By adding complementary specialty medication offerings to their generic drug businesses, manufacturers can add instant value and counteract the margin compression that is currently occurring as a result of high generic drug utilization.
As growth prospects in the generic sector wane, Pharma will look to complex specialty products to provide some financial stability and boost earnings. New market entrants with very few competitors are ideal candidates for large generics firms. Many firms have already picked up on this trend; Bloomberg estimates that the amount spent on specialty pharmaceutical deals in the past year has totaled nearly $60 billion.
In addition, increased margin compression could be a consequence of changing generic drug sourcing practices, recent wholesaler agreements and contract arrangements between Walgreens Boots Alliance Development and AmerisourceBergen, McKesson and Celesio, and Cardinal and CVS Caremark.
“Several factors, including acquirers’ desire to offset slower organic growth and margin compression in their generic drug businesses, are driving the current deal-making,” said Jessica Gladstone, VP and senior credit officer of Moody’s. “Companies also are looking to reduce their effective tax rates and drive earnings accretion.”
One of the most recent transactions in the generic/specialty sector is Mallinckrodt’s announcement about the purchase of Questcor Pharmaceuticals for $5.6 billion, which follows their Cadence Pharmaceuticals acquisition last February. Other notable transactions include Mylan’s purchase of Agila, Actavis’ deals for Warner Chilcott and Forest Labs, Valeant’s buy of Bausch & Lomb, Perrigo’s purchase of Elan, Endo Pharma’s acquisition of Paladin Labs, and Par Pharma’s play for JHP.
Another influence driving acquisitions is the reduction of effective tax rates, according to the Moody’s report, “Rising M&A Among Generic Drug Makers Increases Uncertainty for Creditors”. It states that pharmaceutical manufacturers acquire foreign companies in order to be “redomiciled” into lower tax jurisdictions. Such tax inversions as these are especially attractive to generic pharmaceutical manufacturers because “these companies have limited opportunities to place intellectual property assets in off-shore tax jurisdictions.” In short, overseas acquisitions can expedite the inversion process, saving companies money much more quickly.
“There is a land grab occurring in the specialty pharmaceutical space,” Michael Zbinovec, senior director of corporate finance for Fitch Ratings, told Drug Store News. In addition to attempting to lower tax burdens and increase shareholder profitability, drug makers are expanding their geographic presence by acquiring assets in new territories, he noted. “Companies are purchasing new medicines to bolster their current drug portfolios and offer a more comprehensive product offering to third-party payers.”
Many of the challenges associated with the adoption of this type of acquisition strategy are primarily related to deal execution, as integration activities will be significant, added Jacob Bostwick, director of Fitch Ratings. “Another potential problem could be patent cliffs (i.e., Teva’s Copaxone) — though for now, for specialty drugs, these are more appropriately called patent ‘slopes,’” Bostwick said. “Having significant exposure to relatively steady top-line and cash-flow producing generics businesses should help offset the risk from patent expiries over time.”
Overall, it will be favorable for generics firms to add specialty drug companies, Bostwick concluded. “Diversifying their business models away from increasingly commoditized generic drugs and adding presence in the fast-growing and much higher-margin specialty drug space should aid margins, cash flows and growth prospects,” he said. “Opportunities to leverage specialty R&D for the development of biosimilars in the medium-to-longer term also are compelling.”