Assessing Q3 2014 healthcare M&A dynamics

In the third quarter of 2014, big deals continued to dominate the healthcare M&A headlines, with transformative divestitures and restructurings reshaping the landscape.

Large scale M&A activity is how large companies are adapting to the new healthcare environment. In the new environment, tight government and hospital budgets loom large and cost has become an enormous part of the equation. Lower reimbursements, more challenging and expensive regulatory pathways, and a tougher gauntlet to get products approved within institutional settings have all led to one obvious conclusion: organic growth and higher levels of profitability are becoming harder to achieve in the new environment.

Companies have to look to M&A and other strategic options to grow revenue, gain operating leverage, enhance specialization, enter new geographical markets and improve the bottom line.

Big deal volume continues

Across many industries, 2014 has been a boon for mega-sized deals. Thus far in 2014, global M&A is worth an estimated $1.2 trillion – already the highest it’s been since 2007. Healthcare deals make up over 13 percent of total M&A, according to Forbes. To a large extent, tax-lowering factors (inversions) have motivated many transactions, but synergies are prominently at play too. In fact, tax lowering strategies are themselves driven by the new environment. 

Some of the “mega deals” include:   

• Medtronic, Inc.’s scaling and entering new clinical areas, including weight-loss surgery and laparoscopic procedures, through its pending $42.9 billion purchase of Ireland-based Covidien plc.
• Bayer's diversification into consumer healthcare by acquiring Merck’s Consumer Care Business for $14.5 billion.

Restructurings streamline and focus companies

Given the new environment, many companies are restructuring  -- emphasizing core competencies and high growth/high margin businesses while divesting underperforming, non-core assets.

Examples include:

• Dutch electronics giant Philips’ splitting into two companies – one focused on healthcare and technology and one on lighting as part of its strategy to transition away from consum-er electronics. It's rebranding the former HealthTech and exploring differing ownership options for the latter.
• After purchasing surgical soft tissue repair products for $235m from Covidien and Medtronic surgical instrumentation lines for $60m September, Integra LifeSciences is spinning off its spine business into a new publicly traded company called SeaSpine, focused on spinal implants and orthobiologics. Integra will concentrate on orthopedic and tissue technologies for the extremities, wound care, and specialty surgical solutions in neurosurgery and surgical instrumentation.

Pushback on inversion deals

Acting administratively -- not legislatively -- the U.S. Treasury Department proposed new measures to discourage tax inversion deals, rampant in recent quarters. Most notably, AbbVie's Board of Directors recommended that its shareholders reject the company’s $55 billion planned purchase of Ireland-based Shire Plc, expected to cut AbbVie’s current tax rate of 22-26 per-cent to about 13 percent. The pull-out will trigger a $1.64 billion break-up fee in Shire's favor.

While the inversion window is narrowing, companies continue to employ the strategy in nuanced ways. Steris Corporation intends to move its domicile to the UK after it announced its $1.9 billion buyout of Synergy Health Plc, lowering Steris’ effective tax rate from 31.3 percent to about 25 percent by 2016. Smaller companies, such as Steris, are less restricted from accessing overseas cash and deemed not as impactful on the overall economy.

Patent expirations drive Big Pharma

Recent events, including the Ebola crisis and the risks of other infectious diseases, have led many large pharma acquirors to target viral infections to hedge bets on the development of blockbuster, proprietary drugs addressing specific conditions. Big pharma, once focused on producing targeted “game changing” drugs, are extending into adjacent infectious disease areas as patent expirations approach.

Notable examples include:

• Pfizer’s expansion into preventative medicine via its $635m purchase of Baxter’s Commercial Vaccines Business.
• J&J’s purchasing Alios BioPharma, a maker of a preventive intervention  for infants with respiratory syncytial virus (RSV) – for $1.75 billion

U.S. now the prime market

The global economy’s performance also has also influenced deal activity and trends. 

Europe is still struggling under its austerity policies and even the gross domestic product of mighty Germany shrank by .06 percent in Q2 2014, compared to the quarter before. German GDP growth over the five-year period 2008-13 is a paltry 2.2 percent … for the total five-year period. 

China reported that its third-quarter GDP rose 7.3 percent compared to a year earlier. This was the slowest growth in more than five years, and many economists believe a more comprehensive index of economic activity shows less than 6.0 percent growth. 

With political and economic issues weighing down South America and recent events, such as Ebola, Islamic extremism and Ukraine, disrupting markets, the climate remains problematic at best. Exemplified by recent stock market increases and industrial production upticks, the U.S. remains the most predictable and favorable market. Of course, niches always exist for new medical products, but companies need to be far more discerning in charting their marketing course.

Adam Cohen works for the Walden Group, a strategic investment banking and consulting firm focused on the healthcare industry. Click here to access Walden's full M&A report.