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AbbVie-Allergan tie-up has biopharma industry searching for next megadeal

AbbVie Inc.'s $84.2 billion Allergan PLC buy has industry watchers speculating which companies might be subject to the next biopharma megadeal.

The transaction value of the AbbVie-Allergan announcement is the third largest of 2019 in all sectors covered by S&P Global Market Intelligence, a list topped by Bristol-Myers Squibb Co.'s $95 billion purchase of Celgene Corp. at the beginning of the year.

Besides the fear of missing out on the next big deal, pharmaceutical companies have several pressure points that suggest they may be ready to buy or be bought, experts say.

"The reason for the acceleration in M&A is continued poor financial performance among the players — not only the acquirers but the organizations being acquired," said PA Consulting's U.S. Healthcare Strategy Lead Bret Schroeder in an interview. "[Competition and regulatory changes] are forcing these companies to take a good hard look at the future and say, the world of the past just isn't going to be there for us, so what do we do now?"

As for who could be next on either side of the auction block, Moody's Michael Levesque said in an interview that the rating agency does not rule out M&A for the industry's top companies with mounting pressure that makes a formative deal a viable strategy.

"Some of the broader industry issues include lower pricing flexibility in the U.S., potential regulatory changes that more directly impact pricing — all companies face the ultimate decline of some of their blockbusters, and then there's also the impact of the tax overhaul," Levesque said. "A lot of these come together and make M&A an attractive option, and so a lot of the companies are looking at it."

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Factors of a deal

Looking at the market performance of the industry's top players, those with lower price-to-earnings ratios tend to be the most volatile and primed for a deal as either buyers or targets. Among selected companies with market capitalization higher than $10 billion, S&P Global Market Intelligence data shows that Celgene, Bristol-Myers and AbbVie — all megadeal participants in 2019 — have some of the lowest price-to-earnings ratios.

The other two — Biogen Inc. and Gilead Sciences Inc. — have similarly low price-to-earnings ratios of 8.2 and 11.1 as of July 9, but differences in their performance tell two contrasting stories.

Biogen's share price has dropped almost 19% year over year, and with such a low price, the company would appear to be available for a premium. But a potential Biogen buyer would have to consider more than just the valuation: the company's growth prospects took a major hit when two late-stage Alzheimer's trials were discontinued in March, causing the stock to plummet. Biogen has only $1.22 billion in cash and $5.94 billion in debt.

Meanwhile, Gilead's stock has only fallen 3.3% year over year. The company also has $17.9 billion cash on hand, bested only by pharmaceutical giant Johnson & Johnson at $18.1 billion, according to Market Intelligence data. That, coupled with its relatively low price-to-earnings ratio, suggests the potential for dealmaking.

"In general, what you would want to look for is a company that has a strong balance sheet, so they have some cash on hand, some assets on hand that companies tend to use as part of that acquisition process," PA's Schroeder said. "I think of strategy pretty simply — either I'm going to grow into new markets or new products or a combination of those two."

E Squared Portfolio Manager Les Funtleyder said the price-to-earnings ratio has an indirect connection to acquisition potential but can be a double-edged sword. While the ratio suggests the health of a company according to the market — hinting at potential deals out of desperation and a premium price — the value of a company with a low P/E ratio would usually not support growth beyond the acquisition.

"If the market says you're not growing, either the market is dead wrong and you can buy the company, or the market is correct in that the growth prospects are mediocre," Funtleyder said. "If that's the case, then why would a company that needs growth buy another company that has no growth?"

The best way to predict successful dealmakers is to assess companies as strategic and cultural fits, matching core products and values, Funtleyder said.

"If you're not doing a deal out of desperation — and I think a strong case can be made that Celgene/Bristol-Myers and AbbVie/Allergan were desperate deals — then you're looking for two-plus-two-equals-five," Funtleyder said.

Accelerating M&A

The AbbVie-Allergan deal was announced halfway through a year in which industry insiders expected to see a flurry of M&A activity due to lower sales forecasts, continued interest rate hikes and 2017's tax reform.

"We've expected an acceleration of M&A among U.S. acquirers ever since the tax overhaul," Moody's Levesque said. "We felt that pipeline-stage deals were more likely than formative deals but we never ruled out any type."

While risk in the industry heightens, so does the number of megadeals, PA's Schroeder said. The previous five years saw buyers making smaller, additive acquisitions, but more recently the deals have grown in size.

"My sense is you've seen more of that in the last 18 months because there's been this realization that, to win in the end, we're going to have to matter," Schroeder said. "You see some of that manifesting itself in the size of some of these deals happening now — to say, listen, if we're going to make a difference, we're going to have to play big, and playing big means we're going to be a top-five player."

In terms of this year's big buyers, AbbVie and Bristol-Myers saw more cash in their hands due to the new tax laws, allowing the companies to pursue such deals and repay debt along the way, Levesque said.

AbbVie was a particularly deal-hungry blip on Moody's M&A radar due to the company's dependence on Humira, the best-selling drug in the world in 2018. The drug will see U.S. biosimilar competition in 2023. Levesque said Humira's decline led AbbVie to prefer a deal that brings dependable cash flow as opposed to a pipeline deal that comes with R&D risk.

"There's no question that AbbVie's business profile is stronger than it would be if it remained standalone," Levesque said. "So we do see the diversification as the main benefit from a credit profile standpoint."

But Botox-maker Allergan was not a target "that we would have predicted," Levesque said, adding that the deal could lead to more risky long-term outcomes.

AbbVie's ability to pay off debt with Humira's continued success before the biosimilar competition would off-set the deal's risk in the near term, particularly from a credit standpoint, Levesque said. Uncertainty will play out in the years after that.

"In this case, the pipeline may not be sufficient to propel growth over the long term," Levesque said. "That's a risk common among pharmaceutical companies, but in this case you also have the added uncertainty about Botox competition."

E Squared's Funtleyder also expressed skepticism regarding the combined company's long-term prospects when Humira's competition enters the arena.

"What I haven't heard from AbbVie is what happens the day after they lose Humira," Funtleyder said. "You buy Allergan, you get through your Humira expiration intact — but then what? And I don't see a 'then what' there."