Once upon a time, the way to be a big pharmaceutical company was to discover and develop drugs. But now, the business is becoming less about R&D, and more about M&A. It may cause excitement in financial markets, but it's not a sign of health.
Valeant Pharmaceuticals International Inc.'s nosebleed-inducing $46-billion (U.S.) hostile takeover bid (in partnership with Bill Ackman) for Botox maker Allergan Inc. is the latest, and boldest, move yet from a company that has become the pharma industry's poster child for buying your way to the top. In the past two years, Valeant has spent nearly $13-billion (U.S.) on acqusitions.
And what did it spend on research and development in 2012 and 2013? All of $236-million – less than 3 per cent of its revenue.
Valeant is an extreme case. Overall, the pharmaceutical industry spends about 16 per cent of its revenues on R&D. Nevertheless, mergers and acquisitions have become rampant. Last year, the sector racked up nearly $180-billion in deals globally, about the same as in 2012. That's nearly double the amount spent on R&D in those years. This week Allergan was just one of several mega-deals in the sector being kicked around (see also Novartis/GlaxoSmithKline and Pfizer/AstraZeneca).
And why not? Developing drugs is a costly and risky business – and it seems to be getting riskier. A study by Deloitte and Thomson Reuters found that it now costs big pharmacuetical companies an average of $1.3-billion to develop each new product, up 18 per cent from 2010. The average projected return on investment for late-stage products in development fell from 10.5 per cent in 2010 to 4.8 per cent in 2013. It typically takes a decade or more to develop a new drug and bring it to market, and it might not ever get there. In the past four years, the termination of products in late-stage development cost the world's leading drug makers more than $240-billion, the report estimated.
The industry's reaction to this deteriorating performance has been to buy already-developed assets, extract cost-saving synergies and, as much as possible, keep a lid on spending – particularly in R&D.
This has left the sector flush with cash. Standard & Poor's latest report on U.S. corporate cash shows that the health care sector is second only to technology in its cash holdings – $206-billion (U.S.) at the end of 2013. And it's concentrated in big pharma and biotech companies: Pfizer Inc., Johnson & Johnson, Amgen Inc., Merck & Co. Inc. and Medtronic Inc. rank among the top-20 biggest cash holders in corporate America, with a combined $112-billion among the five of them.
But the realization, increasingly, is that it's quicker and less risky to use that money to buy assets than to develop new (hopefully) blockbuster drugs yourself. Fickle investors don't have the patience for decade-long development cycles, not when growth and dividends can be acquired.
In Valeant's case, the market has certainly put its stamp of approval on this strategy. The stock has tripled in value in the past two years. It surged 7 per cent Tuesday on the New York Stock Exchange, on news of the Allergan bid.
Still, this is an industry necessarily built on research and innovation. There's a problem when the best use of money isn't in the products anymore. The Deloitte/Thomson Reuters report suggests the industry's R&D practices are inefficient and have lagged others in the sophistication of analytics and decision-making processes; the result is returns that are volatile and inconsistent, at best. Without a serious R&D overhaul, all the M&A may just be shuffling the deck, in an industry that's finding organic returns harder to sustain.