No end in sight to wave of pharma dealmaking

Since the start of last year, pharmaceuticals companies have agreed $462bn of mergers and acquisitions - greater than the gross domestic product of Austria.

This record wave of dealmaking has swept every corner of the industry, from the household names of big pharma to up-and-coming biotech companies to the lower-profile makers of generic and over-the-counter drugs.

This latter category produced the latest deal activity last week when Teva of Israel launched a $43bn hostile bid for its US-based, Dutch-registered rival Mylan. If completed, the combined group would have annual revenues of about $30bn - placing it above AstraZeneca among the world's top 10 drugmakers.

Mylan has so far resisted Teva's advances, preferring instead to pursue its own $33bn hostile bid for Perrigo, a Dublin-based generic drugmaker, just two months after completing a $5.3bn acquisition of products from Abbott Laboratories of the US.

This blur of deals and attempted deals involving Mylan is the latest subplot in the wider M&A drama gripping the industry. What is driving the frenzy? Jeremy Levin, former chief executive of Teva, says the most important factor has been financial rather than strategic. "Capital costs have come down so the return on investment from buying assets is higher than in the past."

This is true for all industries in an era of ultra-low interest rates, but Mr Levin, now chief executive of US biotech company Ovid Therapeutics, says other catalysts have made drugmakers especially eager to take advantage. For generic manufacturers such as Teva, Mylan and Actavis, the pressure has come from the rise of lower-cost Indian rivals such as Sun Pharma and Cipla.

Actavis has responded by shifting towards higher-value branded products, culminating in its $72.7bn acquisition of Allergan, maker of Botox, last November. Teva's proposed tie-up with Mylan would double down on generics, but with the aim of saving $2bn a year and creating more firepower to chase Actavis up the value chain.

This prolific dealmaking has thrust these previously second-tier drugmakers - Valeant is another - towards the top table of global pharma, and investors are cheering them on. Shares in Mylan had risen by more than a third over the past year even before Teva's approach, compared with 16 per cent for the broader sector.

This insurgency is increasing pressure on the biggest pharma groups - such as Pfizer, Roche and Novartis - after years of sluggish returns from their much heavier investment in research and development.

In the past, some of these stalwarts might have looked to join forces. That was what happened in the last big round of consolidation, around the turn of the millennium, through Glaxo Wellcome's merger with SmithKline Beecham and Pfizer's with Warner-Lambert and Wyeth. But these huge deals largely failed to boost R&D and, with the exception of Pfizer's failed bid for AstraZeneca last year, the top groups have since steered clear of megamergers.

Instead, big pharma has sought to buy growth off-the-shelf through the acquisition of promising new medicines from smaller biotech companies. Among the most recent deals was AbbVie's $21bn takeover last month of Pharmacyclics, maker of a fast-growing blood cancer drug.

Mr Levin says the maturing science of the biotech sector has been an important driver behind the M&A boom, as big drugmakers scramble to refill their R&D pipelines after the heavy patent expiries of recent years.

The US Food and Drug Administration last year approved 41 new drugs - the highest tally for 18 years and the second-highest on record. Hepatitis C, cancer and heart disease are among the areas seeing big advances, much of it stemming from smaller biotech companies.

"M&A provides the fuel for this innovation by delivering a return for the people who funded it and this can then be recycled into further innovation," says Mr Levin. "Deals are a healthy part of the biotech ecosystem."

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At the same time as they hunt fresh growth, big groups have been shedding non-core assets in an effort to become more streamlined. Novartis and GlaxoSmithKline, for example, last month completed a $20bn asset swap in which they each offloaded sub-scale businesses and beefed up areas of strength.

Dan Mahony, healthcare fund manager at Polar Capital, says that, while the deals of the past year have come in many shapes and sizes, they all have a common motivation: pressure on the industry to become more efficient in the face of rising demand from an ageing population.

Drugmakers are wearily accustomed to wrangling with cash-strapped public health systems in Europe over pricing. But these tensions are increasingly evident in the US too, as insurers and care providers show signs of finally trying to squeeze more value from the 18 per cent of gross domestic product spent on healthcare.

Mr Mahony points to last month's $13bn deal between UnitedHealth, the insurer, and Catamaran, a prescription management company, to argue that the hitherto fragmented US healthcare market is consolidating - creating more leverage over drug pricing. "Healthcare has been like a cottage industry but that is beginning to change."

In this environment, pharma companies must either deliver innovation of such clear value that it justifies a premium price, or reduce costs in order to make medicines more cheaply. All of the deals of the past year have been aimed at one or both of these goals. Bankers say there are more to come. "They're going to continue until interest rates rise or valuations become too high as the pool of available assets shrinks," says one. "We haven't reached that point yet."

Fight for domination: Three drugs vie for your medicine cabinet

Open the average household medicine chest and the chances are there will be a product from Teva, Mylan or Perrigo inside. As a three-way takeover battle rages among the trio, who are these companies and how did they become such powerful forces in generic drugs?

Teva: Its roots go back 114 years, but the breakthrough came in 1967 when, during the Arab boycott, the Israeli government allowed local drugmakers to copy patent-protected foreign medicines. Teva has since grown into the world's top generics producer, but a fifth of its $20bn annual sales comes from a branded drug - Copaxone, for multiple sclerosis.

Mylan: Founded in West Virginia in 1961 by two army friends who sold medicines from an old Pontiac car, its annual sales are nearing $8bn. Heather Bresch, daughter of Joe Manchin, Democratic senator for West Virginia, is its chief executive. When Mylan used a $5.3bn acquisition of overseas assets from Abbott to move its tax home to the Netherlands last year, the senator said such "inversion" deals should be banned.

Perrigo: Set up by Luther Perrigo in Michigan in 1887, sales exceeded $4bn last year. Its recent €3.6bn purchase of Omega Pharma put it among the top five over-the-counter drugmakers. Perrigo moved to low-tax Ireland in 2013 through a $8.6bn tie-up with Elan. Andrew Ward

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