This Corporate Trend Is the Secret to Big Pharma Profits

There has been no sector hotter for deal-making than the pharmaceutical sector. Last year saw in excess of $250 billion worth of deals struck, a record for the sector.big-pharma-profits

So far this year, we’ve seen an even more torrid pace. In the first three months of 2015, there was a total of $95.3 billion worth of deals announced. According to Reuters, that is a 70% increase from the same period a year ago.

But behind all these headline grabbing deals is a trend that may have escaped the notice of investors seeking Big Pharma profits. The large pharmaceutical companies are pursuing a very specific strategy – what Novartis AG (NYSE: NVS) CEO Joe Jiminez calls “precision M&A.”

Jiminez says this kind of deal-making is a drastic change from the mega-mergers of the past, which often left the newly merged company nothing more than a collection of assets that really didn’t fit well together.

The Precision M&A Trend Is Clear

Big Pharma companies have decided to focus solely on a few select strategic core areas and sell off their remaining divisions. That means drug companies will likely be facing only two or three other competitors in a specified area, rather than the wild free-for-all in the past where everyone competed against each other in nearly every disease category.

A look at recent Big Pharma moves show this trend to be accelerating.

One of the largest precision M&A deals consummated last year was a $20 billion swap between the aforementioned Novartis and GlaxoSmithKline PLC (NYSE: GSK). The Swiss company traded most of its vaccine division for GlaxoSmithKline’s cancer medicines division. The two also agreed to form a joint venture in consumer health care.

But that is hardly the only such Big Pharma streamlining deal out there. Other notable deals include:

  • The $2 billion sale by Johnson & Johnson (NYSE: JNJ) of its cardiovascular care business to Cardinal Health (NYSE: CAH). Johnson & Johnson also sold off its blood testing business in a $4.15 billion sale to The Carlyle Group (NASDAQ: CG).
  • The $17 billion acquisition by Pfizer (NYSE: PFE) of Hospira (NYSE: HSP). The deal boosted Pfizer’s portfolio of injectable drugs and biosimilar drugs.
  • AstraZeneca PLC (NYSE: AZN) had some smaller, streamlining deals, such as a $325 million sale of its Myalept drug and a $600 million purchase of the rights to Actavis PLC (NYSE: ACT) branded respiratory drugs in North America.

Sensible Deals

Investors may be wondering if this new strategy being pursued by Big Pharma companies make sense. According to a 2014 study from consultancy Bain & Company, it does.

Bain looked at the industry over a 20-year period and found that 10 companies consistently outperformed, based on total shareholder return.

Big-Pharma-chart

The secret to success? Bain found three factors, two of which, I believe, are extremely crucial:

  • Focus on building leadership in categories and capabilities.
  • Use targeted M&A strategies to build leadership positions.

The third factor was developing distinct capabilities in one of four repeatable business models.

Bain pointed out the value of targeted M&A versus prior megadeals by saying that in 2010, 46% of all pharma deals resulted in underperforming companies. But today, many of the deals are different and more targeted.

The bottom line for investors is that the current wave of precision M&A deals are just what the doctor ordered.

Just look at the model for this new era – the GSK-Novartis deal. It created leaders in both oncology (Novartis) and vaccines (GSK). Their joint consumer health venture also created a leader in the consumer health care sector – and additional value for their respective shareholders.

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Published by Wyatt Investment Research at