One of the sectors most affected by technological disruption and disintermediation is healthcare. Advances in technology and big data are expected to help accelerate the process of discovering the next blockbuster cure, even as the industry itself undergoes unprecedented consolidation and convergence. Pricing pressures are forcing the adoption of new business models that reduce intermediaries and emphasize efficiencies of scale and cost structures.
Despite new technologies, drug development remains a lengthy, expensive and highly risky process. The research and development (R&D) lifecycle for advancing new drugs through multi-stage testing and approvals still takes 10–15 years at an average cost of US$2.5 billion – and only 5 percent of compounds make it through to the end.
Adding to big pharma’s cost pressures are those products close to the end of their patent protection cycles. Moreover, the huge growth in healthcare costs in markets like the United States is putting pressure on drug makers to lower prices.
Taken together, these forces have helped drive periodic waves of merger and acquisition (M&A) activity in the sector over the past 25 years. In total, there have been close to 600 deals with a value above US$1 billion during this period.
While M&A in healthcare tends to be less dilutive than in other sectors, there is still a large dispersion in outcomes. According to our analysis, around 40 to 50 percent of deals actually destroy shareholder value. Each transaction must be considered on its own merits, of course, but we found that deals focused solely on cost-cutting tended to be unsuccessful.
Innovate or die
In our experience, the most successful deals have focused on innovation and growth, rather than cost-cutting. Obviously if companies overpay for acquisitions, that destroys value as well. But with the cost of developing drugs so high, many companies have found that acquiring an advanced drug pipeline and innovative therapies is one of the most cost-efficient ways to bypass years of research and billions of dollars spent on development.
For many companies, we believe M&A has become the quickest and cheapest path to effective R&D. Acquiring new compounds that are more advanced in the R&D process can also be an effective way for companies to offset the declines in revenue from products whose patent protection is expiring.
So what are the more promising areas of drug innovation? We think the revolution in immunotherapy for cancer treatment offers some of the most exciting game-changing therapies. The first generation involves a new wave of drugs that can prime the immune system to seek out and destroy cancer cells, potentially improving cure rates and extending life expectancy for patients with certain types of tumors.
For example, through Roche’s involvement with Genentech – first acquiring a majority stake in 1990 and then buying out the minority shareholders in 2009 – its clinics have discovered, developed and launched many monoclonal antibodies that have become the standard of care in the fight against cancer, including blockbusters like Herceptin, Avastin and Rituxan.
Another milestone M&A deal in oncology was Merck’s acquisition of Schering Plough in 2009, gaining access to a patented antibody compound discovered by Organon, which Schering had acquired from Akzo Nobel in 2007. That compound, Keytruda, has been taken through the R&D process by Merck, approved for a range of tumors by the FDA and now on the market for three years, with sales projected to hit US$11 billion by 2021.
Thanks to these acquisitions, Roche and Merck are likely to be major players in the next wave of therapies for cancer and other rare conditions, which may involve techniques like gene editing that hold the promise of not just treating but curing disease. Such curative approaches may initially be more expensive than current standards of care, but may lead to longer-term savings to the healthcare system as patients who get better will no longer require treatment for chronic conditions.
Finding the winners
Despite a more recent slowing of M&A activity in the healthcare sector, we believe companies will continue to consolidate and restructure because of persistent price-cutting pressures. Healthcare is one of the last sectors to rationalize its supply chains, so we expect to see new business models developing that will also include service rationing to keep costs down.
In drug and device development, we expect the most successful companies will be those that can harness innovation through M&A and are adept at integrating the acquisition. They will be better protected against pricing pressures. At the same time, companies that fail to innovate will be negatively affected in an outsized way.
We think large-cap biotech can be an attractive area of opportunity, as bigger companies may be better positioned to expedite the regulatory approval and patent processes. And with deeper distribution networks for selling their newly acquired innovations to a wider audience, they can accelerate revenue generation to offset the high costs of R&D.
With populations aging around the world, the sector will continue to enjoy strong tailwinds. The individual winners will be those who use innovation to keep their pipelines filled, lower their costs and grow their revenue base.
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