After A Blockbuster 2014, What Will 2015 Hold For Pharmaceutical M&A?

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2014 was a banner year for mergers and acquisitions globally, but few sectors dominated the deal-making cycle like pharmaceuticals and biotech.

According to Bloomberg data, drug makers announced a record $234 billion in acquisitions last year, nearly triple 2013 volumes.

The year was marked by a string of mega-deals and serial acquirers, from Medtronic's $42.9 billion purchase of medical device manufacturer Covidien COV, to Actavis' ACT multibillion buys of Forest Laboratories and Allergan AGN. Barely a month in to 2015, the industry shows no signs of sweating out the M&A bug.

Here's a look at the primary drivers behind pharmaceutical and biotech deals in 2014, and what they indicate for M&A over the next twelve months.

1. Reimagining R&D

For more than a decade, pharmaceutical giants have made a habit out of acquiring smaller, more agile firms for their research and development capabilities. From 2002 to 2012, the percentage of drugs under development at the leading 10 pharmaceutical firms (that were initially developed at another company) doubled from 16 to 33 percent.

Noting Shire's SHPG early 2015 purchase of NPS Pharmaceuticals SHPG, another maker of rare disease treatments, this investment thesis is alive and well. Global brands continue to hunt for similar product portfolios and like-molecules that complement their revenue streams and reduce their time to market.

At the same time, industry consolidation is encouraging some companies to spin off their excess R&D arms. R&D, once a critical in-house function, is shifting to a just-in-time need.

Rather than immediately acquire smaller players, large drug makers are pouring funds into young venture-backed firms—in a sense, outsourcing early-stage research operations. Consolidation among these spun off and well-funded R&D organizations may be inevitable as 2015 progresses.

2. Portfolio Clean-Up

Years ago, pharmaceutical industry success was measured by who had the largest portfolio and the most scalability.

But recently, even the giants are trimming down and honing in on their core competencies. In some cases, this go-lean mindset motivates more targeted acquisitions, such as Merck's MRK December buy of Cubist Pharmaceuticals, a move that fit well within the company's plans to focus specifically on diabetes, acute hospital care, vaccines and oncology.

Given the number of massive deals over the past few years, companies are more likely to spend 2015 and possibly 2016 carving out excess assets and nonstrategic portions of their portfolios. Indications of the latest divestiture surge surfaced in 2014, with Novartis NVS selling its animal health unit to Eli Lilly LLY and its influenza vaccines unit to CSL Limited.

Actavis also recently agreed to sell its respiratory business to AstraZeneca AZN to focus more on their core therapeutic areas. Asset swapping could also be prevalent going forward, echoing moves similar to GlaxoSmithKline GSK and Novartis' oncology/vaccines trade last April.

3. Diagnostics' Comeback

Despite a lackluster showing in the M&A arena as of late, the medical diagnostics market is ripe for activity. Since the latter half of 2014, a handful of diagnostics transactions have been announced (even from unlikely suitors), including American Liberty Petroleum Corporation's OREO purchase of Avant Diagnostics.

Roche has kept busy as well, snapping up non-invasive prenatal testing company Ariosa Diagnostics and entering an Asset Purchase Agreement with AvanSci Bio.

Consolidation in the diagnostics sector is bound to grow this year as businesses fight for visibility into new molecules. Within the first month of 2015 alone, there's been a notable uptick in diagnostics deals, including DNA Electronic's $24 million purchase of nanoMR, Amarantus BioScience's acquisition of DioGenix, and Natus Medical's acquisition of Global Neuro-Diagnostics.

4. New Geographic Hotspots

New life sciences hubs are popping up throughout the U.S., but few boast the same quantity of growth-stage firms and investment potential as the New England region. Major biotech incubation is underway in Boston and its surrounding submarkets, resulting in a large pool of small and mid-sized firms well positioned for funding and acquisitions.

2014 kicked off with Sanofi shelling out $700 million for Cambridge, Massachusetts-based Alnylam Pharmaceuticals ALNY, a maker of rare disease treatments.

The market started on similar footing this year, with Roche buying a majority stake in Cambridge's Fountain Medicine, and Biogen Idec BIIB acquiring the U.K.'s Convergence Pharmaceuticals. While other regions (particularly on the West Coast) continue to breed the mega-deals, New England's voracity for smaller-scale M&A should not be undermined in 2015.

If January's announcements are any indication, the pharmaceutical industry will continue riding its M&A wave well into the rest of the year. Established players and budding firms alike are set on strategic visions, and many have the balance sheet flexibility to see them through. With these critical pieces in place, the deal-making bubble is unlikely to burst any time soon.

Steve Sapletal is a director in West Monroe Partners’ Minneapolis office, and John Nicol is a senior consultant in West Monroe Partner’s operations excellence practice. 

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