This morning, news broke of a massive deal in the healthcare sector. Bristol-Myers Squibb (BMY) is buying Celgene (CELG) in a cash and stock deal worth around $74 billion. It is tempting to look at a deal like that and draw inferences for the broader market, but that is not advisable here. It does have implications, but they are at a sector level rather than applicable to all stocks.
Optimists may paint it as a sign that those in the know see the current market decline as temporary, and that there is value to be had in stocks at these levels. That may be true, but this deal doesn’t really confirm or deny it. Rather than surging as prices have fallen, M&A activity slowed during Q4.
As this Bloomberg article put it “…a rocky fourth quarter caused many firms to put takeover aspirations on hold.” That suggests that corporations are just like individuals in that they are unsure what the drop really means, and unwilling to act until volatility is reduced.
In pharma and biotech though, the uncertainty that is holding back others is not the point. Investors’ main fears and worries are around international trade and growth, neither of which has a massive effect on healthcare. Drug companies do however face their own challenges, and consolidation may be seen as an answer.
When Donald Trump was elected along with a Republican Congress, there was a feeling that it was a good thing for pharma. The Clinton campaign had talked a lot about reining in drug prices, but a more business-friendly Republican administration was presumed to be less likely to opt for any form of price controls. So far, although there have been some rumblings from the White House that has been the case.
But the combination of an embattled President desperate for a win and a Democratic House will probably bring the subject back to the fore this year. With that in mind, consolidation in the industry offers multiple advantages.
Firstly, the bigger the company, the easier it is to fight proposals on pricing on two fronts. The new company will, for a while at least, have an overly large R&D budget and a massive workforce, both of which can be cited as reasons not to force price cuts. Eventually, synergies will be found in both areas as that is the whole point of the deal, but in this case the delay while that is achieved could well turn out to be more of a feature than a bug.
Secondly, when those cost savings do come about, the resulting company will be better placed to survive if the battle over pricing is lost. If prices are forcibly lowered, costs will have to be cut and that is easier after a merger than in two separate companies.
Mergers and acquisitions in pharma and biotech make sense for other, simpler reasons too. This is a time of rapid change in the industry, with new therapies that work in previously unimagined ways revolutionizing healthcare. That puts pipelines, which have always been valuable, at even more of a premium, especially as only around 1 in 5,000 new therapies actually make it to market and the process takes around twelve years.
So, with risk out of favor, leading to some huge drops in biotech stocks over the last three months, even relatively large companies like Celgene are natural targets for buyouts. Celgene is not a struggling biotech startup; it is a mature, profitable company, but the stock was still down around sixty percent from the late 2017 highs at the end of the year, leading to a forward P/E of around 8.
It is not alone, either. The threat of action on pricing and the general climate of fear have led to many biotech stocks dropping in a similar way, and with good reasons to consolidate it is likely that the Bristol-Myers/Celgene deal is just the beginning. What this deal shows is that size is no protection and may actually make a potential target more appealing. In other words, in the drug business, elephant season is open.