In this segment from The Motley Fool's Industry Focus: Healthcare podcast, Kristine Harjes and Todd Campbell field a question asked by Foolish intern Amanda Way about the aftermath of the Pfizer/Allergan no-go. They explain why the death of that deal does not at all spell out the death of M&A activity in the healthcare space. Also, they go over how investors should look at buying into smaller drugmakers that might get snapped up by bigger fish, and why many companies in the sector are still interested in M&A as a growth strategy.
A transcript follows the video.
This podcast was recorded on Jun. 22, 2016.
Amanda Way: Ben Estep, another investing team intern, points out that M&A -- which stands for mergers and acquisitions -- topped $4 trillion last year, and many of these deals seemed to be formed in odd ways just to lower taxes. He specifically noted the fall off through the Pfizer/Allergan deal, which I know you guys covered on this show in detail. His question specifically was, "Is the only way for a lot of big companies to continue generating earnings growth through M&A and creative deals to lower taxes, and should investors and companies heavily involved in M&A be concerned"?
Kristine Harjes: Todd, I'm going to let you take a swing at this one first.
Todd Campbell: What we are talking about here are the tax inversions, right? Where you had a U.S. company that would then go out and acquire a company that had a headquarters somewhere else, such as Ireland, where the corporate tax rate was very low. That kind of M&A was financially rewarding to the acquirer because they were able to significantly reduce their costs without having to do much of anything. They could basically say, "Hey guess what, we're now headquartered over here in Ireland, and as a result if we've got $50 billion in sales, we're now paying a couple billion dollars less in taxes." Yes, mega-tax inversion deals are now DOA -- dead on arrival. I don't anticipate we'll see any more of these now that Allergan and Pfizer broke off their deal following some changes to tax inversion rules from the Treasury Department late last year.
Harjes: We can talk about regulatory risk, and that right there, that's a regulatory effect that healthcare industry had to deal with.
Campbell: Absolutely! They had to deal with that. Does that mean that you don't want to invest in Pfizer and Allergan anymore? Not necessarily. You've got two very different companies that have great, theoretically, great pipelines. That's what you should be focusing on. Is M&A, as a whole, dead now? No! There's ways to grow your company in your sales, in your profitability, by going back to the grassroots of M&A -- looking for promising new drugs that are coming through the pipeline that can either shore up your market share or expand you into new indications.
Harjes: So despite these tax inversions deals being pretty solidly less lucrative now, I agree with you, Todd, that we are not going to see as many companies going at M&A with this perspective, but it is still a humongous trend within the industry. I think it is something to be aware of. It's not necessarily a concern for investors that are invested in these companies that are very into M&A, but it depends on management's perspective on it. You get companies like Pfizer, for example, right after the Allergan deal fell through, not too long after it, they go out and they make a pretty splashy acquisition for $5.2 billion acquisition of Anacor (UNKNOWN:ANAC.DL), essentialy just for one drug that is competing in a pretty competitive market for a specific type of eczema.
Just recently on the show we were talking about AbbVie (NYSE:ABBV) bought Stemcentrx for $5.8 billion. There are a lot of companies out there trying to grow by acquisition.
Campbell: Right, and if you were an investor and you were at one point looking and saying, "What Irish company is going to get bought next?", and trying to figure out that, stop doing that. Instead, let's take a look at de-risked clinical-stage companies -- and by de-risked, I mean maybe there are stage III or beyond or approaching regulatory approval. Those are probably the ones that are going to end up being the biggest targets from here.
Harjes: As opposed to the really early-stage ones. I'll also throw it out there that you never want to be buying any of these smaller companies simply because you think that they are going to be bought out, but it almost is one and the same to say "I think that this is a really attractive buy for a big pharma" and "I think this is a really attractive company on its own." Those two are very tightly intertwined, and so you want to be focused on the latter -- the "I think this is a great company " -- but if it's a great company then it's probably also a great buyout candidate.
Campbell: Yeah, it all depends on the evaluation. It's always going to come down to product, pipeline, and profitability. If you consider those three things, worst-case scenario, you end up buying a good stock for the long haul. Maybe not one that gets taken out right away, but you'll still end up being relatively happy with the purchase, hopefully.
Harjes: Exactly. I wouldn't be concerned about M&A as a big red flag unless that is the entire business model, in which case, that's the kind of company that is really coming under a lot of scrutiny, could potentially face more regulatory risk going forward, and then you want to watch out.
Campbell: Right, and the other thing to watch too, especially with these companies that have been "serial acquirers," is just this whole concept of how are they reporting their numbers, GAAP numbers versus non-GAAP numbers. Are they reporting clean numbers, or are they adjusted and include all sorts of kitchen-sink type stuff?
Harjes: Yes, I completely agree.
Kristine Harjes has no position in any stocks mentioned. Todd Campbell has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.