Checking Healthcare’s Vitals

Examining today’s M&A-dominated environment

2014 has been an extremely active year for Healthcare investing thus far. Biotech stocks have been volatile in recent weeks. Several major companies have been hit by significant price fluctuations. The recent ramp-up in Healthcare M&A activity demonstrates how investors are adjusting their strategies in this environment.

An extraordinary amount of money is being poured into the Biotech sector. Is the space overvalued? After the recent correction in the market, we do not believe so. This level of activity is allowing Healthcare bankers to do what they used to be able to do in the ‘90s and early 2000s – match investors with certain assets or asset classes, whether it’s an IPO, follow-on or M&A deal.

A flurry of major M&A offers and deals – Valeant’s proposed hostile takeover of Allergan, Pfizer’s blockbuster bid for AstraZeneca, Novartis and GlaxoSmithKline’s asset swap, and Bayer’s purchase of Merck’s over-the-counter pharmaceutical unit, to name just a few – have dominated headlines. Large players are turning to M&A as a way of “filling holes” and building critical mass in their areas of focus. Companies are exiting their weaker businesses in favor of chasing global leadership in their core areas. In addition to the competitive advantages of scale, the larger companies will continue to be more efficient with: 1) research and development (R&D) dollars and 2) distribution of products. And, as a recognized global leader in a specific area, certain companies will be viewed by physicians as the “go-to” drug maker in their field.

While some Biotech companies are apprehensive of this trend, Baird believes it’s actually an opportunity for these companies, many of which offer a therapy that is a critical component to a large pharma’s R&D in a specific area. The current environment further enhances these Biotech companies’ values.

Some large industry players claim late-stage assets are now too expensive for their portfolio strategies, so they are planning to target more early-stage companies. But because many early-stage companies are obtaining financing, they simply aren’t incentivized to enter into a licensing deal with a larger company. Consequently, large players are becoming aggressive in their pursuit of targets in their areas of focus – the spaces where they’ve been a category leader, possess significant market share or already have the expertise to support future growth. They are also demonstrating a greater willingness to in-license at an early stage and pay a premium price for those opportunities.

On the IPO and follow-on side, we’re seeing almost all companies being able to obtain financing in one way or another. Recent volatility has prompted many generalist investors to take pause or cycle out of Biotech investments. But fundamental Healthcare investors are further attracted to these stocks with the more favorable valuations and view the current state as a buying opportunity.

Over the past year, the three hottest areas for investment have been cancer, central nervous system (CNS) and autoimmune. We believe those areas may continue to be promising for investors, particularly because large pharmaceutical companies could be drawn to these areas for potential M&A deals. We are also seeing significant investment in ophthalmology and renal/kidney/liver spaces. We believe these are exciting areas at the moment and could become very attractive areas for investors in the coming months.

In the past, companies needed to be in late-stage phase two or phase three to capture investors’ attention and capital. Today’s investors are more willing to entertain and pursue early-stage opportunities. At Baird, we’re seeing licensors and acquirers demonstrate interest in single entities or products. As for IPOs and follow-ons, we’re finding that it’s easier to bring investors and generalists in when the company has a comprehensive platform with multiple “shots on goal.”

We foresee the back half of 2014 being an active period for additional M&A and licensing deals. We believe we’ll see an uptick in activity as companies that have gone public or completed financings gain traction. Products that are differentiated or address an area of high unmet need will continue to be very attractive for investors, but it’s also important to pay attention to the subsectors where deals are getting done and where the prominent industry investors seem to be focusing. We believe all of these trends will ultimately benefit the patient. By focusing resources on R&D, companies will produce more sophisticated products with the ability to improve patient healthcare.

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This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change.