Pharmaceutical giant Pfizer (NYSE:PFE) is poised to acquire Ireland-based Allergan (NYSE:AGN) in a deal worth an estimated $160 billion. The merger could spell tremendous tax benefits for Pfizer and would create the largest pharmaceutical company in the world. What other deals shook up the healthcare industry in 2015?
Join Motley Fool analyst Kristine Harjes and healthcare contributor Todd Campbell as they discuss the growing trend of M&A in the healthcare industry.
A full transcript follows the video.
This podcast was recorded on Dec. 16, 2015.
Kristine Harjes: M&A -- the new R&D. This is Industry Focus. Hey, everyone. Welcome to Industry Focus, Healthcare Edition. I'm your host, Kristine Harjes. We've got Motley Fool healthcare contributor Todd Campbell on the line.
It is Dec. 16, 2015, and it has come to my attention that one of the other Industry Focus podcast hosts, Sean O'Reilly, put in a plug recently that I'm a bourbon fan, which is not wrong. And what he very selflessly forgot to tell you, and here's me just returning the favor, is that he is also a fan particularly of Woodford Reserve.
It's maybe an Industry Focus-wide thing. I don't know. Todd, are you in the bourbon fan club as well?
Todd Campbell: I am, I am. Although I've found that I'm pretty partial to rye lately.
Harjes: Oh, well, there you go. Tastes all over the place. So, duly noted. It's a little insight into our Christmas lists and also some Friday afternoons here at Fool HQ.
So the inspiration for today's episode comes from an episode of MarketFoolery that I recorded with the stellar Chris Hill and my fellow healthcare analyst, Michael Douglass, earlier this week, in which we talked about some of our favorite healthcare stories from 2015, some best stocks and top headlines. Worst CEO, cough-cough... Shkreli. It was a really fun episode. Check it out when you get done with this one.
One of things that we talked about as a top healthcare story in that show was the surge in M&A, or mergers and acquisitions. And really, this has been a key theme for the year, more broadly than just healthcare.
Campbell: It is huge, and this is a record year, not only in terms of the number of, well, deals in healthcare, but also in terms of the number of deals that are occurring everywhere in the market. This is, in total value terms, this is the biggest year on record, surpassing 2007, which was the last year that ominously, potentially, I don't know that we had so many deals being done. And the numbers are just absolutely staggering. You know, $4.6 trillion in M&A deals across all sectors; 18,600-plus deals have been done, and a lot of those deals are occurring within the healthcare space.
Harjes: Yeah, it's been the biggest year for M&A both globally in across all the sectors and also definitely within the healthcare space. We saw the biggest healthcare acquisition ever announced earlier in November, and this was of course Pfizer and Allergan.
Campbell: Yeah, the first nine months of the year, so not even including Pfizer's Allergan deal, we had 268 different pharmaceutical deals that were done for $231 billion in value. So you know, you throw the $160 billion on top of that for the Pfizer bid for Allergan, and you're talking about half a billion dollars in deals in the pharmaceutical industry alone.
Harjes: Yeah, and Pfizer had been in a bunch of talks recently regarding M&A. I mean, there was the failed bid for AstraZeneca; they bought Hospira back in February, and actually I think that's kind of a more interesting story than the Allergan deal, even though it was way smaller -- only $17 billion. Only.
Campbell: Yeah, obviously this deal for Allergan is huge, right? I mean $160 billion, right? And, but a lot of the deal benefit, you could argue, is because of the tax-inversion component of it, meaning that you're going to move your headquarters, on paper at least, out of the U.S. in order to save on taxes.
And I think that the projection that the company offered out there is that their tax rate will fall to about 17% to 18%, down from 24%. Now Allergan obviously has Botox and other drugs that are single-digit-plus growers. But I don't think, I tend to favor the Hospira because I think that could actually be more transformative over time, solely because the Hospira deal gets them now into a leadership position in which the burgeoning, brand-new, nascent market of biosimilars, which are the -- for lack of a better term -- the generic equivalent of a lot of these high-priced biologic drugs that dominate healthcare spending today.
Harjes: Yeah, and this is an enormous story -- the boom of biosimilars, and actually one of the things that we highlighted in that MarketFoolery episode earlier this week. Because this could really be transformative for the entire healthcare space. I mean, you've got about $100 billion of biologic medicines that are slated to lose their patent protection in the next five years. Pfizer itself is saying that the addressable market for biosimilars should climb from $3 billion this year all the way to $20 billion in the year 2020.
So in buying Hospira, it gets its foot really firmly in the door of this important market. And at the time of the deal, about 68% of Hospira's sales were coming from specialty medicines. But that's because the biosimilar part has just started to take off.
Campbell: Yeah, biosimilars have been available in overseas markets in Europe for years. But the FDA has been slow to embrace them because there really wasn't a clear pathway that was established to say, "OK, if a drug isn't exactly the same, can we still approve it and call it a generic?"
Biologic drugs are created living organisms, so it's virtually impossible to precisely duplicate them. So once healthcare reform came in and the pathway was established, the floodgates, if you will, are set to open. And the first of the biosimilars to be approved in the U.S. happened already this year. It was a drug from Novartis. And many more are coming, especially with high-profile patent expirations about to happen. For example, Humira, the top-selling autoimmune disease drug at AbbVie (NYSE:ABBV), is set to lose patent protection at the end of 2016.
Harjes: Yeah, and speaking of AbbVie, they had a pretty big buyout, too, in March. That one was Pharmacyclics for $21 billion.
Campbell: Yeah, Humira counts for 61% of AbbVie's sales. So with the pending patent expiration, despite their best efforts to use legal wrangling, and new formulations to try and delay the entrance of biosimilars ...
Harjes: And that has been a valiant effort on their part.
Campbell: Yeah, and they'll continue to advance that. And who knows? Maybe they push back the entrance of these biosimilars by a few years by doing it. But it's delaying the inevitable. So they needed to go out and really get something that was going to be big and potentially transformative to make up for the sales that could be lost to Humira -- a drug that has $13 billion in annual sales. Not easy to fill.
However, they did go out, they spent $21 billion to buy Pharmacyclics earlier this year to get their hands on the blood cancer drug, leukemia especially, Imbruvica -- which is co-developed by Johnson & Johnson. And that drug has just been a gangbusters drug, incredibly successful, potentially going to get approval next year for use in the first-line setting. And that has AbbVie thinking, "Well, at least we can get peak sales out of that drug of $5 to $6 billion over time."
Harjes: Yeah, and that's especially impressive when you think about the fact that they only get to retain 50% of the profits. And so if you have management saying that they could bring in $7 billion in revenue just from this one drug, you're talking about that equating to a projection of peak sales of $14 billion.
Campbell: Yeah, these drugs, again biologics are, like Imbruvica, are the very expensive drugs. They carry $100,000-plus-per-year price tags. I think now some of those drugs, expensive drugs, arguably don't add a lot of value in as far as extending progression for survival, or overall survival. But in the case of Imbruvica, it really does. The trial that's backing up the application for approval in the first-line setting in CLL, chronic lymphocytic leukemia, that showed an 85% reduction in risk of death. So this is a very important drug, it's an expensive drug, and it certainly could generate significant revenue for the company. Whether or not it's enough to offset the risk to Humira, that still remains to be seen. But it's definitely one of the bigger deals of the year.
Harjes: So there is one more drugmaker deal that I want to highlight, and that one is Celgene (NASDAQ:CELG) and Receptos. What was the story here?
Campbell: This is, if you look at all of these deals, and there's so many to consider, this is one of my favorite deals. Especially if you're a growth investor who's interested in getting involved in a company that maybe didn't acquisition. That could really pay off over time. This is not a small deal, but it is certainly much smaller than Pfizer's deals.
Celgene agreed to pay, or paid, $7.2 billion to buy Receptos -- to get its hands on a multiple sclerosis drug named Ozanimod. And Ozanimod has already finished phase 2 trials in which it significantly reduced brain lesions, but it did so with a safety profile that was very similar to placebo.
Now that's pretty remarkable, because the market from MS drugs is shifting dramatically toward drugs that are taken orally rather than injected, and those drugs -- Tecfidera is the market share leader. Another was Novartis' Gilenya, another one is Sanofi's Aubagio -- these drugs generate out billions of dollars a year in sales. And this drug could conceivably be safer than those drugs with similar efficacy.
Harjes: So one question mark for me with this deal happened a little bit afterwards. When they initially announced it, I was like, "Oh, OK. That sounds great." And then in thinking about it, there was some news that was released that Biogen (NASDAQ:BIIB) licensed a pretty similar drug to Ozanimod that's also being studied for multiple sclerosis and some other autoimmune diseases. And they licensed it for only $60 million upfront and about half a billion dollars in potential milestones. Which is kind of a head-scratcher to me that Biogen could get basically the same drug, maybe, have not compared them in clinical trials. Who knows? Maybe the Receptos drug is way better. But I don't know. It leaves me thinking that maybe Celgene overpaid.
Campbell: It's so hard to tell, but I will tell you this -- when you come through phase 2 and you have results that are as good as this, and you have a management team that's as successful as Celgene at ferreting out good potential values, needle-moving values -- I tend to fall in the camp of let's give management the benefit of the doubt on this one. Could this other drug also put up very strong numbers in late-stage trials? It's possible. But right now, in my opinion, the evidence supports this being the better option.
Harjes: Yeah, I think you make a point there, where Celgene management has proven that it does know exactly what it's doing.
So beyond even the drugmaker space within healthcare, there have been so many companies announcing M&A activity in other subsectors of healthcare. One of the big ones was in the retail pharmacy space with [Walgreens Boots Alliance] (NASDAQ:WBA) and Rite Aid (NYSE:RAD).
Campbell: Walgreens agreed to a deal that's worth $17 billion, if you include the $7 billion on Rite Aid's books, to buy the third-largest pharmacy operator in the country. The deal comes on the heels of Walgreens' integrating its merger with Alliance Boots, a major European pharmacy operator. Walgreens, they're going after it. There's no getting around it. It's [CVS Health] (NYSE:CVS) versus Walgreens, and whichever one can get the biggest, theoretically, is going to win the battle.
So we'll see how this plays out. Rite Aid has had some troubles in the past. It's only just recently emerged back to profitability. It was a pretty leveraged company. There's a lot of overlap in various markets. So we'll have to see how many stores have to get closed or otherwise sold off.
But it's absolutely an interesting deal. One of the other things, too, Kristine, is all these deals are happening, and why it is that they're happening now is probably because the fear that interest rates and the cost to orchestrate these deals may rise as we go forward.
Harjes: And hey, I mean, look at what happened today. I mean, the bump in the interest rates. It was not huge, but I think a lot of these deals were orchestrated at a pretty smart time.
Campbell: It's huge in that it marks the first major policy shift in almost a decade as far as...
Harjes: Oh, yeah, it's a strong signal for sure.
Campbell: A big signal. It's not -- you're right, 25 basis points isn't a tremendous increase, but the guidance they issued today is something that people have to pay attention to. And that guidance is that, all things equal, subject to change, all the caveats that the Fed typically says, you can get a percentage worth of increases over the course of the next 12 months. Well, when you're talking about billion-dollar deals, that percent can add up.
Harjes: It definitely could. You're right. Should we be worried as investors about all this leverage?
Campbell: Well, it really comes down to... leverage is bad if, you know, we talked last week a lot about balance sheets and ways to analyze leverage. Debt is bad if cash flow doesn't exist. If you're taking on debt and that debt is translating into an investment that yields a lot of cash flow, and you can finance the debt through that cash flow, then it's fine.
Typically speaking, though, you want to make sure that you're sticking with companies that have debt-to-equity ratios that are less than 100%. Lower is better where possible, and you want to focus on companies that the short-term assets outweigh the short-term liabilities so that you don't have to worry about insolvency within a given year.
Overall, though, I'm not overly concerned about how much leverage they're taking on. You've got to take it stock by stock.
Harjes: Yeah, indeed. And speaking of stock by stock, I'll remind everybody listening that, as always, people on the program could have interest in the stocks they talk about. The Motley Fool could have formal recommendations for or against them. Don't buy or sell based solely on what you hear. You hear me say this every single time. Do your own research.
Before we sign off, and here's another insight to the inner workings of Fool HQ. So I am actually the woman behind the curtain that is our show's email account: email@example.com. So I got to see the seriously impressive amount of emails that came in as a response to Monday's episode about financial and investing books.
Apparently you guys are both listeners and readers. So we did not just rely on one of your senses. But time, I thought, it would be worthwhile to add some of our favorites to the list. Todd, do you have a favorite investing or financial book?
Campbell: Oh, absolutely. I have a library full of them, but the one that I hand out to every intern that has come in and out of my offices, both when I was working on the sell side, now the various things that I do, is Market Wizards by Jack Schwager. Market Wizards is a collection of stories from the leading money managers of our time. And it's easy to read, it's a great book to have in your collection, and you will learn a lot about investing, trial and error, and how to succeed.
Harjes: You know, I've never heard of that one. I'm going to have to pick it up and add it to my list.
Campbell: Absolutely do so. I'll send you one.
Harjes: Oh, awesome. So my recommendation comes with a good bit of recency bias because I just finished it less than a week ago. But I'm going to add to our list: The Big Short by Michael Lewis, which a lot of you have probably heard of it. It's a really fascinating account of the buildup of the housing and credit bubble during the 2000s and the wildly interesting characters behind it that saw the impending doom and made enormous amounts of money as a result.
I mean, it's a fairly finance-heavy book, but it reads like a novel and it teaches you a good deal about what goes on, on Wall Street and how some of these complicated financials work behind the scenes. So I highly recommend it.
Todd, thanks for your contribution today, both to the list and to the episode. Folks, I hope that you enjoy the books and the episode. And have a good one. We'll talk to you next week!
Kristine Harjes has no position in any stocks mentioned. Todd Campbell owns shares of Celgene. The Motley Fool owns shares of and recommends Celgene. The Motley Fool recommends Biogen, CVS Health, and Johnson & Johnson. 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.