Last year broke the record for most M&A activity, and 2016 is looking to follow close on its heels. And regardless of what many people seem to think when a new M&A deal is announced, it's probably not all because of tax inversion (though that very well might be playing a big part).

In this clip, Michael Douglass and Kristine Harjes talk about three factors to consider to figure out what companies might be looking for with a merger or acquisition, and a way to categorize and frame your thinking about deals that have already gone through.

A full transcript follows the video.

 

This podcast was recorded on Jan. 6, 2016.

Kristine Harjes: So, Michael, without further ado, how are you thinking about M&A?

Michael Douglass: Sure. So, I think when you really break down mergers and acquisitions, there are some very clear strategies that are involved. So, I think the decision-making around them seems to sort of fall around three axes. Those are what I would call intent, which is, what are you planning to do? What are you trying to get? Are you trying to get better at something that you're already good at, or get scale in that? Are you trying to get into something new? Are you trying to do a tax inversion?

I think the second piece, then, is, what's your risk appetite? Are you looking for really early stage small cap biotechs that everybody talks about in the growth space in healthcare? Are you talking about somewhat less risky biotech that are still not commercials? You've got your primary asset in phase 3, or phase 2 data's out, maybe even have phase 3 data out. Or, you're looking for a company that's already commercial, a big, already-successful company.

Of course, the amount you're going to pay is going to depend on how much your risk appetite is, which then gets us to the third piece, which is what I would call mechanism. That's thinking through, are you licensing a drug? When you're signing this deal, are you basically agreeing to be the marketing partner for this drug, so you're paying a royalty out? Is it a licensing plus equity investment, which is something that we see Celgene (NASDAQ:CELG) doing a lot?

I don't want to get too much into that, because we'll be talking about it more later, but it's very much something that Celgene does a great deal in their M&A when they're going after drugs, so they then get an opportunity to participate in a smaller-cap biotech's growth. So, their shareholders can benefit from that. Really, are you looking to buy them? Is this a straight-up purchase?

So, I think those three things interlock into this complicated mechanism for thinking about how these deals go through and how they work. And I think by looking along these three axes, we can categorize deals and understand them, and then look out for potential pitfalls.

Harjes: So, what I really love about this way of thinking about it is that it's very visual. I'm a very visual person, so of course, that's going to appeal to me. But you have your three axes, and not only is that a reminder that, oh, 3-dimensional thinking, we're so multi-faceted. Because, you know, you look at a deal sometimes, and something will stand out as, "Oh, they're doing this for tax inversion, that's all anybody wants to talk about."

But there are the other two dimensions to it. And, I also want to point out that they exist on a spectrum, too. So you don't have binary options, three of them. You have an entire scale of, say, your risk appetite could range from very low to very high. Same thing for your other two axes, your intent and your mechanism. 

Kristine Harjes has no position in any stocks mentioned. Michael Douglass owns shares of Celgene. The Motley Fool owns shares of and recommends Celgene. 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.