Many trends already in motion before COVID-19 have been accelerated by the crisis – including digitalisation of healthcare and pharmaceutical services. So what does this mean for M&A in the sector? Laura Morrill of ECI Partners reports.

Pre-pandemic, the pharmaceuticals and healthcare sectors had been relatively slow to make significant progress on their tech adoption and digitalisation journey. Pharma companies have faced a number of barriers to the adoption of new technologies, including: regulation and data protection concerns; the need to recruit and resource new talent and skillsets in these areas; and the balancing of a complex web of stakeholder views and objectives. Despite a number of pharma giants, including Novartis, Pfizer and Sanofi, having taken positive steps in recent years, such as appointing chief digital officers to their boards, across the industry there has still been an innovation lag compared to other industries.

The arrival of COVID-19 changed this. Healthcare providers had to rapidly remove obstacles and deploy digital technologies in a bid to transform services in a matter of days. Pharma companies have had to find new ways of operating clinical trials, not only to enable the process to be carried out remotely, but to speed the process up considerably. Tech-enablement, once a nice-to-have in many healthcare and pharma companies, has moved front and centre to become mission-critical across the sector.

Buying tech

The acceleration of technology adoption in pharma and healthcare presents a significant M&A opportunity. Uncertainty has of course affected M&A and deal completions this year. Globally, there have been 1,077 healthcare, pharma and biotech M&A deals in the year to mid-October, versus 1,809 for the whole of 2019, according to data from White & Case. But there is clear appetite for resilient healthcare and pharma businesses, from both private equity and trade, particularly given the defensive nature of these types of company as we enter a challenging economic environment.

Private equity is sitting on significant dry powder, and trade acquirers are boosted by the fact that healthcare stocks have, by and large, performed well throughout the pandemic. The S&P500 Healthcare has outperformed the S&P500 over the year to mid-October – one-year returns were 21.4% for the former compared to 17.6% for the latter.

Indeed, the strong performance of healthcare-related businesses is reflected in the collapsed attempt by US-based Thermo Fisher to buy Dutch diagnostics business Qiagen. Shareholders rejected a €10.7bn bid on the basis that Qiagen had experienced ‘unprecedented demand’ through the pandemic and had increased significantly in value.

Game changers

One area that has long commanded significant private equity and trade interest is the pharma services segment, with contract research organisations (CROs) and niche specialist services businesses being targets. The attraction of this part of the market sector is its growth potential, as pharma groups continue to outsource functions and services, including research. This has resulted in private equity interest as well as consolidation opportunities for trade acquirers, particularly CROs who were looking to develop more end-to-end service offerings. The global CRO market was valued at $45.8bn in 2018, according to a report by research consultancy Frost & Sullivan, and was expected to reach $71.7bn by 2024.

Here, COVID-19-induced deployment of technologies, data analytics, machine learning and artificial intelligence has been, and will continue to be, game-changing. These organisations have assisted pharma organisations in setting up new virtual trial processes that leverage technology to source and screen the right patients from diverse populations on a global scale, to monitor them remotely, and share information and data in digital formats. The fact that patients now do not always need to travel to participate increases the available pool of participants, improves efficiency and patient retention, and reduces costs.

At the same time, increasingly complex data can now be collected and analysed through, for example, machine learning, which helps to accelerate results and improve decision-making.

The capabilities offered by tech-enabled outsourced pharma services companies to their customers can make them highly attractive targets for both trade and private equity. For private equity investors and larger CROs, the highly fragmented nature of the market, which consists of many niche specialists with expertise in particular geographies, therapeutic areas, or stages of drug development, makes these businesses both high-growth standalone platforms or strong consolidation plays.

Even pre-COVID-19, buyers were pursuing strategies to consolidate and form larger CROs with the right expertise and service offering to help them win contracts with pharma companies, which were increasingly outsourcing drug discovery and trial work, and seeking end-to-end solutions. This is a trend that will only be reinforced by a recession.

Large pharma business, facing regulatory and compliance pressure, has been employing M&A to strengthen its therapeutic offerings, and increase geographic reach and niche areas of expertise, which may include helping it face regulatory and compliance changes. One attractive area has been data-driven decision-making. Roche’s $1.9bn acquisition of Flatiron Health, a digital health analytics business focusing on oncology, is one example.

At the same time, as pharma companies reshape their organisations to focus on core areas and capabilities, we’ve seen some look to divest certain in-house functions. Bain Capital’s 2018 tie-up with Pfizer to spinout Cerevel Therapeutics, a developer of central nervous system drugs, demonstrates that these can provide attractive opportunities for private equity investors.

Highly valued

Against this backdrop, we are seeing significant deal flow in the tech-enabled pharma services sector. While this has been a healthy M&A market for some time, the events of 2020 cemented it as a market for those with positive growth dynamics and proven resilience. There is plenty of competition – we’re seeing US and European private equity houses as well as trade interest here. This inevitably leads to higher multiples, now often in the higher teens.

This makes it all the more important to focus on the company’s resilience and growth story. The most attractive companies in the space offer a distinct and valuable USP, high-quality services, a track record of winning and retaining customers, a diversified customer base, strong technology-based IP and long-term, recurring contracts.

While due diligence may be challenging, given the high levels of competition in the market and reduced access to management in the middle of a pandemic, due diligence and deals can still take place, even with less physical time on site or with management teams. Key areas of focus include the capacity of the company’s technology to scale, the value of its technology, digital or data analytics to customers and, in situations where targets have previously engaged in M&A, how successful the business has been in integrating past acquisitions.

In a market where bidders are vying for vendor attention, sellers can afford to be selective. They are looking for expertise, strong networks and deep technology knowledge among private equity buyers, and for access to new customers and markets among trade buyers. Sellers’ attention is increasingly focused on finding the right home for the business, where the company’s legacy and people being well looked after has always been important.

It’s clear that M&A activity in resilient healthcare and pharma, and related services, will be robust in the coming period. For tech-enabled pharma services businesses in particular, there will continue to be strong appetite among buyers as the benefits of technology adoption become more recognised by pharma groups. 

While the focus to date has been on first-wave digitalisation, and data capture and analysis, the next wave will encompass more sophisticated machine learning, workflow automation and artificial intelligence. The most successful businesses in this space – and the ones that will attract most investor attention – will be those with the capability to lead in a continually evolving tech-enabled space, demonstrating clear ROI to their pharma clients.

About the author

Laura Morrill is an investment manager at ECI Partners, which is a member of the Corporate Finance Faculty.

About the article

This is extracted from the full article in the Corporate Financier December 2020 /January 2021 edition - exclusively for Corporate Finance Faculty & Faculties Online members - who can access our award winning magazine in its originally designed form, and our extensive archive brought to you by the ICAEW Corporate Finance Faculty.