Tax re­form fears driv­ing Big Pharma merg­ers

Modern Healthcare - - 2014 HEALTHCARE MERGERS AND ACQUISITIONS REPORT - By Beth Kutscher

The rum­blings that cor­po­rate tax re­form will close fa­vor­able loop­holes for phar­ma­ceu­ti­cal and biotech­nol­ogy com­pa­nies are get­ting louder. The sec­tor, which ben­e­fits from de­duc­tions for re­search and de­vel­op­ment and in­ter­na­tional op­er­a­tions, has the most to lose in any shake-up of the cor­po­rate tax code. The tax breaks give sec­tor com­pa­nies sig­nif­i­cantly lower ef­fec­tive tax rates com­pared to health­care ser­vices com­pa­nies such as providers and in­sur­ers, whose op­er­a­tions are al­most wholly do­mes­tic, with small R&D bud­gets.

The nu­ances and holes in the tax sys­tem helped fuel an ex­plo­sion of cross-bor­der merg­ers and ac­qui­si­tion ac­tiv­ity last quar­ter—with price tags to match. Driven largely by the life-sci­ences sec­tor, and par­tic­u­larly do­mes­tic drug com­pa­nies ac­quir­ing over­seas com­pa­nies, the value of year-to-date M&A ac­tiv­ity reached new heights.

Mod­ern Health­care’s quar­terly Health­care M&A Watch re­port tracked $229.8 bil­lion in deal value in the sec­ond quar­ter—more than four times higher than any pe­riod since at least 2011.

The 287 trans­ac­tions also rep­re­sented a 30.5% in­crease in deal vol­ume over the sec­ond quar­ter of 2013 and 22.1% over the pre­vi­ous

quar­ter—a sure sign that mo­men­tum is pick­ing up again af­ter a lull that per­sisted through­out last year. But it was the prices paid for those trans­ac­tions that lifted eye­brows about the re­ju­ve­na­tion of M&A ac­tiv­ity by point­ing to po­ten­tial tax changes be­ing dis­cussed in Wash­ing­ton.

For com­pa­nies that al­ready en­joy a low ef­fec­tive tax rate, the ben­e­fits of mov­ing their head­quar­ters over­seas in­clude be­ing able to move cash back into the U.S. with­out a tax penalty. About $2 tril­lion is held off­shore by U.S. com­pa­nies, and the por­tion held by phar­ma­ceu­ti­cal and med­i­cal-de­vice com­pa­nies is in the “hun­dreds of bil­lions,” said Martin Sul­li­van, chief econ­o­mist at Tax An­a­lysts. “They want to un­lock their trapped for­eign prof­its,” he said. “This gives them a plat­form for fu­ture growth for their own M&A and they also be­come a tar­get them­selves.”

To get the ben­e­fits of a “tax in­ver­sion” deal, a U.S. com­pany’s share­hold­ers must own less than 80% of the com­bined en­tity. The string of deals came af­ter Pres­i­dent Barack Obama’s March budget pro­posal sug­gested tight­en­ing that thresh­old to 50%.

Pfizer in April set the tone when it launched a record-set­ting bid for Lon­don-based com­peti­tor As­traZeneca. The ini­tial $101 bil­lion of­fer topped even the $90 bil­lion the New York-based drug gi­ant paid to buy Warner-Lam­bert in 2000.

The deal was no­table not only for its size, but be­cause it would al­low Pfizer to shift its head­quar­ters to the U.K., where it could take ad­van­tage of lower tax rates. As­traZeneca fought off the un­so­licited ad­vance.

Pfizer bumped up its of­fer to $119 bil­lion, but ul­ti­mately had to aban­don the deal af­ter it failed to con­vince As­traZeneca of its mer­its. Bri­tish law now man­dates a three­month cool­ing-off pe­riod be­fore Pfizer can try again. Be­cause the deal is no longer on the ta­ble, the $226.5 bil­lion in M&A value tracked in the re­port does not in­clude Pfizer’s bid.

Still, other drug and tech­nol­ogy com­pa­nies quickly fol­lowed Pfizer’s lead, driv­ing up the to­tal.

Two other tax-driven deals—where a U.S.-based com­pany went shop­ping across the At­lantic—fol­lowed weeks later. Minneapolis-based Medtronic will pay $42.9 bil­lion to buy Dublin-based Co­vi­dien and shift its head­quar­ters abroad. And Ab­bVie, in North Chicago, Ill., this month in­creased its un­so­licited of­fer for Shire, also based in Dublin, to $53.7 bil­lion, prompt­ing Shire to fi­nally en­ter takeover talks af­ter re­ject­ing lower of­fers.

Ru­mors also have swirled around whether Lon­don-based Smith & Nephew could be next in line for a takeover— though at least one po­ten­tial bid­der, Kala­ma­zoo, Mich.based Stryker, has de­nied that it is eye­ing the ac­qui­si­tion.

As leg­is­la­tors in Wash­ing­ton rush to usher in leg­is­la­tion that would make it harder for U.S. com­pa­nies to move their head­quar­ters abroad, other op­por­tunis­tic bid­ders are re­al­iz­ing they may have only a small win­dow for ac­tion.

Most of the deal value in the sec­ond quar­ter—$159.1 bil­lion or about 69% of the to­tal—came out of the phar­ma­ceu­ti­cal, life sci­ences and biotech­nol­ogy sec­tor, ac­cord­ing to the Health­care M&A Watch re­port. And $109.5 bil­lion was con­cen­trated in deals in­volv­ing an over­seas tar­get com­pany.

Ac­quir­ers also showed greater will­ing­ness to pur­sue a hos­tile takeover, or one where the tar­get com­pany is re­sist­ing the deal. The largest still-ac­tive deal tracked in the re­port is Valeant Phar­ma­ceu­ti­cals’ play for Bo­tox-maker Al­ler­gan, which has been bumped up to $52.7 bil­lion in an ef­fort to win over the re­sis­tant com­pany.

In to­tal, phar­ma­ceu­ti­cal, life sci­ences and biotech­nol­ogy com­pa­nies forged 79 deals, a 71.7% in­crease in ac­tiv­ity over the same pe­riod last year and 36.2% higher than last quar­ter.

The high ac­tiv­ity level also was seen in the ven­dor space, par­tic­u­larly for med­i­cal tech­nol­ogy and de­vice com­pa­nies. The 99 ven­dor deals rep­re­sented an in­crease of 52.3% year over year and 8.8% quar­ter over quar­ter. But those solid gains in deal vol­ume were dwarfed by the in­crease in deal value, which soared to $60.2 bil­lion, or 2.8 times higher than the sec­ond quar­ter of 2013, and 4.3 times higher than the first quar­ter of this year.

“There is a lit­tle bit of a herd men­tal­ity,” said Ellen Fe­d­er­man, se­nior con­sul­tant for global M&A ser­vices at Tow­ers Wat­son.

Health­care M&A ex­perts said the sud­den boom in deal prices is hardly sur­pris­ing in the con­text of the cur­rent fi­nanc­ing en­vi­ron­ment. Stock prices have ral­lied and lenders are more will­ing to of­fer fa­vor­able terms to bor­row­ers. Com­pa­nies are tak­ing that op­por­tu­nity to eval­u­ate their portfolios and di­ver­sify into new busi­ness ar­eas.

“What we’re see­ing that’s dif­fer­ent in the sec­ond quar­ter is that this isn’t just or­ga­ni­za­tions look­ing to take out weaker play­ers to gain some cost syn­er­gies,” Fe­d­er­man said.

The tax-driven frenzy in the life-sci­ences sec­tor stood apart from ac­tiv­ity in the provider seg­ment of the in­dus­try, where deal-mak­ing slowed, even as year-over-year trans­ac­tion val­ues con­tin­ued to rise. In 2013, the provider space was the lone sec­tor that con­tin­ued to put up a higher num­ber of deals de­spite the broader slow­down in health­care M&A.

Two of the largest hospi­tal groups—Com­mu­nity Health Sys­tems in Franklin, Tenn., and Dal­las-based Tenet Health­care Corp.—are now busy in­te­grat­ing their re­spec­tive block­buster merg­ers from last year, said Brian Tan­quilut, an an­a­lyst at Jef­feries & Co. Other ac­quir­ers are fac­ing road-

blocks, in­clud­ing fewer tar­gets and higher val­u­a­tions.

An­other ma­jor hur­dle ap­pears to be the threat that an­titrust reg­u­la­tors might block in-mar­ket trans­ac­tions.

In to­tal, providers forged 100 deals with a to­tal dis­closed value of $9.8 bil­lion. Deal vol­ume fell about 5.7% com­pared with the same pe­riod last year, even as deal value in­creased about 7.7%.

But the num­bers did show a sig­nif­i­cant bump over last quar­ter, with vol­ume in­creas­ing 29.9% and value doubling. “You’re start­ing to hit a stride where sell­ers that were hold­ing out for a higher mul­ti­ple are will­ing to sell,” said An­gela Humphreys, a health­care M&A at­tor­ney at Bass, Berry & Sims. “Now you’re hit­ting a po­ten­tial sweet spot.”

Many of the provider deals showed a quest to di­ver­sify, she said, point­ing to one of the sec­tor’s largest trans­ac­tions, Am­surg Corp.’s $2.35 bil­lion bid for Sheridan Health­care.

The M&A Watch re­port found that com­pared with last year, the num­ber of deals for hos­pi­tals and post-acute-care providers de­clined in the sec­ond quar­ter while a greater num­ber of deals were signed for clin­i­cians and out­pa­tient ser­vices.

Out­pa­tient ser­vices were at the cen­ter of two other large provider deals in the sec­ond quar­ter. In the sec­tor’s third­largest deal, pri­vate-eq­uity firm Clay­ton Du­bilier & Rice com­mit­ted $910 mil­lion to ac­quire Healog­ics, which op­er­ates about 500 wound-care cen­ters. And Surgery Cen­ter Hold­ings, which man­ages am­bu­la­tory surgery cen­ters, forged a $792 mil­lion deal to buy Sym­bion Hold­ings Corp., which runs short-stay sur­gi­cal fa­cil­i­ties.

While tax con­sid­er­a­tions didn’t mo­ti­vate providers, there was in­ter­est in in­ter­na­tional deals. Aca­dia Health­care, an op­er­a­tor of psy­chi­atric hos­pi­tals, made a $660 mil­lion play for U.K.-based Part­ner­ships in Care, also a be­hav­ioral­health provider. And hospi­tal gi­ant HCA, which in April was or­dered to di­vest two of its cen­tral Lon­don hos­pi­tals, was ru­mored to be look­ing at a bid for Aus­tralia’s Health­scope, a large pri­vate eq­uity-backed chain that ul­ti­mately de­cided to pur­sue an ini­tial pub­lic of­fer­ing.

The sec­tor also saw its own hos­tile takeover bat­tle as Kin­dred Health­care made its $573 mil­lion case for Gen­tiva Health Ser­vices, a home-health and hospice op­er­a­tor that is still fight­ing for its in­de­pen­dence.

As large com­pa­nies get even larger, the next wave of trans­ac­tions may be a spate of di­vesti­tures. The sec­ond quar­ter al­ready saw two dozen com­pa­nies prun­ing their portfolios. Two of the pe­riod’s largest trans­ac­tions in­volved No­var­tis buy­ing Glaxo SmithK­line’s on­col­ogy port­fo­lio for $16 bil­lion, while GSK bought No­var­tis’ global vac­cine busi­ness for $7.1 bil­lion.

The two drug­mak­ers also plan to join hands to launch a new con­sumer health­care busi­ness. The out­look for deal ac­tiv­ity, there­fore, re­mains ro­bust. “No one has a crys­tal ball, but I think there’s a fair amount of mo­men­tum around the trans­ac­tions,” Fe­d­er­man said. But while she saw vol­ume in­creas­ing through­out the rest of the year, it’s less clear whether deal val­ues have hit their peak. “That’s the big con­cern—that the prices will con­tinue to rise above where they make sense and there will be buy­ers’ re­morse,” she said.

Down­load the com­plete 2014 Q2 Health­care M&A Watch re­port at mod­ern­health­ mawatch

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