This morning, we saw some interesting transaction coming out of a major European Pharma – GlaxoSmithKlein annnouced a global collaboration in immuno-neurology for neuro-degenerative disease with Alector for $700mm upfront and $1.5bn in potential milestone payments (“biobucks”).
Nobody really care much about the milestone payments, but the $700mm upfront payment shows that this is a MAJOR transaction for GSK.
Alector is an innovative biotech company in the US, but a company that largely remains a “science project”. However, the company has had some challenging times – with delays to its clinical programs due to covid19 that led the stock underperforming since mid-2020 – that is UNTIL TODAY.
This transaction is particularly interesting because GSK is currently under pressure from an activist investor, Elliott Management, who is suggesting that GSK has poor operation execution, value creation strategy, and incapable management team.
In public investors’ mind, GSK unfortunately has reputation for being poor capital allocators, and they pulled this transaction with Alector on Parkinson’s disease and Alzhimer’s disease – one of, if not the most, complicated diseases in neuroscience. The big players, Roche and Biogen, have seriously struggled in this area with multiple big failures and now you have GSK jumping in here without real significant expertise in the space. Right at the time when the company is being accused of being poor managers of the company operationally and financially.
I do not know the inner thinkings of GSK management team, but they were probably thinking that this represents an incredible value opportunity – paying $700mm for Parkinson’s disease and Alzheimer’s disease programs is definitely a steal and an amazing value play IF this plays out. But usually cheap assets are cheap for a reason particularly if they are in high growth sector, like biotech.
Anyways, this presented me with an opportunity to talk about bad M&A cases that had been pitched to investors as “value” deal – it is not exhaustive, but should give you an idea that cheap things are cheap for good reason. Obviously I am saying all these with the benefit of hindsight, but I still believe that they are very instructive.
Bad deal #1: Takeda’s acquisition of Shire for GBP 46bn
Shire’s problem was in the making since its opportunistic acquisition of Baxalta (great move by Baxter to dump Baxalta as a public public). When the transaction was announced, Takeda pitched to investors that Shire acquisition would be great for cashflow and accretive to earnings – a quintessential VALUE DEAL.
It was very accretive short-term, but it was accretive because Takeda was buying low multiple Shire stock with its high multiple Takeda stock – investors were rewarding Takeda’s high growth potential while they were punishing Shire for impending destruction of its base business by innovative products. Takeda also had to borrow a lot and now leverage is limiting investment with respect to long-term value creation. Takeda never recovered to its pre-transaction share price.
Bad deal #2: GSK’s acquisition of Tesaro for $5bn
GSK paid $5bn for Tesaro – what GSK was really buying was Zejula (niraparib) – an oral PARP inhibitor that is used for ovarian cancer – biggest value was for 1L ovarian cancer maintenance. GSK also bought this deal as a “value” deal because TSRO had traded down significantly from its 52wk high before GSK decided to pull the trigger. Tesaro had traded as high as $175 before it was acquired $75 per share / $5bn for the whole company. It looks like they acquired low relative to where it had been.
However, $5bn is a big price to pay with a lot of growth being paid upfront…. which did not pan out. In 2020, Zejula put up GBP 339mm for the whole year – in its third year of launch. This is not a great outcome for a $5bn “value” deal because they ended up paying 10x 2-year forward revenue for a small molecule drug. With AZN/MRK’s Lynparza increasingly positioned as the standard of care, Zejula growth prospect gets worse every year and this value deal was not so great.
Bad deal#3: Sanofi’s acquisition of Bioverativ for $12bn
This deal is essentially the original version of Takeda/Shire. Sanofi wanted cash flow and EPS accretion so it decided to buy Bioverativ – a spin out of hemophilia asset from Biogen (great job spinning out growth dilutive asset) after Biogen could not find a buyer.
Bioverativ is a classic melting ice cube company – its entire business was and is at risk from innovative therapies – Hemlibra from Roche, which has a subcutaneous therapy that works MUCH better with MUCH longer dosing interval (you don’t have to give yourself intravenous infusion every 2-3 days) AND gene therapy (Biomarin, Pfizer, and Roche). Regardless Sanofi decided to buy Bioverativ, citing value, cash flow, and earnings accretion.
In 2019 (only one year after acquisition), Sanofi had to write down Bioverativ asset by $2bn (out of $12bn transaction value) – the write-down should continue to come.
Pharma M&As generally do not create a lot of value because they usually do tend to pay the value upfront to the seller. However, above deals are generally considered to be the worst deals by biotech market investors.
Pharma / biotech investors are generally growth investors – they are not investing here for cash flow. There are other sectors that are much better suitable for that type of investing.
Also, capital market is not perfect, but it does a decent job of appropriately valuing companies based on their future prospects and appropriately discounting some companies for risks – expensive assets are expensive for a reason and cheap companies are cheap for many reasons.
In my view, it is usually better to pay up for top tier assets especially in pharma because the first-to-market or best-in-class assets simply have unparalleled market domination in the market.
We should remember that pharma is one of the very few industries where there is both legal and natural monopoly that is protected by the market and the government (where applicable).
Usually only one product dominates the whole market for each disease because it is the best drug and it is the right thing. There are so crumbs left for second / third tier products in pharmaceutical industry.
Therefore, trying to be cute and model out a small m/s share to get to a valuation that makes a transaction a value simply does not work
Anyways, we touched out bad deals today and next time, I will discuss great transactions in which pharmas were criticized for having paid too much, but worked out spectacularly because the transaction was truly transformational to its equity story.
Until then, happy investing and wish you best of luck!
*not investment advice.
