M&a: using uncertainty to your advantage

M&A: Using Uncertainty to Your AdvantageA Survey of European Companies' Merger and Acquisition Plans for 2012 André Kronimus, Peter Nowotnik, Alexander Roos, and Sebastian Stange
This report was prepared by The Boston Consulting Group on the basis of a survey of corporate executives in Europe conducted jointly with UBS Investment Bank.
December 2011 This year's survey of top European executives by BCG and UBS Investment Bank finds that the desire for mergers and acquisitions persists in Europe as cash-rich corporations seek to grow their businesses and gain a competitive advantage. WILLING BUT WAITING
As companies finish their housecleaning and as internal barriers to deal-making
disappear, executives are increasingly willing to invest in M&A. But activity in 2012
will strongly depend on whether worries about the larger economy dissolve.
When operations stabilize and the impact of macroeconomic developments is
understood, it will be time to move from focusing on risks to looking for opportuni-
ties. Investing in information will allow executives to act carefully but courageously
while others remain paralyzed.
Mounting structural challenges and recent deals in the pharmaceutical industry
demonstrate the strategic value of M&A. But uncertainty and deal complexity
increase execution requirements for successful transactions.
M&A: Using Uncertainty to Your Advantage Ducunt fata volentem, nolentem trahunt. (Fate leads the willing soul, but drags along the unwilling one.) – Seneca Despite stock market turmoil and worries about sovereign-debt crises that
have rattled the euro zone, the region's corporations remain cautiously optimis- tic about the prospects for mergers and acquisitions (M&A) in 2012. Indeed, a number of indicators suggest that 2012 could be a good year for M&A if economic conditions improve. According to our fourth annual survey of the M&A plans of European companies, conducted together with UBS Investment Bank, companies continue to be optimistic about doing major deals next year. Market valuations in sectors ranging from financial institutions to energy look attractive. Cash piling up on the books of blue-chip European companies is at new record levels. And after spending several years getting their houses in order and honing their strategies in an environment of bewildering uncertainty, executives are once again ready to concentrate on growth.
But while the desire to acquire may be strong, the climate of risk and ambiguity could make it difficult to execute deals in 2012. This mixture of heightened internal optimism and external doubt showed up clearly in our survey. One in six companies is ready to make large-scale deals in 2012, for example. But some companies that last year were cautious are now even less likely to make a move owing to height-ened unease over the macroeconomic environment. Internal constraints to doing deals are declining, however, because many companies have cleaned up their operations. Even the willingness to invest has increased. Two- thirds of the companies we surveyed want to deploy their record stockpiles of cash to achieve growth, and a large share want to do so through M&A.
today's turbulent But M&A deal-making in the midst of today's turbulent market is more difficult and requires skillful execution. Success increasingly depends on the ability to assess requires skillful risks and create value from complex deals that go beyond simple consolidation. When M&A works, however, it has the potential to overcome mounting challenges and substantially improve a company's competitive position. As is evident from our analysis of pharmaceutical companies, M&A is still regarded as a vital tool for addressing the urgent strategic issues confronting certain industries.
Will M&A activity remain flat in 2012, or will it shift into a higher or even a lower gear? How can executives adapt to the current environment and drive successful M&A? Much will depend on whether the macroeconomic picture becomes clearer. The Boston Consulting Group After aggregating and dissecting the views of chief executives and senior managers from 148 of Europe's largest public companies, we find that a large number of companies are itching to pull the trigger as soon as the fog lifts.1 Navigating Lingering Uncertainty For all the unsettling Companies making M&A transactions in 2012 will likely have to do so in a climate news that rattled of continued macroeconomic doubt and in the face of multiple sources of risk. Three years after the onset of the global financial crisis, capital and raw-material markets show heightened volatility. Potential sovereign defaults in Europe threaten M&A activity was banks and the future of the euro. U.S. and European economic forecasts point to remarkably stable.
sluggish growth. These factors translate into very weak visibility for corporate earnings.
On top of the rocky economic environment, industry challenges are proliferating. Structural changes are occurring in response to government policy or political pressure, such as Germany's sudden decision to abandon nuclear power and calls in many countries for tougher regulation of financial institutions and health care providers. In industries such as automotive, pharmaceuticals, and chemicals, demand is steadily shifting to emerging markets that can be difficult to penetrate and that are producing their own aggressive corporate challengers.2 Some indus-tries are being redefined by new technologies or disruptive innovation. In many others, competition is intensifying, destabilizing market share and putting pressure on margins. Understanding the specific strategic challenges in an industry is key to successful M&A. At the same time, capital is no longer reliably available to all companies. The market for initial public offerings has almost disappeared. Highly volatile stock prices make it difficult to price targets because neither acquirers nor targets want to be caught on the wrong end of a major market swing. As the sovereign-debt crisis develops, banks under pressure to increase regulatory capital are once again becoming very discerning about to whom they lend. Financing acquisitions could become even more difficult if European banks have to absorb further losses from sovereign-debt defaults. Still, for all the unsettling news that rattled markets through much of 2011, M&A activity was remarkably stable. (See Exhibit 1.) The number of transactions re-mained high, at about 4,500 per quarter. Although transaction values were moder-ate, they too were stable for most of the year. By the third quarter, however, the impact of mounting fears over the financial crisis in Europe and the direction of the EU economy began to be felt. Deal values fell by 33 percent. Large deals—those valued at between €1 billion and €5 billion—plunged by almost 50 percent.
While executing deals in the midst of increased uncertainty is difficult, periods of structural disruption are actually favorable to M&A. In the current environment, financial deterioration is often due to the systematic decline of a company's com-petitive position rather than to a cyclical dip in demand. Generally a company's competitive position can be improved more quickly through M&A than through organic moves. M&A: Using Uncertainty to Your Advantage Exhibit 1 European M&A Was Moderate in 2011 but Dampened After the Recent Correction
Value and number of announced European M&A transactions,
first quarter, 1990, through third quarter, 2011
Transaction value (billions) Number of transactions 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Value of megadeals (> 5 billion) Value of all other deals (< 1 billion) Value of large deals (1 billion to 5 billion) Number of transactions Sources: Thomson Reuters; BCG analysis.
Note: Includes all M&A transactions announced from January 1990 through September 2011 that involved either a European acquirer or a
European target.
That said, it is likely that M&A deals in 2012 will have to be undertaken despite the low visibility of market conditions, company performance, and the impact of strategic moves, making sound analysis and execution all the more important. M&A is also likely to become more complex, especially as European companies focus on cross-border transactions or on weak targets in need of restructuring. This sense of necessity and opportunity mixed with caution was also evident in the responses of European companies to this year's survey. Expectations for 2012: Willing but WaitingAs 2011 draws to a close, the expectations of European companies regarding M&A in 2012 closely resemble those at the end of last year. A stable share of companies are optimistic about deal making. As in last year's survey, one in six companies said it was likely to undertake large-scale acquisitions. (See Exhibit 2.) Among large corporations with sales of more than €15 billion, one-third are likely to do large deals. Some industries show a particularly strong inclination toward M&A, namely finan-cial institutions (34 percent likelihood), industrials (27 percent), and energy (23 per- cent). A small share of companies have become slightly more pessimistic, however, answering that they are "very unlikely" (rather than "unlikely") to do a major deal. Similarly, more executives this year than in 2010 (36 percent versus 31 percent) said they do not expect European public deals next year in their sector.
The Boston Consulting Group Exhibit 2 Optimism Remained Steady in 2011, Although Pessimism
Was More Pronounced
Companies likely to make large-scale acquisitions in the next year
% of respondents 2 Definitely won't Source: UBS and BCG CEO/Senior Management M&A Survey, 2008, 2009, 2010, and 2011.
Note: Large-scale acquisitions are defined as those involving a target with sales of more than €500 million.
Because of rounding, not all percentages add up to 100.
Continued optimism is strengthened by the perception that the prices of acquisition targets are attractive. Respondents who regard current price levels as fair or low jumped from 37 percent in 2010 to 46 percent this year. (See Exhibit 3.) Particular value is seen in telecommunications, where 75 percent see fair or low pricing, in financial institutions (72 percent), in energy (69 percent), and in health care (50 percent). Furthermore, a substantial number of respondents (38 percent) view 2012 as the ideal time to go ahead with a significant acquisition. But skepticism is somewhat on the rise. The share of executives who are unsure about the ideal timing nearly doubled, from 22 percent in 2010 to 41 percent this year. Surprisingly, recent stock-market turmoil has had virtually no influence on companies' appetite for M&A. Seventy-five percent of companies said the market correction had "no impact," while 12 percent said it had actually increased their appetite. Internal Housecleaning Complete. This year's optimism is also driven by inter-
nal conditions that are much more favorable to M&A than they were in 2010. (See
Exhibit 4.) Balance sheet and credit constraints have steadily declined as a per-
ceived barrier to deals, from 29 percent in 2009 to 25 percent in 2010 to 20 percent
this year. Investor concerns and lack of management capacity are regarded as only
half as important as they were in 2010, with only 8 percent and 7 percent of compa-
nies, respectively, citing them as barriers. Similarly, companies seem to have essen-
tially finished elaborating their internal strategies.
These signs of confidence are tempered by suspicions that the global economy may not be out of the woods in 2012. A lack of strategically attractive targets has be-come the chief barrier to M&A, with the number of companies citing that as an M&A: Using Uncertainty to Your Advantage Exhibit 3 Perceived Price Levels Became More Attractive in 2011
Perceived pricing of current acquisition opportunities
% of respondents Sources: UBS and BCG CEO/Senior Management M&A Survey, 2009, 2010, and 2011; BCG analysis.
Note: Because of rounding, not all percentages add up to 100.
Exhibit 4 The Internal Conditions for M&A Have Improved, but External Barriers Have
Barriers to M&A in 2012
No strategically attractive targets Target valuations too high Uncertain demand outlook Balance sheet or cash/credit constraints Other corporate focus Need to integrate recent acquisitions first Limited risk appetite Investor concerns Limited management capacity Need to finalize strategy first % of respondents Sources: UBS and BCG CEO/Senior Management M&A Survey, 2010 and 2011; BCG analysis.
Note: The responses "Regulatory changes/concerns," "No targets that fit our acquisitions criteria," "Lack of pressure from competitors seeking
same asset," and "Other" are not shown because of low frequency.
The Boston Consulting Group obstacle jumping from 35 percent in 2010 to 45 percent. Companies that cited an uncertain outlook rose from 20 percent to 24 percent, and those deterred by a limited appetite for risk increased from 8 percent to 11 percent. Unshaken Willingness to Make Deals. In last year's survey report, we noted that
European companies had piled up record cash reserves that were ready to be
deployed for growth. That is even more true this year. (See Exhibit 5.) Cash levels
have risen by another 15 percent, and most of the increase is available for invest-
ment, as reflected in net debt levels and net-debt-to-EBITDA ratios. Although
companies showed a high willingness to invest in 2010, the mounting cash indicates
that executives retained considerably more money than intended. This is also
reflected in the moderate M&A values noted above.
This year, European executives are even more impatient to put their cash to pro-ductive use. Those citing growth moves as the most effective use of cash climbed from 57 percent to 64 percent—another sign that companies have completed their internal housecleaning. Unaffected by the recent stock-market turmoil, 28 percent want to invest their cash in M&A, the same proportion as last year. While barriers to M&A have changed significantly since last year, the drivers have not. (See Exhibit 6.) The most commonly cited motives for M&A in 2012 again relate to growth: new products (55 percent), expansion into new regions (36 per-cent), and access to new customers (32 percent). The growth focus is shifting, however. While new products and new customers are declining as rationales for M&A, access to new regions is on the rise. The importance of increasing profitability Exhibit 5 Companies Continue to Pile Up Cash and Are Increasingly Ready to Use It
European companies have more cash than ever
Most effective uses of c
ash in the next year
Cash and net debt (2000 price levels; 1990 = 100) Net debt/EBITDA (x) Paying down debt/loans Share buyback/dividends No cash available '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 Sources: Thomson Reuters Datastream; UBS and BCG CEO/Senior Management M&A Survey, 2010 and 2011; BCG analysis.
Note: The left-hand graph is based on 257 nonfinancial companies in the current Stoxx Europe 600 index that reported cash figures throughout the
period shown.
M&A: Using Uncertainty to Your Advantage Exhibit 6 Growth Continues to Be High on Executives' M&A Agenda
Most relevant deal rationales in 2012
Expand product or service offering Access new customers or distribution channels Achieve cost economies Access intellectual property, R&D, or brand Balance business portfolio Respond to changing industry consolidation Increase earnings per share Access to resources Restructure and refocus Strategic position or capabilities Change from 2010 Sources: UBS and BCG CEO/Senior Management M&A Survey, 2010 and 2011; BCG analysis.
Note: The responses "Access to human capital," "Offset increased supplier and customer power," "Preempt predator acquisition," and "Other" are
not shown because of low frequency.
and improving the company's capabilities or strategic position remains similar to last year.
Deal-based restructuring also remains high on the agenda, with 30 percent of executives saying that such moves are likely for their company in 2012. Next year will probably see a large number of asset disposals to strategic investors, which 64 percent regard as the most attractive route. This is not surprising. Recent regula-tory tightening in the banking industry has lowered the funding available to finan-cial investors, and opportunities for initial public offerings are limited in today's fluctuating capital markets.
Emerging Markets Gaining Relevance. When focusing on geographic growth,
more and more companies look to emerging markets. In 2010, only 16 percent of
the European companies surveyed named cross-continental acquisitions in emerg-
ing markets as "most relevant." This year, that number jumped to around 28 per-
cent. By contrast, those viewing intra-European deals as key dropped by six per-
centage points, to 27 percent. The shift to emerging markets is hardly surprising.
The global economy increasingly resembles a two-speed world, comprising the
relatively stagnant industrialized nations and such rapidly growing economies as
Brazil, Russia, India, and China.3
Home Turf Transformation. While in many industries the potential for future
growth is clearly in emerging markets, most European companies must still act to
The Boston Consulting Group transform their strong but challenged position in the slow-growth West. Transfor-mational deals, therefore, are gaining in importance, with 24 percent of companies expecting such deals in their industry in 2012 (up four percentage points from last year) and only 56 percent not expecting them, compared with 64 percent last year. (See Exhibit 7.) Financial objectives are gaining in importance in transformational deals, with the number of executives citing consolidation as a driver rising from 75 percent to 83 percent. Other leading drivers of such deals are "struggling com-petitors putting themselves up for sale" (cited by 49 percent of respondents, com-pared with 36 percent in 2010) and "attractive target prices" (40 percent, up from only 19 percent last year). The search for cost advantage is also a growing motive, cited by 23 percent of respondents. Although the focus on financial improvement—rather than growth—in transforma-tional deals may seem to contradict our earlier findings, in fact it does not. Execu-tives do assign great strategic importance to growth, especially in emerging mar-kets. But such opportunities are long term and are not yet large enough to dramatically improve competitive position. Instead, companies must achieve transformation primarily by addressing the financials of the bulk of their business, which is on their stagnant home turf.
Prepared Companies Favored by Uncertainty. In 2011, many companies cleaned
up their internal affairs. In 2012, M&A activity will strongly depend on how the
macroeconomic climate evolves. If current worries dissolve, we expect that compa-
nies will move ahead, and 2012 will be a strong year for M&A—at least in the
second half, since deal volume would likely take some time to pick up. If worries do
not abate, we expect next year to be very difficult.
Exhibit 7 Transformational Deals Are Reviving as a Means of Improving Financials
Expectation of transformational
deals in the next year
Drivers of transformational deals
Struggling players putting themselves up for sale Attractive target Regional expansion % of respondents Sources: UBS and BCG CEO/Senior Management M&A Survey, 2008, 2009, 2010, and 2011; BCG analysis.
Note: The response "Securing raw material access" is not shown because of low frequency.
M&A: Using Uncertainty to Your Advantage We believe that the results of our survey series—and of this year's survey in partic-ular—indicate that we have entered a new normal for M&A. Uncertainty is here to stay. Visibility will remain murky. Large waves of M&A deals across all industries will be unlikely, because everyone is contending with the same macroeconomic bar-riers. As opportunities arise, we will see spikes in deal volume driven by daring but far-sighted executives intent on improving their companies' competitive position. Because they will have spent time doing their homework, they will be armed with superior information and will be able to act when the window of opportunity opens. While the majority of companies will remain frozen by uncertainty, the strong and prepared will reap the benefits of M&A and catapult ahead. Companies should Use Uncertainty to Your Advantage Last year, we argued that companies should make friends with uncertainty. We and effort screening believe that this year, more companies are starting to realize that uncertainty is not M&A opportunities. likely to be a temporary phenomenon. Executives should take the next step and use Prices and conditions it to their advantage. For at least the next year, success in M&A will largely hinge on can change quickly, the ability to execute opportunistic deals in uncertain times. We offer three guide- and the window of lines in the art of using uncertainty to your advantage. open only briefly.
Change the focus from risk to opportunity. Understanding and quantifying
risks—and developing contingency plans for when bets go awry—will obviously be
essential. But risk and opportunity generally go hand in hand. When internal
housecleaning is complete, it is important to start looking for pearls in muddy
waters. Structural shakeups can open up valuable opportunities to enter new
markets or to buy assets at attractive prices.
Companies should spend more time and effort—not less—systematically screening M&A opportunities. Prices and conditions can change quickly, and the window of opportunity may open only briefly. Clearly identifying potential targets and their strategic fit well in advance will enable companies to act quickly when opportuni-ties arise.
Mental flexibility is also important. Because visibility is weak and conditions are fluid, solutions to strategic challenges may lie beyond the trodden path. Acquirers should look twice at assets that are of mixed quality, for example. These may offer great value at attractive prices that can be extracted in unconventional ways. Taking out redundant costs is not the only way to create value through M&A. Buyers and sellers should also consider creative deal structures, such as risk-sharing arrangements or deals that include payment or financing options. These can alleviate concerns about uncertainty and risk. Invest more in information. Solid information is most valuable when times are
uncertain. Greater due diligence is required to minimize risks—and improve the
chances of success. Companies in the market for deals in 2012 should spend more
time and resources understanding market dynamics, their own strategic challenges
and position, and their potential moves. They should sharpen their grasp of the
true boundaries of their markets and the universe of available targets. Solid infor-
The Boston Consulting Group mation can increase their chances of finding convincing opportunities that their competitors fail to identify.
Developing a clear story to justify a deal is necessary in order to convince skeptical investors and employees. Similar principles apply to asset divestitures. A clearly articulated equity story can maximize the prices paid. For a troubled asset, a convincing restructuring concept and early implementation of first steps can substantially increase its market value.
Take energizing but careful action. Acting with solid but still incomplete informa-
tion requires courage. But taking decisive, careful action while others remain para-
lyzed wins respect in the capital markets and among staff seeking guidance in
difficult times—and this can release the energy needed to transform an organization.
If a company is optimistic, it can leverage the crisis to gain a competitive advantage Taking decisive, by investing countercyclically. If the environment seems too murky for big moves, small investments in tangible business opportunities can put a company in a while others remain position to ramp up in promising new areas once external factors improve. Compa- nies should hedge their bets by acquiring minority stakes, making investments that respect in the capital secure a foothold in new markets, and investing in stages or through cooperation markets and among staff—and this can release the energy To be able to invest, companies must make financial provisions. External funding needed to transform constraints are likely to linger next year. The flexibility to mobilize funds internally, an organization.
therefore, can offer a significant competitive edge. Companies looking for acquisi-tions should prepare by building an internal financial cushion so they can act when others can't.
The M&A environment in 2012 will remain challenging. Therefore, executives should start coming to terms with uncertainty and adapt their strategic approach. By understanding the specifics of the current situation, they can use it to their advantage—and move ahead of the competition.
Pharmaceuticals: Using M&A as a Cure (While Avoiding Side Effects)Given the acute pressures faced by biopharmaceutical companies that originate innovative drugs, this industry provides a good illustration of why skillfully execut-ing the right kind of M&A can spell the difference between emerging from the current uncertainty in a weaker or a stronger competitive position. Below, we provide a brief overview of the industry's challenges and M&A options, based on our strategic insights into the industry and our functional expertise in M&A, fol-lowed by specific recommendations for biopharmaceutical companies regarding M&A. Our analysis focuses on drug originators rather than on producers of generic or over-the-counter drugs, although some of the same challenges and solutions apply to them as well.
Facing pressure from all sides, the pharmaceutical industry is one of the likeliest to generate a high degree of M&A activity. A confluence of four major strategic chal- M&A: Using Uncertainty to Your Advantage lenges makes the prospects grim for large drug originators: the so-called patent cliff, rising pricing pressures, the faltering R&D-driven business model, and the growing importance of emerging markets. Falling Off the Patent Cliff. Over the next five to ten years, many of today's
top-selling drugs will lose their patent protection, especially the small-molecule
drugs that dominate the product portfolios of major originators. For many of these
companies, revenues in the near future will fall steeply as prices plunge and cheap-
er generic versions grab market share. We estimate that originators' sales from
currently marketed small-molecule drugs will drop by about 40 percent by 2020
due to patent expirations, with almost two-thirds of this loss occurring in the next
five years. (See Exhibit 8.) Not all originators will be hit equally. Pfizer, for example,
with the expiration of just one patent—for the cholesterol-lowering drug Lipitor in
November 2011—faces a potential loss of up to $11 billion in revenue, or 15
percent of its sales. As a result, the company is expected to lose its number-one
market position in terms of sales to Sanofi. Because of the patent cliff, many
pharmaceutical companies face enormous pressure to slash their large fixed costs or
to refill their product pipelines.
Price Premium Pressures. Further revenue losses are being induced by pressure
on price premiums for innovative drugs from governments and payers trying to rein
in soaring health-care costs. Prices for new drugs are increasingly tied to clear
evidence of incremental benefit over the next-best drug available. Other price-
Exhibit 8 About 40 Percent of Originators' Sales of Small-Molecule Drugs Will Be Lost Through
Patent Expiry by 2020
Cumulated sales facing patent expiry ($billions) Market share loss to generics Off-patent sales of originator Sources: Evaluate Pharma; IMS; Datamonitor; BCG analysis.
Note: Off-patent originator sales reduced by price erosion rates (separate for the U.S. and EU) and market share loss to generics players; no sales
growth assumed.
1Small-molecule sales in 2010 calculated from IMS market size and Evaluate Pharma originator share.
The Boston Consulting Group control mechanisms imposed by health care providers that depress the revenues and margins of both new and existing drugs include price caps, mandatory dis-counts, and reference price systems.
A Faltering Innovation Model. The basis of originators' business model—creat-
ing innovative drugs—is also being fundamentally challenged. While global R&D
costs have risen by an average of 9 percent annually since 1999, the payoff has
not increased. The number of new-drug approvals per year has remained essen-
tially flat for more than a decade. (See Exhibit 9.) The reason for this decline in
R&D productivity is that achieving breakthrough innovation with chemically
synthesized drugs, still the dominant technology among many originators, is
becoming more difficult. Small-molecule drugs for many diseases already exist,
and further advances tend to be incremental. In addition, regulators are tighten-
ing approval requirements, making it harder to bring new products to market. The
search for breakthrough therapies that address important unmet needs, such as
chronic and degenerative diseases like cancer and HIV, is frequently driven from
the field of biologics, where many originators are not yet as strong as in small
The problem becomes especially evident when we look at the number of hugely profitable blockbuster drugs in the market. (See Exhibit 10.) While this number rose by an average of 13 percent each year from 2000 through 2010, it is expected to remain flat over the next five years.
The Emerging-Market Imperative. Most originators are facing a mismatch
between their geographic exposure and product portfolio, on the one hand, and
Exhibit 9 Pharma R&D Productivity Is Essentially Flat
Historically rising R&D expenditures…
…have not increased the market entry of drugs
R&D expenditures ($billions) Number of new drugs approved in the U.S. '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11E '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 Sources: FDA; PhRMA, "Pharmaceutical Industry Profile 2011"; Evaluate Pharma; BCG analysis.
1BLAs = biological license applications.
2NDAs = new-drug applications.
M&A: Using Uncertainty to Your Advantage Exhibit 10 The Number of Profitable Blockbuster Drugs Is Flattening Out
Number of blockbuster drugs >$0.6 billion 02000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Sources: Evaluate Pharma; BCG analysis.
their market opportunities, on the other. As a result of the patent cliff, price pres-sure, and a stuttering innovation engine, their core markets in the developed world are expected to stagnate in the years ahead. Growth will come from emerging markets with large and expanding populations, developing health-care systems, rising wealth, and a growing incidence of lifestyle diseases such as diabetes. Phar-maceutical sales are projected to grow by an average of 14 percent per year in key emerging markets through 2015. In contrast, 5 percent average annual growth is expected in Japan and virtually none in North America and Europe. Yet Western originators still have a relatively limited presence in the "pharmerging" regions, and these drug markets remain small. As a result, emerging markets will not easily compensate for stagnating revenue in the West, at least in the short term. What's more, the product portfolios of many originators are frequently not well suited to emerging economies, where demand is still focused on basic, low-cost generic and over-the-counter medications. Selling product portfolios that are heavily dominated by innovative drugs at high premiums, therefore, is a challenge. In addition, originators' focus on innovation makes it difficult to establish the rock-bottom cost structures often necessary to succeed in emerging markets. Biopharmaceutical companies can, of course, expand into the growing segments of biologics and generics. But these businesses can only partially compensate for losses in the short term. Margins in the generics industry, for example, are them-selves under pressure from the clampdown in health care spending and from competition that is even stiffer than that for patented drugs. Finally, operating a low-cost business model in parallel with one driven by innovation is generally difficult for originators because of the differences in governance, corporate culture, and strategic focus. The Boston Consulting Group Dissecting Pharmaceutical M&A MovesThe patent cliff. Price pressures. The faltering innovation model. Underexposure to growing market segments. Strategic challenges are hitting pharmaceutical companies from all sides, strangling growth prospects and margins. While organic changes are therefore a necessity for most biopharmaceutical companies, the extent of the challeng-es make M&A an increasingly necessary part of the strategic response as well. To understand the many ways in which pharmaceutical companies are using M&A to respond, we analyzed the 80 largest pharmaceutical M&A transactions since 2005.4 (See Exhibit 11.) We found that the companies that did these deals had some combination of three basic goals: maintaining margins in an environment of price pressure, bolstering the innovation pipeline, and adding new revenue pools to strengthen top-line growth. Maintaining Margins. In most large deals (58 percent), the major objective was to
slash costs through pure consolidation. By combining sales forces, manufacturing,
and overhead with those of another company, originators strive to eliminate
redundant costs—and to spread R&D investment and the associated risks over a
larger revenue base. For example, Pfizer's 2009 acquisition of Wyeth, which fol-
lowed its 2003 takeover of Pharmacia, enabled it to build greater scale and secure
its position as the world's largest pharmaceutical company.
Around 35 percent of deals aimed at improving margins by building dominance in a specific therapeutic area. In so doing, companies increased their negotiating Exhibit 11 The Majority of Pharma M&A Deals Aim to Take Out Costs
Key M&A buyer rationales
Deal examples
Consolidate to achieve • Pfizer–Wyeth (2009; $68 billion) economies of scale • Merck & Co.–Schering-Plough (2009; $41.1 billion) • Bayer–Schering (2006; $21.3 billion) Achieve dominance in • Pfizer–King Pharmaceuticals (2011; $3.6 billion) • Novartis–Alcon (2010; $49.7 billion) • GSK–Stiefel (2009; $3.2 billion) • Sanofi–Genzyme (2011; $20.1 billion) technology platforms • Lilly–ImClone (2008; $6.5 billion) • Novartis–Chiron (2006; $5.4 billion) • Sanofi–Merial (2009; $4 billion) • Abbott–Advanced Medical Optics (2009; $2.8 billion) • Novartis–Hexal (2005; $6.9 billion) • Abbott–Solvay (2010; $6.6 billion) • Pfizer–Wyeth (2009; $68 billion) • Merck & Co.–Schering-Plough (2009; $41.1 billion) • Abbot–Piramal (2010; $3.7 billion) • Takeda–Millennium (2007; $8.8 billion) • Roche–Chugai (2008; $0.9 billion) New revenue pools Sources: Evaluate Pharma; company information; BCG analysis.
Note: Based on the 80 largest deals closed between 2005 and 2011.
1Diversification into generic and over-the-counter drugs, medical technology, and diagnostics.
M&A: Using Uncertainty to Your Advantage power with health care providers and regulators and leveraged their sales forces, R&D capability, and knowledge of patient needs in a given area. In the future, a dominant position in a therapeutic area will also allow companies to extend their business model beyond the provision of drugs to the offer of holistic treatment programs. Novartis's $49.7 billion acquisition of Alcon in 2010 enabled it to strengthen its presence in the growing eye-care segment, for example.
Bolstering Innovation. It is not surprising that addressing the innovation chal-
innovation challenge lenge is the most urgent priority after maintaining margins, since R&D is integral to is the most urgent originators' business model. Thirty percent of big M&A deals sought to bolster priority for originators innovation by giving the company access to new technology platforms. Biotech after maintaining companies are a major target of small-molecule-dominated originators seeking margins, since R&D is more sustainable growth. The biotech industry is growing much faster (8 percent integral to their per year over the next five years) than the small-molecule segment (2 percent) business model.
because it still offers greater potential for breakthrough innovations that can command high premiums. While biologics face their own patent cliff, it is often less steep because these especially complex drugs and their production processes are more difficult and costly to copy, which limits competition from generics. Revenues from biologics are therefore more sustainable.
Twenty-five percent of large deals—in addition to a large number of smaller deals—are aimed at strengthening the R&D pipeline with drugs in the early or late stage of development. There is considerable debate in the industry about whether acquisitions are the best way to expand the portfolio of new-drug candidates. One attraction of going to outside sources rather than relying on internal R&D is that the company can essentially turn fixed R&D costs into variable costs. Another is lower risk, since much of the cost of failure is shifted to the outside partners. Moreover, pharmaceutical companies cherish the entrepreneurial spirit that is often pronounced in start-ups. On the other hand, spotting and securing the most promis-ing targets ahead of the competition is difficult, and the deal premiums paid for companies with successful R&D can be stiff. This can depress returns on external R&D investments.
New Revenue Pools. The intensifying search for new avenues of growth beyond
established markets was reflected in many of the large pharma M&A deals that we
studied. Diversifying into fields adjacent to classic prescription drugs was an objec-
tive in 28 percent of these deals. Diversification into over-the-counter drugs, diag-
nostics, or medical technology can help reduce risks by easing a company's depen-
dence on patented drugs and by helping it achieve a more balanced mix of
businesses and cash flows. For example, Abbott's acquisition of the surgical-device
company Advanced Medical Optics for $2.8 billion in 2009 allowed it to diversify
into the fast-growing eye-care device market.
In general, many companies in the diagnostic and medtech segments are still posting attractive growth because they address unmet patient needs, achieve relatively high levels of innovation, and face fewer regulatory challenges. By mar-keting drugs along with diagnostic and medtech products through product bundling or personalized medicine, originators can often add value and charge higher prices. In ophthalmology, for example, several players offer drugs, surgical instruments, The Boston Consulting Group and implantable lenses together. However, establishing a good governance model and go-to-market approach for such a combination of diverse businesses is not easy.
Thirteen percent of transactions were aimed at expanding the company's presence in strategically important emerging markets. Such acquisitions are generally driven by the search for market access, distribution power, local market know-how, and a suitable portfolio of low-cost products. Abbott, for example, acquired the generic-drug business of India's Piramal Healthcare for $3.7 billion in 2010. These deals are especially challenging because of the complexities of cross-border transactions.5 Favorable Conditions, but Solid Execution RequiredDespite current market volatility, pharmaceutical companies' M&A activity should seek to address the challenges described above while also taking advantage of favorable external conditions. M&A activity in the sector has remained strong in recent years, so there is ongoing momentum. Major drug companies have substan-tial financial firepower: lots of excess cash, low debt levels, and cash flows from current blockbusters that are still strong. Debt financing is still available to high-quality strategic corporate buyers, including pharmaceutical companies. And there are many potential targets. The industry is still highly fragmented, with numerous start-ups and emerging biotech and medtech companies in need of new funding sources in the current environment. Antitrust issues are generally not serious. The market prices of potential targets have dropped, especially since the recent stock-market correction. The current low valuation multiples of most pharmaceuti-cal companies partly reflect the industry's structural challenges, inducing many executives to regard potential targets as still too expensive. But others regard this as overly pessimistic. A UBS analysis of global pharmaceutical companies' current market valuations concluded that they may actually be significantly undervalued relative to their fundamental cash flows. The analysis shows that current valuations assume a 12 percent yearly decline of free cash flow between 2013 and 2020—an outlook that even the most pessimistic industry managers do not share. M&A activity in the pharmaceutical sector Complex Value Creation. Many pharmaceutical executives tell us that the pool of
has remained strong attractive assets is dwindling and that those remaining are of mixed quality. Com- in recent years, so petition for the remaining high-quality targets is intense, driving up prices and there is ongoing making value creation increasingly difficult.
major drug compa- But the belief that asset quality—if measured by profitability—is deteriorating may nies have substantial be off-base. Our analysis of pharmaceutical acquisitions over the past decade does not indicate a downward trend in the profitability of acquired assets. (See the left-hand graph in Exhibit 12.) About 80 percent of acquired targets are profitable, a proportion that has remained roughly constant since 2001. It is true, however, that our analysis looked only at transacted assets, which could be of better quality than those generally available for sale.
Good assets are regularly becoming available as pharmaceutical companies divest well-performing businesses that are not an optimal fit with the parent portfolio and M&A: Using Uncertainty to Your Advantage Exhibit 12 Operational Fit Is Getting More Difficult to Achieve
While the quality of transacted
. extracting value from M&A requires
targets is roughly constant.
more sophisticated skills
% of targets by standalone profitability1 % of deals by rationale2 (diversification) Near core
–30 to <–10 '00/'01 '02/'03 '04/'05 '06/'07 '08/'09 '10/'11 2005 2006 2007 2008 2009 2010 Year of announcement Year of announcement Sources: Thomson ONE; Evaluate Pharma; BCG analysis.
1EBIT margins of the targets of global pharmaceutical deals worth more than $100 million.
2Based on the 80 largest deals closed between 2005 and 2011.
that could perform better under different ownership. For example, AstraZeneca sold Astra Tech, its dental technology, urology-device, and surgical-device business, to Dentsply for $1.8 billion in June 2011. Pfizer is exploring strategic options for its nutrition and animal-health businesses, which it believes have limited synergies with its core human-biopharmaceutical businesses.
Pharma executives are right, though, that fit and the creation of operational value from deals are increasingly difficult. As the focus of M&A shifts from simply consoli-dating and taking out costs to expanding R&D platforms and fostering adjacent growth, integration and synergies become much more difficult to achieve. (See the right-hand graph in Exhibit 12.) Extracting revenues from innovation-oriented deals and achieving operational synergies across assets not directly related to the core business are tricky endeavors that often require building new competencies. Deals in which pharmaceutical companies aim to diversify into medtech illustrate how complicated value creation can be. On paper, synergies are often sought by leveraging sales forces or by devel-oping and selling combination therapies. However, many hurdles must be overcome to make this work. Sales forces must learn to sell these combined products, very different R&D departments must cooperate closely, and executives of the combined drug and device business must learn to manage two very different operations. Indeed, Abbott recently announced that it will break up its pharmaceutical and medtech businesses into two independent companies, which it believes can per-form better on their own. The Boston Consulting Group Rigorous Execution Requirements. Given that M&A is increasingly necessary—
though extracting value is more difficult than it was in the past—what should
pharmaceutical companies do?
First, they must be more thorough than ever in searching for attractive targets, determining the optimal fit, and delivering on the promised synergies. To get all Companies must go this right under the time pressure of completing a deal requires that companies beyond looking only develop clearly defined hypotheses that can be validated early on, instead of for problem-free waiting until the due diligence process to look for opportunities to create value. assets with products Complex opportunities for value creation require that the value proposition, the that fit perfectly integration model, and the governance model be clearly defined well ahead of the into their existing Second, pharmaceutical companies must go beyond looking only for problem-free assets with products that fit perfectly into their existing operations. The key to successful M&A is finding assets that offer more value than is currently reflected in their price. Viewed this way, many complex assets—such as those with issues limited to one area or whose future is uncertain—might make attractive targets if the acquirer is skilled at turning around troubled assets and the deal is structured accordingly.
Sanofi's $20 billion acquisition of Genzyme in February 2011 is a good illustration. When Sanofi was negotiating the deal, there was considerable disagreement about the value of Genzyme's product pipeline and the company's ability to resolve its severe manufacturing problems. To get past the disagreements, Sanofi made Genzyme shareholders a creative offer. In addition to the cash price offered for Genzyme shares, Sanofi offered a tradable option known as a contingent value right (CVR). The CVR could pay up to an additional 20 percent of the purchase price contingent on the achievement of milestones in resolving the manufacturing problems and developing Lemtrada, Genzyme's experimental multiple-sclerosis drug. Although the uncertainties could not be resolved, this innovative option structure made the deal successful.
Third, deals involving innovation require special execution. While often necessary to complement the organic R&D pipeline, these deals are especially challenging from a governance perspective. Tightening the reins on an acquired R&D team can strangle innovation and prompt researchers to flee the new bureaucracy. Too little control, on the other hand, can result in R&D cost overruns. Finding the right balance is essential. Solving governance questions is also a key challenge in diversi-fication deals. It can be successfully addressed through meticulous up-front plan-ning and experience in integrating and organizing such business models. Still, diversification almost always requires company-specific solutions; there is no one-size-fits-all governance or go-to-market model.
In general, the degree to which a company relies on external innovation should depend on the competencies available. An originator needs to be strong either in building entrepreneurship internally and fostering organic innovation or in screen-ing M&A deals and building an external pipeline. In any case, building one compe-tence or the other is required.
M&A: Using Uncertainty to Your Advantage Fourth, as pharmaceutical M&A continues to grow more complex, acquirers' com-munications with investors and employees need to be very clear. The deal's ratio-nale should unambiguously address one or more of the industry's core challenges that relate to value creation. Clear messages on synergies require a good under-standing of the future relationship between the target and the acquirer—and they need to spell out exactly where the added value will come from. The good old days of simply consolidating businesses and taking out costs are certainly over in the pharmaceutical industry. Yet in today's environment, where M&A is one of the key ways to tackle strategic market challenges, the ability to do the right deals the right way will give companies an even clearer competitive edge. 1. The BCG-UBS M&A survey was carried out between October 3 and November 9, 2011, and polled 701 publicly listed European companies across 28 industries; it had a 21 percent response rate.
2. See The 2011 BCG Global Challengers: Companies on the Move—Rising Stars from Rapidly Developing Economies Are Reshaping Global Industries, BCG report, January 2011. 3. For a more detailed discussion, see Collateral Damage, Part 8: Preparing for a Two-Speed World—Accel- erating Out of the Great Recession, BCG White Paper, January 2010.
4. We excluded licensing deals from further analysis and focused on general (and often strategically more significant) M&A transactions. For a discussion of licensing in pharma, see Simon Goodall and Dirk Calcoen, Biopharma Partnering: Perspectives from BCG's Latest Biotech and Pharma Partnering Study, BCG, March 2011.
5. See Cross-Border PMI: Understanding and Overcoming the Challenges, BCG Focus, May 2010.
The Boston Consulting Group About the Authors
André Kronimus
is a principal in the Frankfurt office of The Boston Consulting Group and a
member of the global M&A team. You may contact him by e-mail at kronimus.andre@bcg.com.
Peter Nowotnik is a partner and managing director in the firm's Düsseldorf office and a member
of the global M&A team. You may contact him by e-mail at nowotnik.peter@bcg.com.
Alexander Roos is a partner and managing director in BCG's Berlin office and the global leader
of the Corporate Development practice. You may contact him by e-mail at roos.alexander@bcg.
Sebastian Stange is a project leader in the firm's Munich office. You may contact him by e-mail at
The authors would like to thank Mark Lubkeman and Olivier Wierzba for their industry insight and
Matthias Hampel, Daniel Nieper, and Konstanze Wagner for their extensive support. They also ac-
knowledge Pete Engardio for helping to write this paper and Katherine Andrews, Gary Callahan,
Kim Friedman, and Gina Goldstein for contributions to its editing, design, and production.
For Further Contact
If you would like to discuss this report, please contact one of the authors.
The Boston Consulting Group (BCG) is a global management consulting firm and the world's lead-ing advisor on business strategy. We partner with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical chal-lenges, and transform their enterprises. Our customized approach combines deep in sight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable compet itive advantage, build more capable orga-nizations, and secure lasting results. Founded in 1963, BCG is a private company with 74 offices in 42 countries. For more information, please visit bcg.com.
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