By Barbara Ryan, FTI Consulting Managing Director in Healthcare Capital Markets and Strategic Communications
In Life Sciences, last year certainly could be called the Year of the Deal. Along with 60 mergers and acquisitions (with the average deal size 49 percent larger than the previous year’s), there were three times as many initial public offerings (IPOs) in 2013 as there were the year before. These IPOs raised a cumulative $2.7 billion, which exceeded the total of the previous five years. And according to FTI Consulting’s fourth annual Life Sciences Investment Survey, investors expect these trends to continue and even grow. By March 2014, for instance, there had already been 21 IPOs in the Life Sciences, raising an aggregate $1.3 billion.
This qualifies as a white hot environment, and it was particularly heated for pre-revenue companies in oncology and specialty diseases. And, perhaps surprisingly, much of this deal-making did not involve what is commonly called Big Pharma.
Where the Action Is
With much of Big Pharma’s cash invested offshore, many of its blockbuster drugs coming off patent, an industry-wide mandate to reduce R&D spending, and shareholders expecting significant dividends, Big Pharma is not looking to take on risky, developmental projects or acquire new companies with yet-to-be approved drugs in their pipelines. As Alan Hartman, a partner at Centerview Partners, a leading investment banking and advisory firm, said at a recent FTI-sponsored life science investment panel, the action is in oncology and other specialized, rare diseases. IPOs are “white hot” in these areas, Hartman said, and “there’s private equity capital for investment. [Pre-revenue companies] don’t need to partner with Big Pharma. Big Pharma is not interested if sales will peak at $200 million, or $300 million, or $50 million in some cases,” as they may in the specialty and rare diseases categories.
So what is Big Pharma’s game plan going forward?
Almost 90 percent of the deals that have occurred in the Life Sciences over the last five years have been for companies with marketed drugs. Big Pharma is interested in companies that are more diversified, that will give them greater market reach and larger cash flow.
Perrigo, for example, the largest manufacturer of OTC pharmaceuticals in the U.S. and a $22 billion company, last year acquired Irish-based specialty drug manufacturer Elan for $8.6 billion. Perrigo’s strategy, according to its Executive Vice President and CFO Judy Brown, partly was driven by the company’s desire to acquire a platform for its “booming” generics business outside the U.S., thereby bringing “quality affordable healthcare to more markets as we have a very specific focus on the prescription-to-OTC switch,” and partly to develop a balance sheet “that will allow us to do more and larger transactions than we would have been able to do in the past”.
The Elan transaction, said Brown, affords Perrigo the ability to keep growing. “By having a footprint in Ireland, by now being an Irish company, we have more flexibility in our cash flow utilization, where we’re going to deploy cash, and how we’re going to be able to invest effectively globally.
“The world is our oyster,” concluded Brown.
The Elephant in the Room: Taxes
Since the global financial meltdown in 2008, the subsequent Recession, and the sluggish economic recovery, there has been a surge of populism in almost every Western country. And Pharma has become an easy target.
“You pick up the paper and you read every day about some outrage over how much money is pooled offshore, avoiding taxation somewhere,” said Tom Crawford, an FTI Senior Managing Director in the Strategic Communications group.
Specifically, much of that outrage has been directed at the practice of inversion, whereby a company moves its headquarters to a jurisdiction where it can pay a lower tax rate even as it keeps its material operations in its country of origin.
“Inversion is like Voldemort [in the Harry Potter books],” Crawford said. “It’s not something we like to say out loud.”
Crawford believes it’s going to be “a rocky road on the inversion side, and I think those deals that appear to have been done for tax purposes only are going to have trouble.”
And this may mean trouble for Big Pharma. With so much of Big Pharma’s cash, IP, and manufacturing now offshore, if the tax rules change, and those companies suddenly are paying 30 percent tax and not 20 percent, those companies’ math, as Hartman said, will “look very, very different.”
A practice that’s drawing even more criticism is analogous to inversion. A company develops intellectual property (IP) at home, migrates it to a lower tax jurisdiction, and is thereby allowed to recognize the revenue from the sale of its IP-derived products in the lower tax environment, deferring home-country taxes.
Right now, in fact, the Organization for Economic Co-Operation and Development (OECD), the European Union, and the G20 are working on rules that would require companies to maintain significant facilities, management, or personnel in the offshore location in order to report revenue there. The U.S. is also saying that if a company is not managed and controlled in the jurisdiction where it’s reporting revenue, it will be disqualified from taking tax deferments.
And although Ireland’s Finance Minister, for example, says Ireland will keep its low tax rate, he also says he will tell companies that have done deals for tax purposes only that they will either have to get right with the new rules or get out.
Perrigo’s Brown acknowledges that there was a tax component to the company’s acquisition of Ireland-based Elan: It needed to be competitive with offshore competitors taking advantage of lower tax rates. Perrigo, however, was not tarred with the tax-avoidance brush (as Amazon, Starbucks, and Apple have been) because it approached the acquisition with a strategic communications plan, establishing a business case for the deal that had more to do with economic growth and lowering costs for healthcare consumers than with financial structures. And it communicated that case proactively.
Brown testified before the U.S. House Ways and Means Committee years before the Elan acquisition, advocating for tax reform, underlining Perrigo’s contributions to the healthcare system and the U.S. economy, and describing the barriers the company confronted in attempting to export its expertise globally. It was only after establishing this business case that Brown began elucidating the merits of the Elan acquisition. Ultimately, according to Crawford, who helped Perrigo design and deploy its strategy, the Chairman of the Committee told Brown, “I don’t blame you for what you did. You’ve been up here for two years telling us we need to do something. You can’t wait for us to go and do your business.”
The lesson, said Crawford, is that “policy makers are not looking to crucify people who explain themselves, who have a rationale for what they’re doing. They’re looking at people who try to arbitrage the system in a way that doesn’t appear to be about anything but getting a tax benefit.
“Your story needs to be consistent,” Crawford continued. “Regulators are now listening to your calls; they’re looking for any inconsistencies, any area where you state something differently than what you’re claiming.”
Ultimately, the big heat in Pharma and Biotech is less about tax loopholes than about finding innovations that will improve the quality and length of life, as well as bend the cost curve. Making drugs and healthcare more affordable will be critical as countries strive to restrain unsustainable increases in costs and improve the health of their populations. This is the great promise of the Life Sciences for the people who work in it, as well as consumers and investors.