Pharmaceutical stocks have been taking a beating over the last couple of weeks as presidential candidates target drug pricing. The sector fell 7.7% in the first three weeks of September, compared to the S&P 500’s 2% decline during the same three weeks.
Valeant in particular has been targeted by lawmakers, and its shares have taken a dive. However, analysts aren’t worried, at least not in the near term. Analysts see mergers and acquisitions as one of the top value drivers in the industry, and of course Valeant has a reputation of being a serial acquirer.
More consolidation in pharma expected
Nomura analysts Shibani Malhotra and Austin Nelson said this week that the steady stream of mergers and acquisitions we’ve been seeing in the pharmaceutical industry lately will likely continue into next year, especially in specialty and generic pharmaceuticals. They say patent expirations and the pricing pressures we’ve already been seeing are driving the different macroeconomic environment in the industry right now. Customer and payer consolidation is intensifying the situation.
As a result, they say the boards of pharmaceutical companies are being pressured to turn their attention to optimizing capital allocation.
Ripple effect thanks to Allergan
Last year the pharmaceutical industry was in center stage, not only because of all the mergers and acquisitions but mostly thanks to the drama involving Allergan, Valeant Pharmaceuticals and Actavis. In light of that drama, the Nomura team expects to see pharmaceutical companies become more aggressive in their M&A tactics and start pursuing more deals, both friendly and hostile.
Recently the U.S. plugged a loophole that many companies had been taking advantage of, which dealt with tax inversion transactions. It is now much more difficult to complete such transactions, so even though it’s unlikely that large tax inversion deals will be done, they still think U.S.-based companies make attractive targets for international drug makers with higher tax rates.
Three companies do half the M&As
Interestingly, investors haven’t been seeing all the M&As in the industry in a positive light. Instead, they’re looking closely at each deal on a case by case basis and focusing more on execution and results achieved from transactions that have closed within the last year and a half.
What’s also interesting is that only three companies have completed half the M&As over the last year:
Further, the Nomura team pointed out that this year the number of hostile pursuits is much higher than it has been in previous years. For most of this year, Teva, Mylan, Shire and Perrigo have been duking it out. Mylan made a hostile bid for Perrigo, but Perrigo fended that bid off by acquiring part of GlaxoSmithKline’s European business.
Then Teva made a hostile bid for Mylan but later withdrew it to buy Allergan’s generics business. Also Shire made a hostile bid for Baxalta less than a year after Abbvie failed to acquire Shire.
Allergan, Valeant the favored ones
Nomura lists Allergan and Valeant Pharmaceuticals as being their two top picks in the pharmaceutical industry. In Allergan’s case, they expect management to create value for shareholders using the capital from the sale of the company’s generics business. They also like Allergan’s underlying business, seeing it as strong and sustainable. They believe Wall Street is underappreciating this.
For Valeant, they see execution as being the biggest value driver, and of course M&A is likely to keep being a key factor in driving upside.
Here’s a brief glimpse of their views of major pharmaceutical players: