SOME OF THE the world’s biggest and oldest pharmaceutical companies have been indulging in a little retail therapy. On January 3rd Bristol Myers Squibb, whose original constituent firm was founded in 1858, bought a smaller biotech company, Celgene, in a deal that valued the latter at $90bn including debt. Four days later Eli Lilly, which was founded in 1876, splurged $8bn on Loxo Oncology, a cancer-focused biotech firm. These deals come after a bumper 2018 for M&A in the pharmaceutical industry, which saw Takeda, a Japanese drugmaker, spend $59bn on Ireland-based Shire, and GlaxoSmithKlein buy another cancer-focused biotech firm, Tesaro, for $5bn. Why are pharmaceutical companies snapping up their competitors?
Over the past decade established pharmaceutical companies have not been very successful at the costly task of finding new drugs. According to a report published recently by Deloitte, an accountancy firm, the average return on research and development (R&D) at 12 of the world’s largest pharmaceutical companies fell to just 1.9% in 2018, the lowest level in almost a decade, as the cost of discovering new drugs has risen sharply. This is well below the cost of capital, the rate at which companies can borrow money. And because investments in R&D have been so fruitless many large drugmakers have relatively few therapies in the pipeline to drive sales once patents run out on existing drugs.
With their pipelines empty, large drugmakers are increasingly looking to acquire other companies. The established sales platforms of the bigger firms grant them certain advantages over smaller competitors. Patents grant a monopoly over the sales of a new drug to its developer or owner for a specific period, which gives firms a limited time during which they can earn bumper profits. But smaller companies cannot ramp up sales as quickly as a larger firm with established distribution networks, which can earn more revenue more quickly from a new therapy. This allows them to lure target firms with deals that are tempting to both sides, even if the purchaser has to pay a premium on top of the target’s market price.
These latest takeovers have been prompted by the fact that biotechnology companies look cheap. During the stockmarket sell-off towards the end of last year investors stuck more readily with stocks that were perceived as less risky, a trend that hurt the value of volatile smaller companies, like biotech firms, more than large established pharmaceutical companies. The Nasdaq index of biotechnology firms fell more than 25% in the fourth quarter of 2018, while a comparable index of pharmaceutical companies fell just 5%. January shoppers love a discount, and pharmaceutical companies are clearly no exception.