By David Tullett, Consultant, Deloitte MCS Limited
Earlier this month our colleagues published their report, The role of innovative and unfamiliar acquisitions in unlocking R&D productivity, which looks at the impact of M&A on the pharma landscape and outlines how external innovation is impacting pharmaceutical R&D and the reasons behind the projected growth in deal volume for 2020. This week’s blog by our colleague, David Tullett, who worked closely on the above report with Heena Dodhia and Mark Stockbridge, provides his view on the key takeaways.
Since 2010, the Centre’s Measuring the return from pharmaceutical innovation series has tracked an overall decline in estimated returns from R&D investment. Most years, average R&D costs have increased, and average forecast sales have decreased across the cohort of companies covered by the analysis. In our latest report Ten years on: Measuring the return from pharmaceutical innovation 2019, R&D returns for the original cohort of 12 large cap biopharma companies declined to 1.8 per cent from a high of 10.1 per cent in 2010; the extension cohort, of four more specialised biopharma companies, declined to 6.2 per cent from 17.4 per cent in 2013. These significant declines demonstrate the increasingly challenging R&D environment that biopharma companies are facing.
The role of innovative and unfamiliar acquisitions in unlocking R&D productivity, provides a deeper analysis of the different approaches that biopharma companies have taken with regard to M&A to improve R&D productivity and value; with a particular focus on the role of making small-to-medium size R&D-driven acquisitions.
The growing importance of M&A to late-stage pipeline value
In line with Ten years on, we analysed the same 12 large cap and four specialised biopharma companies but combined them into a single cohort. We found the contribution of self-originated (in house) R&D to the total value of their late stage development pipeline fell from 59 per cent in 2015 to 41 per cent in 2019, whereas the proportion contributed by R&D acquisitions increased from 10 per cent to 27 per cent over the same time period (Figure 1). This suggests that the current market environment requires M&A to bolster pharma companies’ pipelines to fulfil current and future revenue targets.
Figure 1. M&A contributions to late-stage pipeline value
This is further evidenced by comparing historic biotech and pharma deal value. After a period of reduced activity in 2016 and 2017, corporate cash is now flowing back into M&A, with investment options more attractive to management than a pure return of cash to shareholders via share buy-backs or dividends (Figure 2).
Analysis performed on R&D driven deals completed since the start of 2017 highlights the significant premiums being paid to access innovation, caused by limited availability of assets and driving competition as a result.
Deals that expand into a new therapy area (TA entry), provide access to assets in a new area (Modality), or provide a significant analytics capability (Digital), command premiums of 148 per cent, 111 per cent and 83 per cent, respectively (Figure 3).
Figure 3. Increases in share prices over a 90 day period by deal type
Companies therefore face significant risks in justifying these premiums. By making acquisitions in ‘new’ areas, the acquirer commits to a research area that will require R&D investment on top of the allocation already made by the acquisition target, making full utilisation of liquid capital even more difficult.
Primary challenges of dissimilar M&A
In R&D driven acquisitions involving an innovative deal (TA entry, Modality, Digital), we have observed the greater the proportion of late‑stage pipeline value that is created externally, the lower the returns on R&D capital invested. However this trend is inconsistent with the reliance of companies on M&A to drive much of their late stage pipeline value.
A number of underlying issues have been proposed to explain the poor returns from externally‑sourced, late‑stage pipeline products for such acquisitions:
- Wrong deal. Did the deal properly address an R&D productivity challenge that needed a solution?
- Scientific understanding. Being an innovative deal, has necessary research underpinning the acquired assets or technologies been complete?
- Integration. How should the acquired entity operate within the larger organisation?
- Talent and capabilities. Have the right talents and capabilities been identified that will deliver the expected productivity benefits?
Given these common challenges, there are core measures that can be taken to mitigate the deal risk involved in such transactions:
- Clear strategy. The buyer needs to be clear about the strategic purpose any proposed acquisition, especially when the target is in an innovative space.
- Who will ‘own’ the strategy implementation? Clarity is needed regarding who will lead the acquired business and deliver the expected value and productivity benefits.
- Take risks while remaining flexible. No target will meet all strategic objectives - flexibility is then needed to shape the acquired assets into providing core requirements.
- Augment the skillset. The right people are integral to implement the acquisition strategy, enable business as usual and begin realising value from acquired assets post-deal.
To capture both value realisation and R&D productivity, R&D-driven acquisitions should fundamentally have a clear rationale. Acquiring organisations need to self-evaluate their current R&D productivity challenges and strategic direction and by doing so, identified targets should fit within the broader corporate strategy, addressing the distinct gaps that exist and providing the competitive advantage intended.
The industry will experience greater M&A activity
As we enter the new decade, we expect deal frequency and associated premiums to continue to increase, with organisations seeking to offset the sustained pressures on revenues and market expectations following the decade-long decline in returns from R&D.
Despite the challenges of unfamiliar deals, M&A will remain a core driver of innovation and productivity – new areas of investment will provide strategic benefits via strengthened pipelines, new portfolios, indication discovery capabilities and reduced time to market to deliver a sustainable competitive advantage moving forwards.