Why Healthcare Stocks Were Such Juicy M&A Targets in 2015

To say that 2015 was a banner year for M&A activity in the healthcare sector would be a gross understatement. Acquirers set their sights on many companies in the industry, and buyouts covered most of its segments, from clinical-stage drugmakers to pharmacies to insurers.

In this clip, MarketFoolery host Chris Hill, and Fool analysts Kristine Harjes and Michael Douglass discuss the reasons for this frenzy of activity, and what it all means for the sector.

A full transcript follows the video.

This podcast was recorded on Dec. 15, 2015.

Chris Hill: Let's hit a few of the big items for this year in review in healthcare. Let's start with just the business story of the year in healthcare. We're talking about a massive industry. Kristine, when you think back on 2015, what's the story of the year?

Kristine Harjes: The thing that stands out to me is the massive industry consolidation that we've seen. This goes beyond healthcare. This is an unprecedented year for mergers and acquisitions. I think actually it's the biggest year ever as of a couple days ago, we hit that mark.

Hill: We still have a couple weeks to go, but yeah.

Michael Douglass: Might as well go ahead and get above that!

Harjes: No, we actually did, as of a couple days ago, hit that last M&A point that it took us over, I think 2012 is the year, or maybe 2007. I don't really remember what the year was. But it doesn't matter, because 2015 wins. As of right now, we're on pace for $4.7 trillion in M&A this year. But just within healthcare, also, a huge year.

We, across the sub-industries of healthcare, you're seeing it. You're seeing it with drugmakers, you've got Pfizer (PFE 0.91%) merging with Allergan (AGN), which is a $160 billion deal. Incredibly huge, right there. You've got Walgreens (WBA 0.82%) acquiring Rite Aid (RAD -43.53%), so that's your retail pharmacy space. Even in health insurers, a couple of deals there, Anthem bought Cigna; Aetna bought Humana. It's something that's happening across the industry and really, to me, stands out as a huge business story for 2015.

Hill: Why do you think this has happened? Because at the beginning of this year, one of the predictions that you heard frequently was, "2015 is going to be a huge year for mergers and acquisitions in the oil and gas industry." And the thesis was, the price of oil has gone straight down, and this is historically when the bigger players, the ExxonMobils, the Chevrons, etc., snap up the smaller players, whose balance sheets can't really handle 12 more months of this kind of pricing. That doesn't seem to be the reason here, though.

Harjes: You get a kind of similar justification when you look at drugmakers. You've got a lot of big giants that are facing patent woes, more or less. They've hit a cliff where all of a sudden, they used to have exclusivity on their key drugs -- that time is over. So, a lot of companies are taking bit hits because of that. And the way that they can compensate for that is snap up some of these smaller players in the industry to try to boost up their own product lines without necessarily having to develop it all in-house. 

It comes down to pricing, too, on the other end of that. That's definitely going to be your case with a lot of health insurers. The more people you have, the better you can bargain. So I think there are some arguments to be made across industries that, in general, it's a way to boost business, and it has to do with pricing.

Douglass: And even to add to that a little bit, you've seen justifications in a couple of the mergers on the drug side where they said, "Well, the people that we're negotiating with, the insurers, they're consolidating, so we have to, if we're going to be in a one-to-one relationship with them." Because if you're a 2-pound Chihuahua, you don't want to be negotiating with an 800-pound gorilla, right? You'd like to both be 800-pound gorillas.

Hill: I'm a 185-pound man, and I don't want to negotiate with an 800-pound gorilla. Nobody wants to negotiate with an 800-pound gorilla. 

Michael, your business story of the year?

Douglass: I think it was the introduction of the first biosimilar in the United States, approved by the FDA in March of 2015. So, going way back to first quarter. 

Hill: First, explain to me what a biosimilar is.

Douglass: Right. So, Kristine mentioned that you have companies losing their patent protection on their drugs. So what usually happens with that is that a generic drug will get creative rights -- and you also see this all the time with Tylenol, and then it's generics in the pharmacy aisles and whatever else. With biologic drugs, that's a more complicated and difficult process. Basically, because of how they're created and their structure, it's much more difficult. You can't get an exact copy, but you can get something that's similar, which is why they call it biosimilar.

And this is, as you can imagine with any sort of generic drug, it's an opportunity to go ahead and lower prices, because these biosimilars are generally being priced at a much lower amount. Again, look at Tylenol versus its generics; you can see the difference. It's not a substantial in the biosimilar side, just because they have to do a lot more work to prove that it's similar as opposed to the same, like, with a small-molecule drug. But this opens up a big pathway for a lot of these biologic drugs to then hopefully become cheaper as their patent protections roll off in the market. So it should be a good thing for U.S. consumers long-term. We'll see how it shakes out in the next couple of years, but it's a big trend.

Hill: It sounds like this is, potentially, a good thing for consumers. Are there drugmakers who are just rubbing their hands together with glee at the market opportunity here?

Douglass: Oh, absolutely. Amgen (NASDAQ: AMGN) has been one of the early big players in biosimilars, and Pfizer has been investing in there as well pretty heavily. Because, at the end of the day, if biosimilars are going to happen, and your drugs are going to get hit, you might as well go ahead and hit other people's drugs, too. So you're seeing this, everyone going after each other effect a little bit. But I'd say, particularly, Amgen and Pfizer have been big players there.