Why pharma megamergers work
Unlike
deals in many industries, big mergers and acquisitions among pharmaceutical
companies generally have resulted in positive returns to shareholders.
Conventional wisdom holds that large mergers have destroyed value in the
pharmaceutical industry. Market commentators insist that these deals don’t
work, that the challenges of large-scale integration unnecessarily disrupt the
organization and critical programs, and that research and development
productivity suffers. These critiques have some merit but ignore larger points:
megamergers have created significant value for shareholders, and some of these
deals have been critical for the longer-term sustainability of acquirers. In short,
we believe that the benefits often warrant the disruption that these deals
entail.
Perhaps that explains their
popularity. Megamergers have played a key role in shaping the global
pharmaceutical landscape. Indeed, most of the pharmaceutical companies that
stayed among the world’s 20 largest between 1995 and 2005 were involved in
“megamergers,” which we define as deals larger than $10 billion in which the
target company boasts at least 10 percent of the acquirer’s sales and 20
percent of the acquirer’s market capitalization (Exhibit 1). To examine the
real impact of megamergers, we analyzed 17 large deals that occurred between
1995 and 2011, looking at excess total shareholder returns above the
pharmaceutical-industry index of the acquiring company in the period two to
five years after the merger was announced. We also evaluated postdeal revenue
growth, margins, new-product introductions, and the product pipeline for the
combined company, along with the relative contribution from the acquired
company.
1.
Megamergers created shareholder value
Median excess returns for
megamergers in our sample were positive, showing returns 5 percent above the
industry index two years after a deal’s announcement. This is in contrast to
large deals in other industries, which have had marginal returns relative to
industry indexes or, in the case of deals in the technology sector, sharply
negative returns (Exhibit 2). What’s more, the median acquired company in our
sample contributed around 37 percent of total pharmaceutical revenue and 10
percent of new-product revenue for the combined company five years after the
deal’s announcement. In our analysis, combined companies expanded earnings
before interest, tax, depreciation, and amortization (EBITDA) margins by four
percentage points two years after a deal’s announcement, while the return on
invested capital (ROIC) rose 14 percent. Acquiring companies emerged from these
mergers with a larger revenue base and leaner cost structure, increasing
economic profit by an average of more than 50 percent in the two years
following the transaction.1
We also classified megamergers into
two broad types—those that consolidated existing players with significant
overlaps, and growth-oriented deals that created new companies or expanded into
new markets. Consolidation deals have historically generated the greatest economic
profit for acquirers (more than 60 percent growth), while growth-platform deals
have on average generated negative economic-profit growth with marginal
improvements in ROIC (Exhibit 3). Among consolidation deals, there was
significant variation in how the acquirers drove economic-profit
growth—accelerating revenue, improving the cost of goods sold, reducing
overhead, promoting R&D rationalization and consolidation, or improving
working capital—which suggested further segmentation of deal types.
Consolidation
deals were more typical in the mid- to late 1990s, and these deals created
meaningful economic profit for acquirers through both cost synergies and
accelerated revenue growth. Pfizer’s acquisition of Warner-Lambert, which was
announced in 1999, drove significant value creation for shareholders as EBITDA
margins expanded by more than 10 percent, aided by the wildly successful growth
of Lipitor. Sales of Genentech products enjoyed a compound annual growth rate
of more than 4 percent for several years after Roche acquired full ownership.
(Genentech remained a stand-alone operating unit.) In addition, a third of
product launches of the combined company and more than 40 percent of the
current Phase III pipeline can be traced back to Genentech, which is the
highest R&D output of all of deals in our database. Conversely, the
Pfizer-Wyeth merger resulted in an overall decrease in economic profit for Pfizer.
While significant costs were cut and the merger buffered a declining legacy
Pfizer portfolio, the EBITDA margin for the combined company improved by just
one percentage point in the two-year period after the transaction due to
headwinds from patent expirations. The legacy Wyeth portfolio contributed
insufficient incremental on-market revenue growth and new-product launches to
offset patent expirations, and economic profit for the combined entity declined
by 26 percent.
Megamergers aiming to create a new
growth platform have become more common recently, but they are also more
expensive for acquirers and generate lower cost synergies given limited
operational overlaps compared with consolidation deals. Some mergers created a
new company, while others involved moving into new markets (Sanofi and Genzyme)
or geographies (Takeda and Nycomed).
3.
Growth-oriented deals changed longer-term expectations
On the surface, the average trading
multiple for acquirers in our sample changed little after a deal. Yet there was
wide variation between consolidation and growth-oriented megamergers. Multiples
declined by around 5 percent for consolidation deals closed after 2000—it
appears that while these deals generated superior near-term gains in economic
profit, they ultimately did not address or solve longer-term issues with
business models. In contrast, growth-platform deals increased trading multiples
by more than 60 percent, or 20 percent relative to top 20 peers, often from a
very low multiple for the acquirer before the deal. One possible explanation
for this difference in long-term expectations is the growth contribution that
acquired companies made in launching new products. For growth-platform deals,
the acquired company contributed around 24 percent of new-product revenue of
the combined company five years postdeal, compared with just 10 percent in
consolidation deals. The difference in multiple evolution and long-term
expectations is reflected in the total return to shareholders (TRS): for
consolidation deals, excess returns are positive three years after the merger
but turn negative after five years; for growth-platform deals, TRS is
consistently positive through the five-year mark.
While the bias of pharmaceutical
megamergers has more recently turned toward creating growth platforms and away
from consolidation, we found that shareholder returns have historically been
positive for both types of deals. However, much of the excess return from
growth deals has been generated from multiple expansion and improvement in
long-term expectations rather than changes in fundamental operating
performance. As drug pipelines unfold and the profile of these new growth
platforms is better understood, not all of these deals may look so rosy. Given
the proven track record of consolidation deals generating economic profit, we
would not be surprised to see them come back in vogue.
By Myoung Cha and Theresa Lorriman
http://www.mckinsey.com/Insights/Health_systems_and_services/Why_pharma_megamergers_work?cid=other-eml-alt-mip-mck-oth-1402
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