Acquisition Enlarges Biotech Pipeline And Revenues
After several quarters of somewhat mall and dilatory acquisitions, Pfizer (NYSE: PFE) made a major announcement at the end of January. The company is buying competitor Wyeth (NYSE: WYE) for $68.0 billion. In doing so, it seeks to enlarge its coffer of biologic and biotech drugs, broaden its business base and expand its revenue sources.
Pfizer is the world’s largest manufacturer of pharmaceuticals. On a trailing 12-month basis, PFE generated revenue of $48.8 billion, EBITDA of $20.4 billion and net income of $10.5 billion. However, the looming expiration of patent protection for several of PFE’s blockbuster drugs, notably Lipitor in 2011, threatens serious erosion of PFE’s ability to generate revenue at the levels to which management, investors and analysts have become accustomed. It comes as no surprise then that PFE has been looking at biologic and biotech drugs in search of new blockbusters; after all, most of the large deals in the biotechnology sector over the past two years have been undertaken by big pharma companies with similar motives.
Pfizer has not been able to develop in-house as many blockbuster drugs as it had hoped; accordingly, it has sought new drugs by acquiring other companies with drugs on the market or in development, in effect outsourcing R&D. The table on page 9 presents a selection of PFE’s acquisition history; of the 29 deals listed, 16 targeted pharma companies (combined total, $246.6 billion), 12 biotechs ($6.5 billion) and one medical device company ($165.0 million). Recently, PFE has been looking to expand into the vaccines business; so, given its acquisition history, the company would favor a mix of pharma and biotech, with an emphasis on vaccines, all of which points in the direction of Wyeth.
Wyeth is engaged in pharmaceuticals, consumer health care and animal health products. While we categorize it as a pharmaceutical company on historical grounds, WYE committed to a strong position in biologics, biotech and vaccines from an early stage. Its Prevnar pediatric vaccine against pneumococcal disease generates about $2.8 billion in annual revenue while its anti-inflammatory biologic Enbrel, which it co-markets with Amgen (NASDAQ: AMGN), is another strong seller. WYE has a strong animal health segment and a consumer health division with such well-known brands as Advil, Robitusson and ChapStick. On a trailing 12-month basis, WYE generated revenue of $23.3 billion, EBITDA of $7.8 billion and net income of $4.5 billion.
Wyeth has been a smaller, but steady acquirer. In January it announced a strategic alliance with Santaris Pharma to discover, develop and commercialize new medicines based on Santaris’ Locked Nucleic Acid (LNA) drug platform. The deal is worth up to $847.0 million, consisting of $7.0 million in an upfront payment, $10.0 million in an equity investment and milestone payments of up to $83.0 million for each of 10 potential targets. Santaris’ LNA platform allows specific targeting and regulation of microRNAs and messenger RNAs as a means to affect gene expression mediated by the targeted RNAs. This collaboration is for three years; WYE has the right to extend the research portion for two years. This gives WYE its fourth platform technology, complementing its small molecule, vaccines and protein-based therapeutics.
Combining the two companies would solidify Pfizer’s dominant position in the pharma industry, with pro forma annual revenue of about $75.0 billion and a stable of proven but admittedly aging blockbusters. It has been suggested that PFE might combine then sell off their animal health divisions, although this would only slightly offset the cost of the deal. In 2006, PFE unloaded its consumer health business to Johnson & Johnson (NYSE: JNJ) for $16.6 billion, a move that drew analysts’ sharp criticism, so this time around it may hold on to WYE’s consumer health unit.
Structuring The Deal
Under terms of the deal, PFE is offering 0.985 shares of common stock and $33.00 in cash for each share of WYE common stock. Accordingly, this deal values each share of WYE common stock at $50.19, which represents a 29% premium to the stock price the day before word of the deal leaked to the media. The premium to the stock’s prior-day price is about half that. What a difference a day makes.
The deal is valued at 2.9x revenue and 8.7x EBITDA; both multiples are lower than other historical, transformative deals of this size, and may well signal a change in valuation and, perhaps, a bottom to this market. In 2002, for example, PFE paid $56.0 billion to buy Pharmacia for 4.1x revenue and 25.8x EBITDA.
How Much Leverage?
In the halcyon days of M&A, a transaction of such magnitude would have involved relatively little equity and lots of debt (think the 2006 privatization of hospital giant HCA.) In light of today’s current credit markets, no one expects such deals to return any time soon.
The financing is structured roughly in thirds: one-third in equity, one-third in cash and one-third in debt. The positive news for the broader health care M&A market is that banks are now lending again. A group of five banks, four of which took Congressional bailout money, have put together a package of $22.5 billion in debt for this deal. They are Bank of America/Merrill Lynch, Citigroup, Goldman Sachs, J.P. Morgan/Chase and Barclays, which as a British bank did not receive any bailout largesse. Not everyone seems to share our optimism. In what may be one of the more loony opinion pieces we have seen in some time, Paul Loeb, author of several feel-good books, railed in The Huffington Post against these banks putting together a financing package for the deal. How dare they take taxpayer money, and use it to make loans? To be fair, Mr. Loeb admits that he is no economist, but can he be so clueless as not to understand that making loans is how banks generate revenue and economic value? Our only reservation is that we would probably have warmer feelings about the credit markets and their ability to support M&A activity if there were 10 deals involving financing packages of $2.0 billion each, literally spreading the wealth around, but this seems to be what the market can bear at present.
As for the cash portion of this financing package, it is estimated that PFE has as much as $27.0 billion in cash and equivalents on hand. The trick is that a large chunk of that is held overseas, and cannot be repatriated without incurring a hefty tax burden or a reenactment of the Jobs Creation Act that allowed for preferential tax treatment of repatriated funds if, so the theory went, the company used them inter alia to create jobs. Not very likely when PFE is laying off staff by the thousands. We expect, however, that PFE’s and WYE’s legal teams will find a way for PFE to use its overseas funds to pay for WYE’s overseas operations without ever troubling the domestic tax authorities.
Implications For The M&A Market
Pundits lost no time in scanning the tea leaves to see whether this will trigger a new wave of acquisition and consolidation. However, this line of enquiry rests on some erroneous assumptions, particularly if we expand the field to include pure-play biotechs as well as mixed biotechs and more traditional pharma companies. One such assumption is that there had been no significant M&A activity before the announcement of this deal. As the statistics in last month’s issue show, the M&A market in biotech and pharma is plenty active, with no need of a jumpstart. Another misconception, we believe, is that the Pfizer-Wyeth deal emerges from nowhere; but it seems likely to us that previous market activity, particularly Roche’s (VX: ROG) bid for the remaining portion of Genentech (NYSE: DNA), factored into PFE’s decision to pursue WYE to enhance its biotech capabilities. Third, due to their size, mega-deals tend to be unique and not to trigger other mega-deals or even a slew of nano-deals.
Querying the players gives us a mixed bag as to whether this deal will trigger others. Roche’s CEO, Severin Schwan recently noted, “Our buys are very, very targeted and we are not interested in mega-mergers … We want to continue with smaller and medium-sized acquisitions. It is also part of our strategy that we have enough liquidity [to undertake deals].” While we wonder if he would characterize the bid for DNA as medium-sized, Mr. Schwan’s message is that his company’s acquisition program is continuing as it had before the Pfizer-Wyeth deal was announced, not because of it. His compatriot Daniel Vasella, CEO of Novartis (NYSE: NVS), observed, “You have to ask if this [Pfizer-Wyeth deal] is a relevant transaction for us. And I think for most companies it’s not. Therefore, I’m not so sure this is a trigger.” So while you must be aware of your competitors in the M&A market, the deals you make must make sense relative to your own company’s goals. Richard Clark, CEO of Merck & Co. (NYSE: MRK), took a more open position. Saying he would look across the whole spectrum of deals, not discounting a mega-deal, he observed, “I don’t think in today’s world any CEO can categorically rule out any type of transaction.”
Despite the doubts raised over the deal serving as a trigger of further consolidation activity, the Pfizer-Wyeth deal does appear to have raised a number of possibilities. Before the announcement of this mega-deal, Wyeth was pursuing Crucell (NASDAQ: CRXL), one of the last independent vaccine makers, in a deal rumored to have been over €20 per share, or as high as $1.5 billion. But once Pfizer entered the picture, WYE called off negotiations with the Dutch company. After that, Crucell declined to put itself up for sale, but it may still be in play whether it welcomes it or not. Sanofi-Aventis (NYSE: SNY) appears to be gearing up for acquisitions, and Crucell may well be in its cross-hairs. Another possible target for SNY, mooted by a UBS analyst in early January, is Merck KGaA’s (DE: MRCG) consumer health business. The analyst valued the deal at about $2.8 billion, which at 4.5x revenue strikes us as a tad rich; after all, SNY paid just under 3.0x revenue for Symbion’s consumer health unit last year. But the financial gossip from Europe suggests that Sanofi has its eyes set on larger targets: it might raise between €17 billion and €20 billion ($22.0 billion and $26.0 billion) to add to its existing $5.1 billion in cash on hand for its war chest, activity which implies much more ambitious acquisitions. Bristol-Myers Squibb (NYSE: BMY) is a natural takeover candidate; after all, it jointly controls with SNY the rights to the blooding-thinning blockbuster Plavix. Apparently, investors took the speculation seriously enough to send BMY’s stock price up over 6% on February 2. Other possible candidates are Amgen and Biogen Idec (NASDAQ: BIIB). We speculate that, due to its new CEO, Chris Viehbacher, Sanofi may be looking primarily at U.S. companies. Before joining Sanofi last fall, Mr. Viehbacher was hired away from GlaxoSmithKline (NYSE: GSK), where he was head of GSK’s U.S., then North American operations. A touch of rivalry may also be at work here. Mr. Viehbacher lost out to Andrew Witty for the CEO spot at Glaxo in late 2007, and may now be seeking to match or better Witty’s program of acquisitions. He has his work cut out for him: GSK has announced 16 acquisitions since Mr. Witty took over.
What the Pfizer-Wyeth deal can do in this environment is change current attitudes and perceptions. If it can show others in the market that it is possible to do good deals with this challenging financial environment, that will be a positive side-effect for M&A.