A Prescription for Deals: Consolidation in the Pharmaceuticals Sector

Consolidation is taking place in the pharmaceutical and biotechnology sector. According to VentureOne, a research firm that tracks the venture capital industry, acquisitions of private biopharmaceutical companies in the first quarter of 2005 reached a total value of $2 billion, more than the $1.2 billion for all such deals in 2004. Recently announced transactions include Shire Pharmaceuticals $1.6 billion deal for Transkaryotic Therapies and GlaxoSmithKline's $300 million deal for Corixa Corporation.

Many larger healthcare firms are buying up privately held biotech and drug development firms. Johnson & Johnson recently entered agreements to acquire Peninsula Pharmaceuticals for $245 million and TransForm Pharmaceuticals for $230 million. Other recent takeovers of private companies include Valeant's acquisition of Xcel Pharmaceuticals, Takeda Pharmaceuticals deal for Syrrx, the takeover of ESP Pharma by Protein Design Labs, and Pfizer's deals for Angiosyn and Idun Pharmaceuticals.

It is not unusual for pharmaceutical and diversified health care companies to acquire biotechnology companies. What is unusual is that corporate takeovers are becoming more desirable to start-ups and small firms in the sector than initial public offerings. The New York Times reports that only four US biotech companies have gone public in the first four months of 2005, and they typically had to reduce their offering prices to complete their offerings.

In the current stock climate, it appears that the corporate sector is placing a higher value on these small companies than public markets. Since venture capital investors do not always sell all their shares in an initial public offering, they have to consider whether a stock will gain market value after it goes public. If the market for biotech stocks seems weak, other options most be considered.

It is becoming more common for companies to plan IPOS while remaining open to corporate takeovers. Peninsula Pharmaceuticals delayed the pricing of its initial public offering in February to conduct talks of a potential merger with a then-undisclosed company. Peninsula has since agreed to be acquired by Johnson and Johnson. Since Peninsula delayed pricing its IPO, no US biotech companies have gone public. Several, including CombinatoRx Inc. and TargaCept Inc., have delayed planned public offerings.

Corporate takeovers offer a wider range of deal possibilities. In the Peninsula acquisition, for example, Johnson & Johnson is only acquiring one of the two antibiotics that Peninsula currently has under development. The other one is being spun off into a new company that will be largely owned by Peninsula's current owners. The deal gives investors the immediate profit of the Johnson and Johnson acquisition while allowing them to remain involved in the spin-off company.

Another factor that may be driving biotechnology sector acquisitions is diversification. Wall Street seems to be favoring more diversified healthcare companies. While major drug giants like Merck & Co. and Pfizer must contend with high-profile health concerns associated with the performance of their blockbuster drug products, investors are favoring more broad-based players.

Johnson and Johnson is one of the world's largest, most diversified health care product makers. Abbott Laboratories, which has publicly stated that it has carefully studied Johnson and Johnson's business model, has been following a diversification strategy for many years. While primarily focused on medical devices, its acquisition strategy has included the pharmaceutical operations of German chemical maker BASF AG. In addition to heart products, Abbott is also working to develop its spinal implant division.

In the medical devices segment, corporate acquisition has long been the standard exit strategy. The medical devices industry is dominated by a small number of major players who are continually on the lookout for new additions to their product lines. Start-ups in the sector can reasonably aim for the goal of being acquired by a larger firm.

The pharmaceutical segment, in contrast, has traditionally worked towards developing a successful company, with the possible goal of an initial public offering. But some biotech start-up companies are changing their strategies. According to Jonathan MacQuitty of Abingworth Management, a venture capital firm, many new start-ups have based their business plans on the goal of being acquired. The change of exit strategy can alter a company's business model significantly. Companies that expect to be acquired would likely avoid hiring long-term management, limit investments in buildings and personnel, and outsource laboratory work and clinical trials.

Such strategies could pay off if the biopharmaceutical sector continues to consolidate. With the consolidation driven, at least in part, by stock market factors, it is difficult to predict whether it will continue in the long term. At present, at least, industry consolidation clearly outweighs initial public offerings as the path to investor returns in the sector.

Sources: Grain's Chicago Business, New York Times, VentureWire, Wall Street Journal