Mergers & Acquisitions

A Strategy for Focused Growth in the Biopharmaceutical Industry During Uncertain Times

The life sciences industry is undergoing a major transformation, evolving from a blockbusterbased business model to one of focused growth. In the process, life sciences companies are experimenting with a variety of business and operating models1 in search of the right mix of businesses and competencies to fuel sustainable growth. The scale-oriented megamergers of the recent recession, such as Pfizer-Wyeth and Merck-Schering Plough, have been augmented by a new breed of M&A activity that is oriented toward focused growth, exemplified by Astellas-OSI, Novartis-Alcon, J&J-Crucell

and Pfizer-King. As the global economy picks up steam and companies enjoy continued access to cheap credit, Accenture expects further consolidation in the pharmaceutical and biotechnology segments over the next two to three years. Accenture research indicates that the biopharmaceutical M&A landscape will likely be shaped by three major trends: health care reform, the innovation gap, and the need for more predictable revenue streams. As these trends apply additional pressure to the blockbuster model, they will force the industry to use M&A more aggressively.

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Macroeconomic Factors and Industry Trends will Likely Intensify M&A Activity

Since the end of the recession in 2009, many U.S. corporations have aggressively deleveraged, driving the cash-to-asset ratio for non-financial companies to the highest levels (7.4 percent) seen in decades and making it easier to raise cheap capital for acquisitions.2 In particular, the continued cost-cutting efforts and cash-rich positions of large pharma companies have put them in a prime position to drive further acquisition activities as the economy improves. In addition to the strength of large companies, a variety of macroeconomic factors and trends are creating a biopharmaceutical environment that favors an accelerating pace of industry consolidation. These trends include:

U.S. healthcare reform

This relatively recent legislation has had a major impact on the life sciences industry by promising to increase healthcare coverage for 32 million previously uninsured Americans, of which approximately 17 million will be Medicaid beneficiaries starting as early as 2010. As life sciences companies become more exposed to Medicaid patients, they will realize incremental patient volume that brings incremental revenue, albeit at a lower margin. Accenture also believes that health care reform is not just a U.S. phenomenon, and that there is continuing activity in Europe and other geographies around more pricing pressures and access controls.3

Patent cliff and sparse new product introductions

During the past few years, multi-billion dollar household-name blockbuster drugs such as Zithromax, Prozac, Zoloft, Norvasc, Claritin and Zocor have gone off patent. The ongoing wave of intellectual property expirations of major blockbuster productsonce the growth and profit engines of pharmaceutical companieswill continue to lead to a loss of future revenue in the range of $75 billion between 2010 and 2014, in addition to $12 billion already lost in 2009.4 Because many established therapeutic areas such as anti-infectives, anti-hypertensives, anti-histamines and antidepressants already are commoditized due to loss of patent exclusivity, the pharma discovery engine must identify new targets, and do so quickly. Companies with de-risked (i.e., post-FDA approval) assets, such as King Pharmaceuticals

and Crucell, are thus coveted by deeppocketed acquirers, pushing deal valuations higher and forcing potential acquirers to pay heftier premiums. Similarly, for products under development and still bearing clinical and regulatory risk, recent deal flow patterns show average upfront payments declining due to biopharma companies preference shifting toward milestone-driven deal structures.5

proposition of its products to clinicians and payers with evidence-based real-world outcomes. Furthermore, in a landscape increasingly moving toward personalized medicine, evidence-based medicine also will be a strategic asset for translational medicine to identify the right molecular targets and patient profiles.

Some bright spots

Despite the preceding challenges, there are several bright spots for growth.

Increasing regulatory scrutiny

In 2010 only 21 new drugs were approved, down from 25 in 2009 and 24 in 2008,6 indicating that it takes longer and is getting more difficult for the industry to gain approval for new drug applications (NDA) and biologics licensing applications (BLA). This reality is further slowing the replenishment of the biopharmaceutical new product pipeline. The cause: The bar is being raised to demonstrate a favorable balance of safety and efficiency before an increasingly risk-averse FDA and its advisory panels, which, politically speaking, have little to lose by deferring approvals.

Exploring diversified growth in devices, consumer health, emerging markets and orphan diseases
With the core pharma discovery and development engine sputtering, diversification is becoming a strategic choice to gain more predictability in future revenue streams (Figure 1). For instance, diversification into generic products has long been an avenue pharma has pursued, as evidenced by Sandoz of Novartis and Greenstone of Pfizer. However, it remains to be seen if pharma can operate generics businesses as cost-efficiently such as Teva, which operates a disciplined, low-cost model. Regardless, because achieving economies of scale is a critical success factor in the generics segment, we expect diversification will trigger further consolidation of smaller or regional generics companies by global players. Tevas acquisition of Ratiopharm to strengthen its European presence is a recent example. In fact, Accentures research into what will drive high performance in the future for biopharmaceutical companies revealed that success hinges upon a sharp focus on what differentiates it in the market and on building true superiority and market dominance in carefully selected segments. In many cases, this means

In 2010 only 21 new drugs were approved, down from 25 in 2009 and 24 in 2008, indicating that it takes longer and is getting more difficult for the industry to gain approval for new drug applications (NDA) and biologics licensing applications (BLA).

Migration from pivotal studies to evidence-based real-world outcomes

Prospective, randomized, double-blind clinical trials for FDA registration purposeswhile considered the gold standardhave strict patient inclusion and exclusion criteria. However, the treatment outcomes generated in this controlled environment do not necessarily replicate providers experiences in real-world patient care. As a result, the medical community and some payers increasingly are challenging the validity of clinical trial findings, limiting new products use in treatment protocols and undermining their potential value. Consequently, the industry would benefit from establishing the value

4 | M&A: A Strategy for Focused Growth in the Biopharmaceutical Industry During Uncertain Times

Figure 1. Life sciences companies vary in extent of and appetite for diversification
Revenue Diversification SplitPharma Majors 2009
100

80

60

40

20

Bristol Myers Squibb

Pharma

Novo Nordisk

Eli Lilly and Co.

Astrazeneca PLC
Generics

Pfizer Inc.

Merck & Co.

SanofiAventis
OTC

Roche

GlaxoMerck SmithKline

Novartis

Abbott Labs

Johnson & Johnson

Bayer

Vaccines

Diagnostics

Other healthcare

Chemicals/other

Note: While the graph identifies pharma as a pure strategic focus area, pharma itself comprises of a diverse set of therapeutic areas and technologies which can provide some level of intrinsic diversification. Source: Jeffries Equity Research, March 2010

pharma companies will need the discipline to divest businesses that do not clearly line up with its strategic focus, the discretion to acquire the right assets and companies that enhance its competitive positioning, and the ability to overturn its established business model and concentrate on a select set of distinctive capabilities that will drive high performance in its focused area.7 In addition to diversifying into generic products, pharma players such as Pfizer have experimented with consumer health with varying degrees of success. To operate as effectively as a P&G or Unilever, pharma companies must develop comparable consumer goods and retail competencies, which currently most lack. On the other hand, the presence of an established consumer health business allows pharma companies to tap Rx-to-OTC switch opportunities for improved lifecycle management.

Diversification to devices, typified by what Johnson & Johnson has been doing with Ethicon and with Mentor (among other examples), is another hedging strategy for pharma to pursue. Medical technology companies typically are not exposed to cliff-driven patent expirations, and with their steadier and more predictable revenue streams and acceptable product margins can be attractive to pharma companies seeking separate and profitable business units. Some small cap players, such as Endo, have been pursuing this strategy centered around disease areas and specialties by acquiring smaller drug and medical technology companies and, as a result, increased their share price considerably in 2010.

Finally, with growth absent in many developed countries, the industry is pursuing a land grab in the emerging markets generally called BRICMT (Brazil, Russia, India, China, Mexico and Turkey), which have annual growth of approximately 15 percent.8 Consumers in these markets are gaining more access to health care services and have increasing disposable income with which to opt for premium treatment modalities. This geographic expansion should help the industry compensate for the lack of growth in developed markets in the next three to five years. This higher revenue growth, however, comes at the expense of margin erosion due to lower prices, which is the norm across BRICMT. Consequently, Accenture expects to see an increasing number of acquisitions of established local branded generics companies with attractive unit market share, distribution networks, supply chains and customer relationships.

Oncology, diabetes, vaccines and autoimmune diseasesamong a few othersconstitute a significant unmet medical need and will be areas of interest for acquisitions or licensing deals as exemplified by Takedas acquisition of Millennium to build presence in the oncology space. Biosimilars, sometimes called biobetters, are another emerging trend that has the potential to change the biologics space materially. However, up-front capital investment requirements in excess of $100 million and the recently granted 12-year patent exclusivity to existing biologics are barriers to entry. Finally, orphan drug companies may continue to be among favored acquisition targets, as demonstrated by Genzymes status as a hostile takeover target for Sanofi-Aventis.

Currently, there are approximately 350 orphan drugs approved with approximately 6,800 rare diseases for which no therapies exist.9 Because these are mostly genetically inherited diseases, the treatment effect may be pronounced, justifying a significant price tag that payers may not resist under pressure from active patient advocacy groups. However, in this regard pharma companies must be careful to avoid pricing actions that would allow them to be labeled as greedy. In sum, Accenture believes that several trends will drive the biopharmaceutical industry into the next wave of consolidation, including new U.S. policy and regulatory developments, an innovation gap, and the need to generate predictable revenue streams.

6 | M&A: A Strategy for Focused Growth in the Biopharmaceutical Industry During Uncertain Times

Biosimilars, sometimes called biobetters, are another emerging trend that has the potential to change the biologics space materially.

Analysis of the Biopharmaceutical M&A Landscape

by the Herfindahl-Hirschman Index (HHI), Accenture attempts to predict where large-scale M&A activity most likely will occur for each core geography around the globe. We also attempt to gain insight into whether largescale M&A activity is more probable within a segment (pharma companies acquiring other pharma companies), or across segments (pharma companies buying biotechs). Each year Accentures M&A practice conducts empirical research on a number of high-profile industries such as life sciences to identify industry segments that are ripe for regional or global consolidation. By looking at an industry segments scale as measured by revenue a proxy for its ability to fund largescale M&A activityand by the current degree of concentration as measured Our analysis of the global life science industriesin particular its pharmaceutical and biotech segments suggests that the global biopharmaceutical segment still has significant potential for further consolidation. Within pharma, we further identified three issues:

Increasing regulatory intervention

While the global pharma segment has potential for further consolidation, moderately concentrated HHI levels in North America and the EU (Figure 2) likely will discourage regulatory authorities from approving large-scale consolidation in their jurisdictions (although consolidation of mid-tier players may still be possible).

Asia-Pacific opportunities
The Asia-Pacific pharmaceutical segment has significant room for further consolidation before it sparks potential concern. Its relatively small scale suggests that consolidation may be driven by larger North American and European firms seeking and participating in market growth by geographically expanding into Asia Pacific, a region offering fewer M&A challenges than their base geographies.

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Figure 2. Pharmaceutical industry in Asia-Pacific is highly competitive and is expected to undergo consolidation
Industry Revenue vs. Industry HHI1 (September 2010)
4,000
Biotech EMEA 09/2010

Pharmaceutical and Biotechnology industries have been broken up into North America (NA), Europe, Middle East and Africa (EMEA) and Asia-Pacific to represent the relative size and competitiveness in each geography within the industry.

3,100
Biotech Asia-Pac 09/2010

HerfindahlHirschman Index (HH)

2,200

Biotech NA 09/2010

Concentrated market > 1,800

Pharma NA 09/2010

1,300

Biotech 09/2010
Life Sciences Tools & Services 2009
Healthcare Supplies 2009 Pharma Asia-Pac 09/2010 Pharma EMEA 09/2010

1,000 > moderately concentrated market < 1,800

Healthcare Equipment 2009

400 0 100

Pharma 09/2010
400 500 600 700
2

200

300

Revenue ($ bn)
Notes: 1 The HHI is a measure of market concentration and has been calculated by adding the squares of the market shares of companies in an industry. Healthcare Supplies, Life Sciences & Services and Healthcare Equipment data points correspond to data for the period ended December 2009. 2 Revenues for all other points are as per last reported financials. Source: CapitalIQ, Accenture analysis

Expansion into adjacencies

Due to challenges resulting from consolidation on their own turf, the North America and EU geographies within pharma likely have the scale and the need to diversify into adjacent segments within the life science industry such as biotech or health care equipment. Within biotech, two main points stood out:

Pharma to keep eyeing biotechs

It is possible that major biotech players could make alliances or buy into geographies where they currently have little or no presence. However, Accenture believes it is more likely that major M&A within the biotech industry will be driven by larger pharma players that have more scale and assets, a greater need to diversify, and limited at-scale M&A opportunities within their core business due to regulatory constraints. We recognize the limits of predictions based on summary data sets. More importantly, we recognize the aim of various regulatory authorities to determine the levels of industry concentration that should not be exceeded.

Research and Data Analysis Methodology

The Industry HHI analysis was conducted on the Pharmaceutical and Biotechnology industries as defined by CapitalIQ for the North America (NA), Europe, Middle East and Africa (EMEA), and Asia-Pacific (APAC) to represent the relative size and competitiveness in each geography within each industry. Latin America was not included due to the limited number of companies with publicly available data. In total, 152 companies were analyzed. The HHI is a measure of market concentration and has been calculated by adding the squares of the market shares of companies in an industry and all data points are for the period ended 9/30/2010. For Revenue data points, last reported financials for each company was used.

Big fish chasing small fish

All geographies within the large biotech segment are moderately concentrated, which may prevent internal consolidation within large biotechfor instance, as seen with large biotechs such as Amgen over the last 3 yearswhile leaving room for smaller companies to pursue technology licensing deals.

Potential Consolidation Scenarios

Another tool Accenture uses to identify likely acquirers and targets within an industry segment is the Strategic Control Map. By plotting the market to book ratio (calculated as enterprise value/invested capital) versus the size (measured by invested capital) for each company within an industry segment, we attempt to identify which companies have the scale and currency to drive

consolidation. Generally, companies near the upper-right quadrant of the Strategic Control Map are likely acquirers while companies near the bottom-left are likely targets. Companies near the top-left lack the scale to drive consolidation, but command high valuations that may permit them to make targeted deals while also making them too expensive to be acquired. For their part, companies near the bottom-right lack the currency to acquire on a large scale but are too large themselves to be acquired by rivals. Because of the potential for pharma companies to drive M&A activity in the biotech segment, Accenture has created a Strategic Control Map covering both segments with data current at the end of September 2010 (Figure 3). We found that:

High enterprise value large-cap

companies like Roche, Johnson & Johnson, Pfizer and GSK retain significant currency to continue to acquire into biotech, as evidenced by J&Js recent acquisition of Crucell. Similarly, Pfizers recent purchase of King shows their ability to acquire into specialty pharma. Looking forward, these Potential Buyers can target biotechs near the bottom left of the Strategic Control Map, as Sanofi-Aventis has done with Genzyme.
At the top left of the map, modestly

scaled biotechs with high EV/IC ratios, including Celgene and Gilead Sciences, are well positioned to either make strategic acquisitions or to shop themselves at attractive valuations to large-cap companies.

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Figure 3. Potential acquirers can target biotech companies like Grifols, Actelion, Intercell Biomedical and Chengzhi Co. Ltd. which have low valuations
Invested Capital vs. Enterprise Value/Invested Capital Ratio (September 2010)
6
Vertex

Top 36 IC median ~ $8,610

Potential Buyers

Top 362 by revenue in North America, Europe, Asia-Pacific and Latin America by TTM revenue
Pharmaceutical companies Biotech companies

Zeltia Biomm

Celgene CSL

Enterprise Gilead Sciences Value1/ Biocon Invested 3 Laboratorios Andromoca Capital Biomarin Actelion Ratio Genzyme
Rigel

Shenzhen Neptunus Sino Biopharmaceutical Shire

Roche Enterprise Value Thresholds

GlaxoSmithKline Eli Lilly Abbott AstraZeneca Johnson & Johnson

Peer Average Biogen Idec Bristol-Myers Squibb Chugai Eisai Endo Grifols Astellas Dimed Takeda Chengzhi Co. Ltd. Intercell Biomedical Daiichi Sankyo Instituto Rosenbusch 1 Merck KGaA UCB

Top 36 EV/IC median ~ 2.2

Amgen Bayer Merck

Novartis $150 bn

Sanofi-Aventis Pfizer (129,717,1.4) $80 bn $50 bn $20 bn $10 bn

Potential Targets

$0

$20,000

$40,000 Invested Capital ($mn)

$60,000

$80,000

Notes: 1 EV and market capitalization values are based on closing share prices as on 9/30/2010. For Invested Capital values, last reported financials have been used. 2 Top 5 companies by revenue have been taken from Pharmaceutical and Biotech segments for North America, Europe and Asia-Pacific. For Latin America only 4 companies had public available data. For Europe AstraZeneca, Bristol-Myers Squibb and Merck KGaA do not belong to Top 5 and have been added for market perspective. Pfizer and Alexion are outliers and their representation is not to scale. Source: CapitalIQ, Accenture analysis

Smaller companies with less-robust

Research and Data Analysis Methodology

The 36 companies in the Strategic Control Matrix analysis were selected by including the top 5 companies by revenue in the Pharmaceutical and Biotech segments respectively in the North America, Europe and Asia-Pacific regions. For the Latin America region, only 4 companies had publicly available data and were thus included. For the Europe region, AstraZeneca, BristolMyers Squibb and Merck KGaA did not meet the top 5 revenue criteria but however have been added in order to provide a holistic market perspective. Pfizer has been identified as an outlier as its representation is not to scale and have thus been excluded from the analysis. EV and market capitalization values are based on closing share prices as on 9/30/2010. For Invested Capital values, last reported financials for each company was used.

EV/IC ratios at the bottom-left of the map, such as the Japanese pharmas Astellas and Daiichi Sankyo, could become Potential Targets. They will increasingly be forced to make larger betssuch as Astellas $4 billion acquisition of OSIor risk being acquired at a relatively lower premium by larger pharmas. Alternatively, it is conceivable that two followers among this group could attempt to merge, thus pooling their assets and their bets.

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However, the most interesting finding from our Strategic Control Map is the high number of well-known pharma companies that currently exist in the middle ground. Companies in this area need to be tightly focused on their strategic approach for continued growth. Accenture believes that if companies in this area do not move with pace and clarity to gain market prominence in their area of strategic focus, they will risk their future independence and profitable growth. Furthermore, Accentures experience across markets suggests that the middle ground may not be a viable long-term landing point, because shareholders may slowly abandon companies that they view as trapped there.

As such, these companies need to very clearly articulate their future growth strategies to their investors. Accenture believes there are a number of options they can pursue: 1) Commit to innovation by refocusing the portfolio, 2) become an outcomes-focused company that provides a range of solutions beyond the molecule to meet customer goals, or 3) embrace a more diversified model of consumer health, medical products, generics, etc.1 Bristol-Meyers Squibb (BMS) is a good example of a company making such a move toward innovation. The company has eschewed the traditional large pharma model and adopted a string of pearls strategy to pursue targeted growth. We expect that BMS and other pharmas such as Takeda, AstraZeneca, and Lilly will further evaluate opportunities to acquire into biotech to move toward the right of the chart or will risk falling behind to become potential targets.

Even slightly larger and more successfully diversified pharma companies such as Bayer and Abbott Laboratories (a successful serial acquirer) may find they need to gain further scale through continued acquisitions, as Abbott did well with the AMO acquisition. Such moves will help these players avoid the risk of becoming targets in a potential future wave of mega-consolidation.

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Accentures experience across markets suggests that the middle ground may not be a viable longterm landing point, because shareholders may slowly abandon companies that they view as trapped there.

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Conclusion

Long known for robust growth and high profitability, the biopharmaceutical industry is at a critical juncture to deliver shareholder value. The industry is faced with massive patent expirations, generic commoditization and an innovation gap, all of which must be overcome to sustain profitable growth. Much will change in the coming years as both segments move toward delivering solutions and improved health outcomes versus products. Currently, ongoing cost reduction initiatives, business process outsourcing and strong cash reserves provide large pharma companies with a strategic option to grow through targeted acquisitions. In addition, there are several trends that favor growth via acquisitions, including US health care reform, evolving FDA standards, and increasing pressure for pharmaceutical companies to diversify into generic products, consumer health, devices, and emerging markets.

Accenture research suggests that the global pharma and biotech segments have the potential for further consolidation and megamergers, both driven by the strategic intent to cut costs and build scale. The segments moderate industry concentration will likely dissuade regulatory authorities from approving large-scale consolidations to a greater extent going forward. This, in turn, is likely to drive increased activity by the larger players into smaller and targeted therapeutic areas, high growth geographies and/or adjacent segments including biotech. It may also force acquirers to divest significant assets to satisfy regulators. A few well-known pharmaceutical companies occupy a middle-ground in which they may lack the competitive scale or capabilities required for sustainable growth without acquisitions.

These companies will likely need to articulate a focused growth strategy to their shareholders or risk acquisition by their larger competitors. In conclusion, several major factors and trends in the life sciences industry make consolidation an inevitable reality. Only through a rigorous process of strategic target identification, due diligence and seamless post-merger integration will tomorrows leading pharma companies lay the groundwork for sustainable shareholder value and high performance.

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About the authors

Tom Herd is a senior executive in Accentures Strategy service line. He has 16 years of management consulting experience in M&A, merger integration, and strategy consulting with Fortune 1000 and entrepreneurial clients. Prior to joining Accenture, Tom worked with another leading consulting firms North American Strategy and Organization practice. Tom has also worked for Procter & Gamble in multiple countries and with the U.S. Army in Germany. He is based in Chicago. thomas.j.herd@accenture.com

David A. Sheehy is a senior executive in Accentures Strategy service line and is the global lead for its Life Sciences Strategy practice. David has 20 years of management consulting experience working with leading Health & Life Sciences companies, with a focus on corporate and commercial strategies. David has recently co-authored Accentures Achieving Future High Performance in the Biopharmaceutical Industry, a point-of-view which addresses approaches to sustainable growth and profitability. David is based in Washington, D.C. david.a.sheehy@accenture.com

Arda Ural is an experienced senior manager in Accentures Life Sciences Strategy practice. Prior to joining the firm, Arda was a VP Strategic Marketing at Becton Dickinson (BD) and served as the SVP Marketing & Sales for a start-up biotechnology company Eyetech (later part of OSI/ Astellas). Arda started his career with Pfizer and over 10 years he had responsibilities including the US Team Leader for Celebrex and worldwide marketing director for Viagra launch. He holds BSc & MSc degrees in Mechanical Engineering from the Bosphorus University and an MBA from the Marmara University in Istanbul, Turkey. He also completed Pfizer Executive Development Program at Harvard Business School. He is based in New Jersey. arda.ural@accenture.com

References
1 Accenture Research, Era of Outcomes, Emerging Business Models for High Performance, 2009 2 Justin Lahart, Companies Cling to Cash, the Wall Street Journal, pg A1 December 10, 2010 3 Accenture Research, US Healthcare Reform: Pharmaceutical Industry Impact and Opportunities , 2010 4 Accenture Research, Achieving High Performance in the BioPharmaceutical Business, 2010 5 Elsevier Business Intelligence Strategic Transactions database; Jan 1, 2007 through Aug 31, 2010.

6 Jennifer Corbett Dooren, Drug Approvals Slipped in 2010, Wall Street Journal, page B2, December 31, 2010 7 Accenture Research, Achieving High Performance in the BioPharmaceutical Industry: How Will You Dominate the Game?, 2010 8 IMS Market Prognosis, IMS Health Press Release, Oct 6, 2010 9 Cliff Mintz, PhD, Orphan Drugs: Big Pharmas Next Act? Life Science Leader, October 2010, pg. 9

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About Accentures Life Sciences Practice

Our Life Sciences industry group works with pharmaceuticals, biotechnology, medical products, medical technology, regulators, distributors, wholesalers and other companies to help bring life-enhancing health solutions to people around the globe. We provide consulting, technology and outsourcing services across the entire life sciences value chain, from large-scale business and technology transformation to post- merger integration. Our key offerings include: Research and Development, including pharmacovigilance and regulatory outsourcing; Supply Chain and Manufacturing Optimization; and Marketing and Sales, including commercial services, analytics and digital marketing.

About Accenture
Accenture is a global management consulting, technology services and outsourcing company, with approximately 211,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the worlds most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$21.6 billion for the fiscal year ended Aug. 31, 2010. Its home page is www.accenture.com.