Morningstar analysts see pharmaceuticals as 2010's hot zone for mergers and acquisitions.
For the second year in a row, Morningstar's health-care team has published a study on merger and acquisition activity, including a list of the most likely biotech acquisition targets. This creates a good opportunity to ask the team about its outlook for 2010: which firms might get bought, who might be doing the buying, and how investors ought to position their portfolios. I posed these questions to Alex Morozov, who heads Morningstar's health- care team; as well as Karen Anderson, a senior analyst specializing in biotech; and Lauren Migliore, an analyst focusing on the same.
Haywood Kelly: How much activity should we expect in 2010?
Health-Care Team: We believe that pharmaceutical companies will continue to account for the lion's share of the M&A activity in 2010. While we still anticipate that diversification will factor as a catalyst for acquisitions (as was the case in 2009), we believe that the focus will increasingly turn to replenishing pipelines, and small- and mid-cap biotechnology companies are likely to find themselves as targets. We also anticipate some activity in devices and instruments, where consolidation is likely to drive the majority of the deals. We think that large conglomerates, primarily General Electric GE, will seek to expand their positioning in health care, particularly as their industrial operations recover and credit markets thaw out. The firms that could be in play include sizable instrument makers that could appeal to conglomerates and niche-product manufacturers that could attract the interest of rivals looking to broaden their portfolios. We are not expecting many splashy acquisitions in other sectors of the health-care industry, but we may see plenty of smaller bolt-on deals by managed-care providers, CROs, and health-care services firms.
HK: The team came out with a list of the most likely biotech acquisition candidates. What factors were considered?
Health-Care Team: The first thing we looked at was the overall promise of a firm's drug portfolio with our Drug Portfolio Strength score. The strength of a firm's portfolio of marketed products and development-stage drug candidates is at the heart of its potential to produce blockbuster-level sales. This is one of two core measures for our biotech takeout score--any acquirer would assess the potential for translating a firm's technology into commercial success. For each firm, we've assigned a 30% weighting to a Drug Portfolio Strength score, which aims to reward the novelty of the firm's approach to treating disease as well as the popularity of the firm's therapeutic area focus among potential buyers.
Second, we considered a target's ability to boost its acquirer's earnings. No matter how novel or popular a firm's drug portfolio, its pipeline must have real potential to boost an acquirer's bottom line. The shorter the timeline to strong profits, and the smaller the investment required to get there, the more appealing these potential profits will look. Therefore, our Profit-Boosting Power score takes into consideration both the timing and size of the target's profit potential, and we assign a 30% weight to this factor.
Third, we examined the likelihood of specific combinations of companies and decide whether such a deal would make sense from the perspective of both the buyer and the seller. We assigned a 20% weighting to our Collaborative Fit score, which takes into consideration both the existence of logical acquirers in the marketplace, as well as the desire on the part of the seller to create or expand a partnership to boost prospects for its drug pipeline. And last, we looked at the target's financial health. Financial health can play a major role in board and shareholder willingness to accept a takeover bid. As a company's cash on hand falls, its receptiveness to an acquisition should increase, particularly as the possibility of being forced to halt operations becomes more likely. While a significant factor in acquisitions, our Financial Health factor also only receives a 20% weighting.
HK: What companies rate the highest in terms of drug portfolio strength?