Plan on more pharma megamergers

With a drought in new blockbuster drugs, generating growth has become a challenge.

  • By Charley Grant,
  • The Wall Street Journal
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The wave of giant pharmaceuticals deals might not be over just yet.

AbbVie (ABBV) stunned investors last month by agreeing to acquire Allergan for $63 billion. Earlier this year, Bristol-Myers Squibb (BMY) announced that it would purchase Celgene (CELG) for $74 billion, while Japanese drug giant Takeda Pharmaceutical (TAK) purchased Shire for $58 billion last year.

AbbVie stock fell 16% when the deal was announced June 25 but has since rebounded nicely. That may be due to investors’ realization that megamergers are a natural strategic choice for drug companies today.

The logic behind these deals is fairly simple: Generating growth has become a challenge. The industry has already met many of the most pressing medical needs, rewarding patients and shareholders in the process. There are a few very big, attractive targets such as Alzheimer’s disease or certain types of liver disease, but clinical trials have yielded serial disappointments.

That drought is becoming a problem since sales can slip dramatically when blockbuster drugs face cheaper generic competition. Adding to the urgency: Many large biotech and pharma companies book a significant share of sales from a single product. In recent quarters, for example, AbbVie has booked roughly 60% of its sales from the anti-inflammatory drug Humira.

At the same time, drug companies seem less willing to raise prices on existing products to generate growth. During the first quarter of 2019, list prices for U.S. branded drugs increased 3.3%, compared with 6.3% a year earlier, according to analysts at SSR Health. Friday, President Trump promised a new executive order to lower the price the U.S. government pays for drugs.

All of that argues for further tie-ups among giants. Buying a larger peer has important advantages over, say, big spending on development-stage biotech stocks. For starters, it means achieving revenue growth is a certainty instead of a possibility. Extra profits can be wrung out by culling research-and-development spending and reducing sales forces in overlapping disease categories.

Despite the industry’s growth challenges, most big drug companies have strong cash flow and investment-grade balance sheets. That makes issuing debt to buy assets attractive, particularly while interest rates remain low.

And these companies are trading at discount prices. At the end of June, large biotech stocks like Amgen (AMGN), Biogen (BIIB) and Gilead Sciences (GILD) fetched as little as eight times forward earnings. Those three companies are also projected to have flat or minimal revenue growth over the next five years, according to analysts at Mizuho Securities. These companies have enough firepower to make large deals and could also be an attractive acquisition target for the biggest drug companies. After all, Allergan had a similar growth profile and valuation when AbbVie decided to pull the trigger.

Betting on industry consolidation continuing in the second half of the year seems like sound medicine.

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