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Royce Funds: What’s Driving M&A Activity In The Healthcare Space?

What’s Driving M&A Activity In The Healthcare Space? by Royce Funds

Portfolio Manager Carl Brown believes that cash-rich corporate balance sheets and increased competitiveness in the healthcare universe will make smaller companies attractive targets for M&A activity.

See the video here.

Royce Funds: What's Driving M&A Activity In The Healthcare Space?

Chip Skinner: We’ve seen a little bit of M&A activity in our portfolio, but also, generally speaking, last year. What is the outlook this year for M&A?

Carl Brown: I think we’ll continue to see a healthy level of M&A in the markets in general, and in the healthcare space specifically. We’ve seen a lot of it in the pharma and biotech space over the last couple of years.

Corporate balance sheets are flush with cash, and even the companies that aren’t sitting on large hoards of cash still have access to capital at very attractive rates. So the economics of buying versus building have tipped somewhat in favor of buying of late, and we don’t see any change in that environment coming anytime soon.

Specifically within healthcare we expect to see continued M&A. There’s a long list of acquirees and acquirers that are out there looking for assets. There is a ton of operational leverage to be had in the healthcare space. We’ve seen it already over the last several years in the pharma and biotech world and we expect that to continue.

I would predict that in the near future we’re going to see an uptick in M&A activity more on the medical device side. We started to see some last year with some of the larger companies combining, and we expect to see more of that and a lot of the smaller med device companies that are out there—and there are a ton of them—to be potential targets for sort of that mid-level, mid-cap medical device and large-cap medical device companies.

Chip: The other driver of M&A certainly is the fact that large pharma companies have a bunch of great products that have been billion-dollar type products which have come off patent. So there is seemingly a scramble to identify up-and-coming products, maybe a pipeline of great products, that can be folded into their infrastructure, their income statement, and create the leverage that you described.

Carl: And not only is it what we think of as large-cap pharma that’s a part of this phenomenon, but there’s an increasingly growing class of middle-tier companies with market caps in the 10-15 and up to $30 billion market cap range that are competing for these acquisitions. So not only is big pharma competing against other big pharma, but they’re now competing against this sort of new emerging middle class pharma space to pick off assets. So it’s more competitive, and that leads to higher acquisition multiples, and that’s good for small-caps.

Chip: I think on the other hand, the fact that equity prices have rung up, that companies will probably be more selective in terms of the companies they buy or the prices they pay. But we’ve seen a giant correction in the energy area with oil prices dropping by 50%. Can you sort of predict that there might be more activity in that area?

Carl: I wouldn’t be surprised if you saw some level of activity. Working against that is the fact that the capital markets, Wall Street basically, is still willing to fund these companies, even ones that have had poor returns or have put a lot of capital to work based upon a premise that we would have $90 oil for a long time.

So, despite the fact that we’ve gone from $90 oil to sub-$50 oil, you would think that perhaps a lot of companies would have trouble getting fresh rounds of funding from investors, and that lack of funding from external investors would lead them to perhaps sell to an acquirer and you would see an uptick in acquisitions in the space.