INTRODUCTION day closing price. The merger was completed

INTRODUCTION

M&A deals in the pharma industry
dates back to the industry’s origins. First pharmaceutical companies such as
Glaxo, Wellcome, SmithKline are the ones that, after dozens of separate deals,
formed the modern GlaxoSmithKine in 2000. The first deals were mostly small
acquisitions with a few significant ones from 1800s to 1980s. Through the end
of the twentieth century the deals trend was enhanced with ‘blockbuster
mergers’, the deals which were valued over $1 billion. In today’s pharma,
giants acquire giants.

There are two major concerns about
the blockbuster mergers. First, mergers of large R&D operations may
concentrate the market for discovery, reduce competition and experimentation
for new discoveries. Therefore, lead to fewer discoveries. Second, merging
large marketing, sales, and distribution forces may strengthen a few companies
and reduce downstream competition. This would result in reduced pricing pressures
and higher entry barriers for innovative new companies.

However, recent studies show that
M&A activity appears to play only a limited role in current pricing
controversies. The analysis also suggests that merger activity is frequently
associated with more active product pipelines and appears central to an ongoing
innovation strategy.

ACTAVIS – ALLERGAN MERGER
DEAL

Actavis and Allergan have announced
that they have agreed on a definitive merger agreement on November 17, 2014. The
deal was an example of the so-called White Knight mergers. Prior to the deal,
Allergan was fighting off a hostile takeover bid by hedge fund manager William
Ackman and their competitor Valeant Pharmaceuticals. The
board’s argument against the offer was that Valeant was an unstable company
with too much acquisition deals and very low growth. It also pointed out the
reputation of Valeant to drastically cut the R spending. So, the board
stated that it would be irresponsible to take a deal that consisted mostly of
Valeant equity. Actavis
CEO Brent Saunders reached out to Allergan CEO David Pyott to offer a friendly
merger. Actavis’ offer of $129.22 in cash and 0.3683 of an Actavis share for
Allergan share was valued at $66B, or $219 a share. This is a 54% premium over
the Allergan price before the hostile bid and a 10.24% premium over the
previous day closing price. The merger was completed on March 17, 2015 and the
final value was $70.5B. The hostile bidders profited $2.6B from their ‘loss’ thanks
to their toehold of 9.7% share in Allergan.

The combined entity will be in the
top ten largest pharmaceutical companies by revenue with expected total sales
of $23B in 2015 and is expected to generate double-digit earnings growth in the
first year and a free cash flow of $8B which will enable the company to
de-leverage its balance sheet. Actavis aims to be the leader of the Growth
Pharma industry model which seeks long-term growth with name brands and generic
drug businesses around the world. The expected synergies between two drug
makers come from both cost savings and combined market power. However, the
bottom line cost savings are what makes both firms shareholders happy. Cost
synergies are estimated around $1.8B annually in addition to $475M in annual
savings from Allergan’s previously announced project. The estimated total cost
savings of $2.3B annually amounts to 10% of the expected annual revenues, a
figure almost unheard of in the pharmaceuticals industry. Furthermore, Actavis
will add its specialty brands to Allergan’s established franchises which will
double Allergan’s North American business. The merged entity will have three
blockbuster drugs with more than $3B in sales per year and increased relevance
among the doctors and patients while enhancing the sales growth in emerging
countries. There will be only $400M reduction in Allergan’s R&D budget,
bringing the merged budget to $1.7B. This is enough to move the potential
blockbusters in the pipeline.

JPMorgan did the valuation analyses
on behalf of Actavis. It used both discounted cash flow and relative valuation
methods. In its DCF valuation, JPMorgan calculated a range of terminal values
for companies for the ten-year period ending in 2024 by using perpetual growth model.
Then, free cash flows and the range of terminal values were discounted to
present values using a range of discount rates estimated based on the weighted
average cost of capital of both companies. The bank has also used DCF analysis
to value Allergan with 50% of expected synergies. In its relative valuation
analysis, the bank used public trading multiples of publicly traded companies
engaged in businesses deemed to be analogous to Actavis’ and Allergan’s
businesses. These companies are listed in the Exhibit 1. Furthermore, the bank has also analyzed multiples used
in previous transactions that the bank deemed similar to this deal. These deals
are presented in the Exhibit 2. The
estimates, multiples used, and implied values are presented in the Exhibit 3. Then, the bank compared the
results of each analysis for both companies. The highest implied value of
Allergan with synergies was compared with the lowest implied value of Actavis
to derive the highest exchange ratio of equities, after adjusting for the
$129.22 cash payment per share. The results of this comparison are presented at
the Exhibit 4. The proposed merger
ratio of 0.3683x was considered fair. JPMorgan was paid $65M in total fees for
its opinion.

The deal is structured as a reverse
triangular merger. Actavis has created the otherwise empty firm named Avocado
Acquisitions Inc. which will merge with Allergan. Allergan will be the
surviving entity of that merger and will thus become a wholly owned subsidy of
Actavis. Shareholders of Allergan will have the right to receive 0.3683 of an
Actavis ordinary share and $129.22 in cash, without interest, which totals to
$39B. After the merger, the shareholders of Actavis will own approximately 72%
share while Allergan’s shareholders own 28% share in the merged entity. Actavis
is expected to issue 128M new ordinary shares to pay for the equity portion of
the deal. Actavis will use the cash it has, up to $8.9B in proceeds from
issuance and selling of new equity, and third-party debt financing for the
rest. The exchange ratio for the equity proportion of the deal is fixed and
will not be increased to compensate Allergan shareholders in the event of a
decline in the Actavis share price. If either Actavis or Allergan terminates
the merger agreement due to a change of recommendation of the board of
directors or to engage in a superior offer, or breach the deadlines stated in
the agreement, pays the other company $2.1B in termination fees. Furthermore,
if it is Allergan which terminates the deal, it has to pay additional
reimbursement payments not the excess of $680M for the expenses incurred by
Actavis in connection with the deal. Actavis CEO Brent Saunders will lead the
combined entity and two members of the Allergan board of directors will join
Actavis. Executive officers who are terminated have rights to significant
payments and benefits presented in the Exhibit
5.

The financial data available now
shows that the proposed synergies did not realize and in fact, the merged
entity and its following mergers have lost significant value in the following
year. The decline in stock prices and market value is presented in the Exhibit 6.

SHIRE – BAXALTA MERGER
DEAL

Shire Plc, a Jersey-registered, Irish-headquartered global specialty
biopharmaceutical company bought Baxalta, a global biopharmaceutical
company based in Illinois for $32 bill?on on the 3rd of June 2016 after 6
months of persuasion following an initial hostile offer of $30 billion. While
the chief executive (Ludwig Hanston) of Baxalta was initially unconvinced of
the synergies due to a lack of overlap between the companies’ portfolios, he
later relented. Baxalta shareholders received $18.00 in cash and 0.1482 Shire ADS per Baxalta share. Based on Shire’s
closing American Depositary price on “January 8, 2016, this implied a total
current value of $45.57 per Baxalta share, representing an aggregate
consideration of approximately $32 billion. The exchange ratio is based on
Shire’s 30-day trading day volume weighted average ADS price of $199.03 as of
January 8, 2016, which implies a total value of $47.50
per Baxalta share.”

The combined company was expected to be the
category leader in rare diseases and to achieve cost and operational synergies
of over $500 million by the third year of operations. Savings were expected to come from the removal
of administrative duplications and from the access to new markets gained from
Baxalta’s wider geographic reach. Shire was especially keen on
acquiring Baxalta’s skilled
employees as they had substantial experience in the rare disease space as they
believed it would constitute a significant competitive advantage for the
combined company. The tax benefits were substantial, Baxalta on its own faced
taxes of 23%, the combined company 16%-17%. Baxalta was satisfied with the
shareholder value created since stockholders are expected to own approximately
34% of the combined company and thus will have the opportunity to participate
in any potential growth in the earnings and cash flows of the combined company.
Since it was part cash, they were satisfied as they were able to realize
immediate value. Shire financed the merger through an $18 billion underwritten
bank facility that included Barclays and MSBIL.

Baxalta’s financial advisor, Citi,
conducted various analyses in order to gauge the possible effect of the merger.
These included a selected public company analysis, a selected precedent
transaction analysis, a discounted cash flow analysis and the most conclusive
of them all, a Pro
Forma Discounted Cash Flow Analysis where they calculated the estimated present
value of the unlevered, after-tax free cash flows that the pro forma combined
company was forecasted to generate during the fourth quarter of the fiscal year
ending December 31, 2015 through the full fiscal year
ending December 31, 2025. Taken into account were the full
realization of potential net synergies expected by Baxalta management to result
from the merger, the use of debt financing to fund the cash portion of the
implied per share merger consideration, and no adverse impact of the merger on
the tax-free nature of the separation. Stock-based compensation was treated as
a cash expense and normalized depreciation and amortization, capital
expenditures and change in net working capital for the terminal year free cash
flows were assumed. Citi calculated the implied terminal value of the pro forma
combined company by applying to the pro forma combined company’s unlevered free
cash flows a selected range of perpetuity growth rates of 1.5% to 2.5%.
The present values of the pro forma combined company’s cash flows and terminal
values were then calculated using a selected range of discount rates of 7.9% to
9.0% derived from a weighted average cost of capital calculation. This analysis
indicated an approximate implied per share equity value reference range for the
pro forma combined company of $266.03 to $388.41 per Shire ADS, or
approximately $57.43 to $75.56 per share for Baxalta stockholders based on the
merger exchange ratio of 0.1482x and cash consideration of $18.00 per share,
reflecting a potential incremental increase in the value of approximately 26.0%
to 65.8% relative to the implied per share merger consideration.

The deal itself was a classic example of a direct purchase. Following
the announcement of the merger on January 11th, 2016, Shires share price fell
as shown in Exhibit 9 while
Baxalta’s fluctuated only slightly.

ABBVIE – PHARMACYCLICS
MERGER DEAL

On March 4, 2015, AbbVie has
announced that it was going to acquire Pharmacyclics for a deal worth $21B. AbbVie
is a global biopharmaceutical company which develops and markets advanced
therapies for complex and serious diseases. It was founded in 2013, as a
spin-off of its former parent company Abbot Laboratories. AbbVie’s flagship
drug is Humira, the world’s best-selling drug with $16B in annual revenues.
Although Humira is protected by more than 100 patents, about tenfold of a
typical drug, its main patents were about to expire. Pharmacyclics is a biotech
company which develops therapies for cancer patients. Pharmacyclics is the
leader of $24B large hematological cancer market. Their flagship drug Imbruvica
is a very promising product approved for many blood cancer types and more
around the world. AbbVie has beaten Johnson & Johnson and Novartis in the
deal. It offered 39% premium over Pharmacyclics’ closing price before it has
announced that it was up for sale in February. The market believed that it was
too expensive. The deal broke the rule that the buyers stock price goes up with
the targets in hot M&As in the healthcare market. Analysts have argued that
even though Imbruvica alone can account for one-third of Pharmacyclics’ price
tag, AbbVie may need to find additional $5B in revenue to profit from the deal.
Nevertheless, the deal would seem like a bargain in the long run if Imbruvica
does become the best-selling treatment for multiple cancers.

The offer was seen as an example of
a big pharmaceutical firm merging with a biotech firm to refill its medicine
pipeline before a major patent cliff. The main reason for AbbVie for the merger
was that the company needed a new blockbuster drug to feed its marketing and
sales forces. After the patent cliff, it is expected that many competitors will
come up with drugs biosimilar to Humira and eat away the revenues. Imbruvica is
very promising on filling the pipeline. The drug had generated $185M, 31% more
than the previous year. Experts have estimated that Imbruvica can generate as much as
$6B before the drug loses patent protection in 2026. The merger did not stand
to generate much cost savings but there are possible operational synergies from
a better-filled portfolio after Imbruvica complements AbbVie’s oncology
portfolio. Moreover, the deal could answer the two major criticisms of AbbVie
CEO Richard Gonzales. The first was the extent which AbbVie depends on Humira
for its sales. The second was the failed $54B merger deal with the Ireland-based
Shire. That deal was blocked by White House as it was an attempt to evade
taxes. AbbVie
projected $0.6 EPS growth by 2019 and accelerating afterwards, but also
expected a $0.2 EPS decline in 2015. Citigroup analysts were skeptical
about whether AbbVie would see any financial benefit. Pharmacyclics can
help AbbVie to increase its sales and earnings by %8 until 2017. However, the
10% share dilution created by the equity offer could offset that growth. Share dilution
could mean that majority of the growth is lost on a per share level. The reason
for Pharmacyclics was simple: the offer was very generous. The firm’s share
price had never reached such levels and the board had believed that it was the
best and final offer. Weighed with risks associated with creating a blockbuster
cancer drug, the offer was in the best interests of their shareholders.
Moreover, the AbbVie offer gave the right to choose between all-cash,
all-stock, and a combination considerations. So, willing shareholders can
continue to participate in the combined entity’s future.

According to the definitive merger
agreement, AbbVie would pay a fixed price of $261.25 per share of Pharmacyclics
of which $152.25 was in cash and $109 worth was equity in the merged entity.
Pharmacyclics shareholders could also choose to receive the amount in all-cash
or all-equity. Centerview Partners was the financial advisor to the
Pharmacyclics board of directors. Centerview has valued Pharmacyclics to
evaluate the fairness of the offer from a financial point of view. As it is the
traditional method, Centerview valued Pharmacyclics from both relative and
intrinsic value perspectives. In relative value analysis, Centerview selected
publicly traded biopharma companies which it deemed similar to Pharmacyclics based
on experience and judgment. Those companies and their enterprise value
multiples of their estimated financials are presented in the Exhibit 7. Based on this analysis,
Centerview calculated a value range for 2016 and 2017; forecasting $1.355B and
$1.888B Imbruvica revenues, respectively. The valuation range is presented in
the Exhibit 8. In the DCF analysis,
Centerview calculated a range of EV by discounting taxed and unlevered cash
flows from 2015 to 2028, using discount rates ranging from 9% to 11%,
reflecting the WACC. Also, a range of terminal values was calculated for 2028
with perpetuity growth decline rates ranging from 70% to 90%, reflecting the
decline in expected revenues once Imbruvica goes generic. Centerview then
divided those calculations to fully diluted Pharmacyclics shares to find a
range of per share value from $195.00 to $223.00. These valuations were then
compared with the $261.25 merger consideration and the offer was concluded to
be fair from a financial point of view.

The merger was structured to take
place in two steps. First, the shell company Offeror would merge with
Pharmacyclics and Offeror would cease to exist. This would enable AbbVie to
collect all Pharmacyclics share before the main merger. The second step was a
forward triangular merger where Merger Sub 2 would merge with Pharmacyclics and
survive the deal. Then, rename itself Pharmacyclics. The deal had a fixed value
of $261.25 per Pharmacyclics share. If a Pharmacyclics shareholder were to want
the combined or the all-stock payment, then the shareholder will receive 261.25
divided by weighted average price of AbbVie stock. However, the shareholder
might be subject to proration and get some of her consideration in cash. That
was due to AbbVie’s plan to pay the aggregate considerations with 41.7% equity
and 58.3% cash. This implies, on average, 3.9879x exchange rate. It was
estimated that Pharmacyclics shareholders would own 8.6% of the merged entity.
Under the definitive agreement, only Pharmacyclics was obligated to pay
termination fees which amounted to $680M.

ROCHE – INTERMUNE MERGER DEAL

On August 29, 2014, Roche, the
world’s largest biotech company acquired InterMune, a Californian biotech
company for $74 a share, totaling an $8.3 billion. The all-cash offer was a
positioned at a 38% premium.  The InterMune agreement followed deals worth
up to $2.5 billion in the preceding months for Roche with the acquisitions
of Seragon Pharmaceuticals of the US, Santaris of Denmark
and Genia of the US. The main reason for the acquisition was rights to a
breakthrough drug used to treat a fatal pulmonary disease affecting more than
100,000 Americans annually. While the drug was not clinically approved at the
time of the agreement, it was deemed a “de-risked asset” due to the expected
mortality benefit and also because it was already being distributed in Europe
and Canada.

This acquisition was also overtaken
by Roche in order to focus on more than just the oncology sector and to
diversify their drug portfolio. However, Roche was not the only one looking to
get their hands on the miracle drug. The InterMune deal was approved only after
an informal “bidding war” (of sorts) amongst 3 other pharmaceuticals, namely
Sanofi, GlaxoSmithKline, and Actelion. InterMune offered $17 more per share
than the only other company that formally placed a bid.  Roche was keen on expanding into the
pulmonary sector in order to focus more on “orphan drugs” for incurable
diseases.  As stated by Severin Shwan,
chief executive of Roche, “This is not about cost synergies at all. This is a
growth story.” The drug is expected to have sales of $1.04 billion by 2019
and revenues were expected to go from $144m in 2014 and reach $675m by the end
of 2016.

InterMune retained Centerview as
the financial advisor. They conducted a Selected Comparable Public Company
Analysis where they calculated and compared financial multiples for the
selected companies. They applied a range of 6.1x to 12.2x, representing the
25th and 75th percentiles, respectively, of estimated 2016 revenue multiples
derived from the selected comparable companies to InterMune’s projected 2016
revenue of $734 million, based on the InterMune Forecasts. This analysis
resulted in a range of implied values per share of common stock of
approximately $41.80 to $78.70. Centerview compared this range to the
per share consideration of $74.00 to be paid to the holders of shares. The
results are shown in the Exhibit 10.
A selected precedent transaction analysis was also undertaken to compare the
takeover to similar ones in the same industry. They reviewed transaction
values and calculated the enterprise value implied for each target company
based on the consideration payable in the applicable selected transaction as a
multiple of estimated two-year forward revenues. They also reviewed the
implied premiums paid in the selected transactions over the target companies’
share price one day prior to and the 52-week high closing share price one day
prior to the date on which the public became aware of the possibility of such
transactions. The results are in the attached Exhibit 11. F?nally, they conducted a sum-of-the-parts discounted
cash flow analysis using discounted cash flows representing the implied present
value of InterMune’s projected unlevered fully-taxed free cash flows from the
fourth quarter of 2014 through 2033 based on the InterMune Forecasts plus the
present value of an implied terminal value in 2033 in each case discounted to
September 30, 2014 using a discount rate range of 10% to 12% using the
mid-year convention. This analysis resulted in an illustrative range of implied
values per share of common stock of approximately $53.80 to
$62.00. Centerview compared this range to the per share consideration
of $74.00 to be paid to the holders of shares pursuant to the Merger Agreement.

The deal was a classic takeover
example, and although the premium paid may seem like a hefty amount, it is not
unusual in the pharmaceutical industry and reflects the intense competition for
promising new drugs among larger companies as they rely on small innovative
firms for a growing proportion of their products.  Termination fees
were set at $266 million for both firms if the merger was terminated due to the
other and golden parachutes for various executives were included in the
contract and are shown in the Exhibit 12.
Esbriet (the drug, containing pirfenidone) sales in the US accounted for 74% of
total sales for the drug in 2016, however, it must be noted that Esbriet was
priced significantly higher in the US than in European countries and Canada
with the annual cost varying from $2000 outside the US to about $90,000 within.
As of 2017, Esbriet has contributed to a 3% increase in total Roche
pharmaceutical sales. Market Capitalization following the transaction is shown
in Exhibit 13.

CONCLUSION

The existence of blockbuster deals
are interpreted as compensations for the lack of discovery of big pharma
companies. Firms make large, sunk investments in their marketing and sales
functions to extract the maximum value out of their blockbuster products, the
ones that bring in more than $1 billion in revenues per year. When such a
product loses its patent protection, the sales experience a sharp decline known
as the ‘patent cliff’. Thus, firms require another blockbuster to supply their
functions. If a firm cannot organically produce such a product, it purchases
another company that owns a valid blockbuster patent, as in the case of Roche
acquiring Intermune.

There is some evidence that these
deals are indeed a response to financial troubles or patent expirations, yet
merged firms experience slower profit growth compared to non-merged firms.
Furthermore, recent studies show that potential benefits from mergers are not
large enough to cover for integration costs related to such deals. While no two
mergers within the industry are the same, they all lean towards a pattern that
illustrates how M deals in the pharmaceutical industry are more
indicative of and inclined towards resolving agency problems rather than increasing
shareholder value.