March 23, 2020

A Perspective on Life Sciences M&A in Uncertain Times

With biotech and broader market valuations plummeting, with market volatility at a historic high, with a public health crisis impacting our very way of life and a recession near certain, Goodwin’s life sciences clients are increasingly asking us for our observations on the world of big pharma M&A and collaborations.

What follows is one man’s opinion and thoughts on the current M&A market.

With an historically accommodative Fed taking rates down hard and a significant diminution in the market cap of the many innovators in the biotech industry, different players in the biopharma industry are likely to experience an extreme divergence in their respective cost of capital.

On the downside, as many of the high Beta biotech companies suffer valuation declines in an investor flight to safety, the innovators may well conclude that their future cost of capital will increase markedly due to the projected dilutive impact of successive equity raises in support of their clinical programs.

On the other side of the ledger, as rates decline, big pharma’s cost of incremental capital should logically decline as their commercial paper or other debt market borrowing costs decline, particularly among the biggest of big pharma.

So, enough with a mere lawyer’s economic stargazing.

What does this mean to Goodwin's life sciences clients and their prospects for M&A or partnering with big pharma? Well, financial modeling is of course at the heart of any M&A or collaboration process and cost of capital really matters in these models, particularly where the buy side is decreasing and the sell side is increasing!

On the buy side, we know that big pharma BD groups are disciplined and model out every deal (with sensitivity analysis) to inform their Board’s decision making and to guide their bidding strategy, particularly in a competitive context. I can recall several instances where Goodwin observed the runner up remarking that they were dropping out, as their MODEL did not support a higher bid.

On the sell side, the Board’s fiduciary duty is also informed by the seller’s model  often referred to as the Long Range Plan or LRP  as approved by the seller’s Board.

Here, the higher cost of capital calculation driven by lower stock market valuations and a continuing thirst for additional capital to finance clinical programs will in turn lower the DCF. Importantly, the valuation expectations of the Board and ultimately the stockholders should logically decline.

So, what should Goodwin’s life sciences clients expect in the context of an industry where big pharma has a declining cost of capital, an announced appetitive for deal making and a demonstrated thirst for new medicines and modalities?

We believe that big pharma’s appetite for both life sciences M&A and collaborations will continue, potentially with greater caution and a longer due diligence timeline in light of the challenging macroeconomic and public health circumstances.

We have a number of processes underway in our client base and we are not observing big pharma standing down, notwithstanding the current market volatility and public health crisis. Most assuredly they are moving deliberately and at a slower pace than customary.

They, still, have continued “to do their work.”

This observation applies not only to enterprise M&A, but also to collaboration and partnering; indeed, it may well be that partnering will increase in the short-term as big pharma takes more modest first steps. In fact, our collaboration and partnering lawyers have observed an uptick in term sheet activities over the past few weeks.

The preeminent biotech bankers are reporting to our clients that multiple big strategics have confirmed that they remain active and very much interested in looking at new opportunities. In fact, with LS valuations off sharply, our banking friends have indicated that they believe that certain big pharma players will view the current market opportunistically in a valuation sense. Of course, the extreme volatility will make bidding processes challenging, particularly for buyers who are focused for precedent or IR reasons on premiums.

A final note on premiums. We have participated recently in conversations with a number of Boards about market premiums in a life sciences M&A context. In recent years, the premiums to the unaffected price in certain highly competitive deals like Spark and Forty Seven have yielded extremely substantial premiums- in some cases exceeding 100 percent and in any case substantially higher than the public non-Life Sciences M&A norm of 25-35 percent.

Our best advice to Boards in fulfilling their fiduciary obligations is to ignore the premium noise particularly in a volatile market, and instead focus resolutely on the fundamental  or risk adjusted time adjusted  value. That’s the Board’s job.

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