More pharma M&A to come?

Viagra maker Pfizer announced on Monday that it would purchase Allergan, the Irish maker of Botox, for about $160bn – the biggest deal ever in the healthcare sector.

Could more mega-mergers be in prospect?

As part of the proposed deal, Pfizer will move its headquarters to Ireland, in a so-called “tax inversion” deal. Inversion is a process under which a company buys a business in a lower tax jurisdiction and moves its headquarters offshore. Last year, US group AbbVie attempted a similar move, taking a tilt at Shire. The deal was primarily motivated by tax reasons. However, it was called off as the US government tightened regulations on such deals and increased political pressure on companies that propose to make such a move, branding them “unpatriotic”.

The White House declined to comment on Pfizer’s acquisition overnight, but said that Congress should take legislative action to prevent such deals. Pfizer’s management appears to believe that a deal is doable, however.

But, beyond the tax savings, do such mergers actually create shareholder value? There is a perception amongst many investors that mega-mergers can actually destroy value. Some even argue that such deals are basically just ego trips by chief executives with one eye on their bonus pot.  It is argued that the challenge of large-scale integration of acquisitions unnecessarily disrupts the company and that research and development productivity therefore suffers. Perhaps the most prominent mega-merger failure is that of AOL and Time Warner just before the dot-com bubble burst.  

However, things are slightly different in the pharmaceutical sector, according to a study published last year by consultants McKinsey & Co.  It examined the real impact of mega-mergers by analysing seventeen large deals that occurred between 1995 and 2011. The analysis looked for excess total shareholder returns above the pharmaceutical-industry index in the period two to five years after the merger was announced.

The study concluded that:

• Most of the pharmaceutical companies that have stayed at the top were large-deal acquirers.
• Mega-mergers in the sector created shareholder value.
• Pharma mega-mergers have outperformed large deals in other industries.

This is good news for the UK sector, as two FTSE 100 constituents are currently expanding by acquisition.   

Shire has made an unsolicited bid for US business Baxalta, seeing the transaction as an opportunity to create a global leader in rare diseases with product sales of about $20bn by 2020. If Shire eventually strikes an all-share deal with Baxalta, which has a market value of about $23.6bn (£15.4bn), the main listing is likely to be in London. However, a fall in Shire’s share price has raised some question marks over whether the deal will eventually happen.

Hikma has also made a reasonably sized purchase, although it is below the $10bn level that McKinsey regarded as a “mega deal” in its study. The company has a generic focus and its recent purchase of US specialist generics company Roxane from Germany’s Boehringer Ingelheim for $2.65bn has transformed its position in the US market.

Whether the US Congress will move to try and scupper this deal remains to be seen. Five new rules were introduced last year, which aimed to make it less attractive for a company to invert. These included a new rule that attempted to limit access to overseas cash without paying US taxes when they move it between different foreign countries. However, it is clear that these changes did not close the door completely.

So, even without taxation benefits, mergers in the drugs sector appear to have created value. This should be reassuring for shareholders in the acquisitive blue-chip pharma companies Hikma and Shire. 

Author biography

Garry joined Charles Stanley as Chief Investment Commentator in September 2013. Garry has been a well-known commentator on equity markets for more than 15 years, having spent the previous five years as the share tipster at the Daily and Sunday Telegraph. He has previously worked for stock market tip sheets such as the Penny Share Guide and Fleet Street Letter and spent five years covering European equities for Standard & Poor’s.