you just get a little bit of a feeding frenzy going on,” Max Jacobs, a biotech analyst at Edison Investment Research, says. “You're worried that the companies you would ideally like to take over in two to three years might be taken over so you have to get them now.”
But groupthink isn't the only factor at play. Mergermarket reports that pharmaceutical executives say the single largest driver for recent deals is to reduce costs through operational efficiency and to seek a lower tax rate in countries other than the U.S. If the Pfizer-Allergan purchase proceeds, Pfizer could claim Allergan’s Dublin headquarters as its own and save the company millions of dollars a year in corporate taxes. Ireland’s tax rate only charges companies 12.5 percent of profits. The U.S. has the highest corporate tax rate of any country, and companies in the U.S. can pay up to 40 percent in some states.
“If they became an Irish-organized company, the taxes could easily go down to half of what they are today,” Albert Wertheimer, a pharmaco-economic expert at Temple University, says.
Many of Pfizer’s competitors have completed so-called tax inversion deals in recent years, and CEO Ian Read said on Thursday at a Wall Street Journal event that he thinks the New York City-based drugmaker is suffering as a result. “I feel we are at a tremendous disadvantage right now in that race,” he said.
In addition to earning a more favorable tax code, large pharmaceutical companies are increasingly focusing resources on a few key areas rather than spreading themselves across specialties ranging from animal health to cosmetics. Increasingly, management teams are choosing to become the best company in two or three areas such as cancer or neurological disorders, rather than funding research teams that try to find breakthrough treatments for every disease at once. Jamie Davies, head of healthcare and pharmaceutical analysis at BMI Research, says this “de-diversification” is another factor fueling the current deal-making frenzy.
Pfizer is among the companies that have adopted this strategy. Read has even said the company is considering splitting into two or more entities focused on patented and off-patent drugs to slim down its operations and maximize value to shareholders. “I think the consolidation is being driven by companies that have the cash and want to accelerate their portfolio,” he said at Thursday’s event.
Les Funtleyder, healthcare portfolio manager at E Squared Asset Management, says acquiring Allergan could be one way to ensure each division is strong enough to stand on its own before the company breaks up.
“You want as many products as you can going through the same channel to leverage efficiencies of scale,” he says. “So the bigger you are, the easier it is to operate in various product classes and therapeutic classes.”
At the same time, many large companies have found that it’s often faster and cheaper to acquire a smaller company with a promising pipeline of potential drugs that are almost ready to hit the market than do the hard work of developing drugs in-house from scratch. While most pharmaceutical companies still fund robust research departments, they are increasingly looking elsewhere for products that can complement their specialties.
“You can never have enough pipeline because products fail so often,” Funtleyder says.
Companies do need cash to make these purchases, and the Pfizer-Allergan deal should expand Pfizer’s financial base substantially, making it easier to be aggressive and competitive in its acquisitions. Such heft also gives the company more influence when it negotiates with governments to set drug prices outside of the U.S. or approaches suppliers with bulk orders.
“I think everybody's trying to bulk up to have a better position to deal with the Affordable Care Act, which brought another 10 million people to the market,” Weirtheimer says. “There's profit pressure everywhere.”
Low interest rates that barely outpace inflation have also spurred companies to be bolder in their courtship of competitors and smaller firms, as they weigh the investment potential of keeping money in a bank versus purchasing a company that can generate profits.
“You get zero money if you put it in the bank, or you get something if you buy a company,” Funtleyder says. “Zero percent interest rates have led to misallocation of capital.”
Of course, not every deal is a merger or acquisition. As companies strive to specialize and focus their missions, more have chosen to swap or sell off divisions that deviate from their core missions. Earlier this year, Novartis completed the trade of its vaccines division to GlaxoSmithKline in exchange for GSK’s oncology group. Companies are also entering into collaborative deals to with partners that have similar interests to cooperate in commercializing and marketing treatments in ways that neither could achieve on its own.
“It’s almost impossible to discover a drug and take it through clinical trials on your own – at the very least, you need to partner,” Davies says.
Pharmaceutical executives recently surveyed by Mergermarket said they expect the fury of deal-making to hold in the second half of 2015. But Wertheimer is skeptical of its long-term sustainability, and expects it to die down.
“Merger is not very sustainable. Acquisition of another company isn’t very sustainable because you'll see a huge bolus of increase this year, and then what do you do next year? You have to buy another company,” he says.