INTRODUCTIONM&A deals in the pharma industrydates back to the industry’s origins. First pharmaceutical companies such asGlaxo, Wellcome, SmithKline are the ones that, after dozens of separate deals,formed the modern GlaxoSmithKine in 2000. The first deals were mostly smallacquisitions with a few significant ones from 1800s to 1980s. Through the endof the twentieth century the deals trend was enhanced with ‘blockbustermergers’, the deals which were valued over $1 billion. In today’s pharma,giants acquire giants.There are two major concerns aboutthe blockbuster mergers. First, mergers of large R&D operations mayconcentrate the market for discovery, reduce competition and experimentationfor new discoveries.
Therefore, lead to fewer discoveries. Second, merginglarge marketing, sales, and distribution forces may strengthen a few companiesand reduce downstream competition. This would result in reduced pricing pressuresand higher entry barriers for innovative new companies.However, recent studies show thatM&A activity appears to play only a limited role in current pricingcontroversies. The analysis also suggests that merger activity is frequentlyassociated with more active product pipelines and appears central to an ongoinginnovation strategy.ACTAVIS – ALLERGAN MERGERDEALActavis and Allergan have announcedthat they have agreed on a definitive merger agreement on November 17, 2014. Thedeal was an example of the so-called White Knight mergers. Prior to the deal,Allergan was fighting off a hostile takeover bid by hedge fund manager WilliamAckman and their competitor Valeant Pharmaceuticals.
Theboard’s argument against the offer was that Valeant was an unstable companywith too much acquisition deals and very low growth. It also pointed out thereputation of Valeant to drastically cut the R spending. So, the boardstated that it would be irresponsible to take a deal that consisted mostly ofValeant equity. ActavisCEO Brent Saunders reached out to Allergan CEO David Pyott to offer a friendlymerger. Actavis’ offer of $129.22 in cash and 0.3683 of an Actavis share forAllergan share was valued at $66B, or $219 a share.
This is a 54% premium overthe Allergan price before the hostile bid and a 10.24% premium over theprevious day closing price. The merger was completed on March 17, 2015 and thefinal value was $70.
5B. The hostile bidders profited $2.6B from their ‘loss’ thanksto their toehold of 9.7% share in Allergan.The combined entity will be in thetop ten largest pharmaceutical companies by revenue with expected total salesof $23B in 2015 and is expected to generate double-digit earnings growth in thefirst year and a free cash flow of $8B which will enable the company tode-leverage its balance sheet. Actavis aims to be the leader of the GrowthPharma industry model which seeks long-term growth with name brands and genericdrug businesses around the world.
The expected synergies between two drugmakers come from both cost savings and combined market power. However, thebottom line cost savings are what makes both firms shareholders happy. Costsynergies are estimated around $1.8B annually in addition to $475M in annualsavings from Allergan’s previously announced project. The estimated total costsavings of $2.3B annually amounts to 10% of the expected annual revenues, afigure almost unheard of in the pharmaceuticals industry.
Furthermore, Actaviswill add its specialty brands to Allergan’s established franchises which willdouble Allergan’s North American business. The merged entity will have threeblockbuster drugs with more than $3B in sales per year and increased relevanceamong the doctors and patients while enhancing the sales growth in emergingcountries. There will be only $400M reduction in Allergan’s R&D budget,bringing the merged budget to $1.
7B. This is enough to move the potentialblockbusters in the pipeline.JPMorgan did the valuation analyseson behalf of Actavis. It used both discounted cash flow and relative valuationmethods. In its DCF valuation, JPMorgan calculated a range of terminal valuesfor companies for the ten-year period ending in 2024 by using perpetual growth model.Then, free cash flows and the range of terminal values were discounted topresent values using a range of discount rates estimated based on the weightedaverage cost of capital of both companies.
The bank has also used DCF analysisto value Allergan with 50% of expected synergies. In its relative valuationanalysis, the bank used public trading multiples of publicly traded companiesengaged in businesses deemed to be analogous to Actavis’ and Allergan’sbusinesses. These companies are listed in the Exhibit 1. Furthermore, the bank has also analyzed multiples usedin previous transactions that the bank deemed similar to this deal. These dealsare presented in the Exhibit 2. Theestimates, multiples used, and implied values are presented in the Exhibit 3. Then, the bank compared theresults of each analysis for both companies.
The highest implied value ofAllergan with synergies was compared with the lowest implied value of Actavisto derive the highest exchange ratio of equities, after adjusting for the$129.22 cash payment per share. The results of this comparison are presented atthe Exhibit 4. The proposed mergerratio of 0.
3683x was considered fair. JPMorgan was paid $65M in total fees forits opinion.The deal is structured as a reversetriangular merger.
Actavis has created the otherwise empty firm named AvocadoAcquisitions Inc. which will merge with Allergan. Allergan will be thesurviving entity of that merger and will thus become a wholly owned subsidy ofActavis. Shareholders of Allergan will have the right to receive 0.
3683 of anActavis ordinary share and $129.22 in cash, without interest, which totals to$39B. After the merger, the shareholders of Actavis will own approximately 72%share while Allergan’s shareholders own 28% share in the merged entity. Actavisis expected to issue 128M new ordinary shares to pay for the equity portion ofthe deal. Actavis will use the cash it has, up to $8.9B in proceeds fromissuance and selling of new equity, and third-party debt financing for therest.
The exchange ratio for the equity proportion of the deal is fixed andwill not be increased to compensate Allergan shareholders in the event of adecline in the Actavis share price. If either Actavis or Allergan terminatesthe merger agreement due to a change of recommendation of the board ofdirectors or to engage in a superior offer, or breach the deadlines stated inthe agreement, pays the other company $2.1B in termination fees. Furthermore,if it is Allergan which terminates the deal, it has to pay additionalreimbursement payments not the excess of $680M for the expenses incurred byActavis in connection with the deal. Actavis CEO Brent Saunders will lead thecombined entity and two members of the Allergan board of directors will joinActavis. Executive officers who are terminated have rights to significantpayments and benefits presented in the Exhibit5.The financial data available nowshows that the proposed synergies did not realize and in fact, the mergedentity and its following mergers have lost significant value in the followingyear.
The decline in stock prices and market value is presented in the Exhibit 6.SHIRE – BAXALTA MERGERDEALShire Plc, a Jersey-registered, Irish-headquartered global specialtybiopharmaceutical company bought Baxalta, a global biopharmaceuticalcompany based in Illinois for $32 bill?on on the 3rd of June 2016 after 6months of persuasion following an initial hostile offer of $30 billion. Whilethe chief executive (Ludwig Hanston) of Baxalta was initially unconvinced ofthe synergies due to a lack of overlap between the companies’ portfolios, helater relented. Baxalta shareholders received $18.00 in cash and 0.
1482 Shire ADS per Baxalta share. Based on Shire’sclosing American Depositary price on “January 8, 2016, this implied a totalcurrent value of $45.57 per Baxalta share, representing an aggregateconsideration of approximately $32 billion. The exchange ratio is based onShire’s 30-day trading day volume weighted average ADS price of $199.03 as ofJanuary 8, 2016, which implies a total value of $47.50per Baxalta share.”The combined company was expected to be thecategory leader in rare diseases and to achieve cost and operational synergiesof over $500 million by the third year of operations.
Savings were expected to come from the removalof administrative duplications and from the access to new markets gained fromBaxalta’s wider geographic reach. Shire was especially keen onacquiring Baxalta’s skilledemployees as they had substantial experience in the rare disease space as theybelieved it would constitute a significant competitive advantage for thecombined company. The tax benefits were substantial, Baxalta on its own facedtaxes of 23%, the combined company 16%-17%. Baxalta was satisfied with theshareholder value created since stockholders are expected to own approximately34% of the combined company and thus will have the opportunity to participatein any potential growth in the earnings and cash flows of the combined company.Since it was part cash, they were satisfied as they were able to realizeimmediate value. Shire financed the merger through an $18 billion underwrittenbank facility that included Barclays and MSBIL.
Baxalta’s financial advisor, Citi,conducted various analyses in order to gauge the possible effect of the merger.These included a selected public company analysis, a selected precedenttransaction analysis, a discounted cash flow analysis and the most conclusiveof them all, a ProForma Discounted Cash Flow Analysis where they calculated the estimated presentvalue of the unlevered, after-tax free cash flows that the pro forma combinedcompany was forecasted to generate during the fourth quarter of the fiscal yearending December 31, 2015 through the full fiscal yearending December 31, 2025. Taken into account were the fullrealization of potential net synergies expected by Baxalta management to resultfrom the merger, the use of debt financing to fund the cash portion of theimplied per share merger consideration, and no adverse impact of the merger onthe tax-free nature of the separation. Stock-based compensation was treated asa cash expense and normalized depreciation and amortization, capitalexpenditures and change in net working capital for the terminal year free cashflows were assumed. Citi calculated the implied terminal value of the pro formacombined company by applying to the pro forma combined company’s unlevered freecash flows a selected range of perpetuity growth rates of 1.5% to 2.
5%.The present values of the pro forma combined company’s cash flows and terminalvalues were then calculated using a selected range of discount rates of 7.9% to9.
0% derived from a weighted average cost of capital calculation. This analysisindicated an approximate implied per share equity value reference range for thepro forma combined company of $266.03 to $388.41 per Shire ADS, orapproximately $57.43 to $75.56 per share for Baxalta stockholders based on themerger exchange ratio of 0.1482x and cash consideration of $18.
00 per share,reflecting a potential incremental increase in the value of approximately 26.0%to 65.8% relative to the implied per share merger consideration.The deal itself was a classic example of a direct purchase. Followingthe announcement of the merger on January 11th, 2016, Shires share price fellas shown in Exhibit 9 whileBaxalta’s fluctuated only slightly.ABBVIE – PHARMACYCLICSMERGER DEALOn March 4, 2015, AbbVie hasannounced that it was going to acquire Pharmacyclics for a deal worth $21B. AbbVieis a global biopharmaceutical company which develops and markets advancedtherapies for complex and serious diseases. It was founded in 2013, as aspin-off of its former parent company Abbot Laboratories.
AbbVie’s flagshipdrug is Humira, the world’s best-selling drug with $16B in annual revenues.Although Humira is protected by more than 100 patents, about tenfold of atypical drug, its main patents were about to expire. Pharmacyclics is a biotechcompany which develops therapies for cancer patients. Pharmacyclics is theleader of $24B large hematological cancer market. Their flagship drug Imbruvicais a very promising product approved for many blood cancer types and morearound the world. AbbVie has beaten Johnson & Johnson and Novartis in thedeal. It offered 39% premium over Pharmacyclics’ closing price before it hasannounced that it was up for sale in February. The market believed that it wastoo expensive.
The deal broke the rule that the buyers stock price goes up withthe targets in hot M&As in the healthcare market. Analysts have argued thateven though Imbruvica alone can account for one-third of Pharmacyclics’ pricetag, AbbVie may need to find additional $5B in revenue to profit from the deal.Nevertheless, the deal would seem like a bargain in the long run if Imbruvicadoes become the best-selling treatment for multiple cancers.The offer was seen as an example ofa big pharmaceutical firm merging with a biotech firm to refill its medicinepipeline before a major patent cliff. The main reason for AbbVie for the mergerwas that the company needed a new blockbuster drug to feed its marketing andsales forces. After the patent cliff, it is expected that many competitors willcome up with drugs biosimilar to Humira and eat away the revenues. Imbruvica isvery promising on filling the pipeline. The drug had generated $185M, 31% morethan the previous year.
Experts have estimated that Imbruvica can generate as much as$6B before the drug loses patent protection in 2026. The merger did not standto generate much cost savings but there are possible operational synergies froma better-filled portfolio after Imbruvica complements AbbVie’s oncologyportfolio. Moreover, the deal could answer the two major criticisms of AbbVieCEO Richard Gonzales.
The first was the extent which AbbVie depends on Humirafor its sales. The second was the failed $54B merger deal with the Ireland-basedShire. That deal was blocked by White House as it was an attempt to evadetaxes. AbbVieprojected $0.
6 EPS growth by 2019 and accelerating afterwards, but alsoexpected a $0.2 EPS decline in 2015. Citigroup analysts were skepticalabout whether AbbVie would see any financial benefit. Pharmacyclics canhelp AbbVie to increase its sales and earnings by %8 until 2017. However, the10% share dilution created by the equity offer could offset that growth. Share dilutioncould mean that majority of the growth is lost on a per share level.
The reasonfor Pharmacyclics was simple: the offer was very generous. The firm’s shareprice had never reached such levels and the board had believed that it was thebest and final offer. Weighed with risks associated with creating a blockbustercancer drug, the offer was in the best interests of their shareholders.Moreover, the AbbVie offer gave the right to choose between all-cash,all-stock, and a combination considerations. So, willing shareholders cancontinue to participate in the combined entity’s future. According to the definitive mergeragreement, AbbVie would pay a fixed price of $261.25 per share of Pharmacyclicsof which $152.25 was in cash and $109 worth was equity in the merged entity.
Pharmacyclics shareholders could also choose to receive the amount in all-cashor all-equity. Centerview Partners was the financial advisor to thePharmacyclics board of directors. Centerview has valued Pharmacyclics toevaluate the fairness of the offer from a financial point of view. As it is thetraditional method, Centerview valued Pharmacyclics from both relative andintrinsic value perspectives. In relative value analysis, Centerview selectedpublicly traded biopharma companies which it deemed similar to Pharmacyclics basedon experience and judgment. Those companies and their enterprise valuemultiples of their estimated financials are presented in the Exhibit 7. Based on this analysis,Centerview calculated a value range for 2016 and 2017; forecasting $1.355B and$1.
888B Imbruvica revenues, respectively. The valuation range is presented inthe Exhibit 8. In the DCF analysis,Centerview calculated a range of EV by discounting taxed and unlevered cashflows from 2015 to 2028, using discount rates ranging from 9% to 11%,reflecting the WACC. Also, a range of terminal values was calculated for 2028with perpetuity growth decline rates ranging from 70% to 90%, reflecting thedecline in expected revenues once Imbruvica goes generic. Centerview thendivided those calculations to fully diluted Pharmacyclics shares to find arange of per share value from $195.
00 to $223.00. These valuations were thencompared with the $261.25 merger consideration and the offer was concluded tobe fair from a financial point of view.The merger was structured to takeplace in two steps. First, the shell company Offeror would merge withPharmacyclics and Offeror would cease to exist. This would enable AbbVie tocollect all Pharmacyclics share before the main merger.
The second step was aforward triangular merger where Merger Sub 2 would merge with Pharmacyclics andsurvive the deal. Then, rename itself Pharmacyclics. The deal had a fixed valueof $261.
25 per Pharmacyclics share. If a Pharmacyclics shareholder were to wantthe combined or the all-stock payment, then the shareholder will receive 261.25divided by weighted average price of AbbVie stock. However, the shareholdermight be subject to proration and get some of her consideration in cash.
Thatwas due to AbbVie’s plan to pay the aggregate considerations with 41.7% equityand 58.3% cash. This implies, on average, 3.9879x exchange rate. It wasestimated that Pharmacyclics shareholders would own 8.
6% of the merged entity.Under the definitive agreement, only Pharmacyclics was obligated to paytermination fees which amounted to $680M.ROCHE – INTERMUNE MERGER DEALOn August 29, 2014, Roche, theworld’s largest biotech company acquired InterMune, a Californian biotechcompany for $74 a share, totaling an $8.3 billion. The all-cash offer was apositioned at a 38% premium.
The InterMune agreement followed deals worthup to $2.5 billion in the preceding months for Roche with the acquisitionsof Seragon Pharmaceuticals of the US, Santaris of Denmarkand Genia of the US. The main reason for the acquisition was rights to abreakthrough drug used to treat a fatal pulmonary disease affecting more than100,000 Americans annually. While the drug was not clinically approved at thetime of the agreement, it was deemed a “de-risked asset” due to the expectedmortality benefit and also because it was already being distributed in Europeand Canada.This acquisition was also overtakenby Roche in order to focus on more than just the oncology sector and todiversify their drug portfolio.
However, Roche was not the only one looking toget their hands on the miracle drug. The InterMune deal was approved only afteran informal “bidding war” (of sorts) amongst 3 other pharmaceuticals, namelySanofi, GlaxoSmithKline, and Actelion. InterMune offered $17 more per sharethan the only other company that formally placed a bid.
Roche was keen on expanding into thepulmonary sector in order to focus more on “orphan drugs” for incurablediseases. As stated by Severin Shwan,chief executive of Roche, “This is not about cost synergies at all. This is agrowth story.” The drug is expected to have sales of $1.
04 billion by 2019and revenues were expected to go from $144m in 2014 and reach $675m by the endof 2016.InterMune retained Centerview asthe financial advisor. They conducted a Selected Comparable Public CompanyAnalysis where they calculated and compared financial multiples for theselected companies. They applied a range of 6.1x to 12.
2x, representing the25th and 75th percentiles, respectively, of estimated 2016 revenue multiplesderived from the selected comparable companies to InterMune’s projected 2016revenue of $734 million, based on the InterMune Forecasts. This analysisresulted in a range of implied values per share of common stock ofapproximately $41.80 to $78.70. Centerview compared this range to theper share consideration of $74.00 to be paid to the holders of shares. Theresults are shown in the Exhibit 10.
A selected precedent transaction analysis was also undertaken to compare thetakeover to similar ones in the same industry. They reviewed transactionvalues and calculated the enterprise value implied for each target companybased on the consideration payable in the applicable selected transaction as amultiple of estimated two-year forward revenues. They also reviewed theimplied premiums paid in the selected transactions over the target companies’share price one day prior to and the 52-week high closing share price one dayprior to the date on which the public became aware of the possibility of suchtransactions. The results are in the attached Exhibit 11. F?nally, they conducted a sum-of-the-parts discountedcash flow analysis using discounted cash flows representing the implied presentvalue of InterMune’s projected unlevered fully-taxed free cash flows from thefourth quarter of 2014 through 2033 based on the InterMune Forecasts plus thepresent value of an implied terminal value in 2033 in each case discounted toSeptember 30, 2014 using a discount rate range of 10% to 12% using themid-year convention. This analysis resulted in an illustrative range of impliedvalues per share of common stock of approximately $53.80 to$62.
00. Centerview compared this range to the per share considerationof $74.00 to be paid to the holders of shares pursuant to the Merger Agreement.The deal was a classic takeoverexample, and although the premium paid may seem like a hefty amount, it is notunusual in the pharmaceutical industry and reflects the intense competition forpromising new drugs among larger companies as they rely on small innovativefirms for a growing proportion of their products. Termination feeswere set at $266 million for both firms if the merger was terminated due to theother and golden parachutes for various executives were included in thecontract and are shown in the Exhibit 12.Esbriet (the drug, containing pirfenidone) sales in the US accounted for 74% oftotal sales for the drug in 2016, however, it must be noted that Esbriet waspriced significantly higher in the US than in European countries and Canadawith the annual cost varying from $2000 outside the US to about $90,000 within.As of 2017, Esbriet has contributed to a 3% increase in total Rochepharmaceutical sales.
Market Capitalization following the transaction is shownin Exhibit 13.CONCLUSIONThe existence of blockbuster dealsare interpreted as compensations for the lack of discovery of big pharmacompanies. Firms make large, sunk investments in their marketing and salesfunctions to extract the maximum value out of their blockbuster products, theones that bring in more than $1 billion in revenues per year. When such aproduct loses its patent protection, the sales experience a sharp decline knownas the ‘patent cliff’. Thus, firms require another blockbuster to supply theirfunctions.
If a firm cannot organically produce such a product, it purchasesanother company that owns a valid blockbuster patent, as in the case of Rocheacquiring Intermune.There is some evidence that thesedeals are indeed a response to financial troubles or patent expirations, yetmerged firms experience slower profit growth compared to non-merged firms.Furthermore, recent studies show that potential benefits from mergers are notlarge enough to cover for integration costs related to such deals.
While no twomergers within the industry are the same, they all lean towards a pattern thatillustrates how M deals in the pharmaceutical industry are moreindicative of and inclined towards resolving agency problems rather than increasingshareholder value.