While public perception of the pharmaceutical industry is on an upswing among the general population due to rapid vaccine and therapeutic development during the COVID-19 pandemic, in the eyes of credit rating agencies, the industry is on a continued downward spiral.
In a report released this week, S&P Global Ratings said they anticipate an eighth straight year of credit deterioration in the pharmaceutical industry. The key to this continued downward trend among creditors is the pharmaceutical industry’s constant appetite for mergers and acquisitions.
Announcements of M&A activity often leads to bursts of motion in the stock market, but it has become a point of concern for the creditors. In the report, S&P Global Ratings said acquisitions are often negative for creditworthiness, because they are often financed in part with debt, particularly multi-billion deals, such as AbbVie’s $63 billion acquisition of Allergan in 2019. The deal was financed in part with debt and that resulted in a decline in credit rating from an A- in 2019 to BBB+ in 2020, according to the report.
That deal-making, including debt-financed M&A, is expected to continue throughout 2021, particularly in areas of oncology and immunology. S&P Global Ratings laid out several key reasons why this is expected.
Primarily, the pharmaceutical industry typically views M&A as an essential element of their long-term drug development strategy alongside internal R&D efforts, which average about 20% of revenues, S&P Global Ratings said.
As an example, this morning, pharma giant Merck announced it was acquiring Pandion Therapeutics to bolster its autoimmune portfolio with that company’s clinical assets. The S&P Global Ratings report was published prior to that announcement, but it pointed to advancements made in both the autoimmune space, as well as oncology, that are driving interest from the larger companies. And that is important to smaller companies because they need the scale and other resources provided by the well-financed pharma giants.
“In addition, some companies have potential patent expirations or gaps in their development pipelines of new drugs that could lead to periods of stagnant or declining revenues over the medium term. We expect those companies to be particularly eager to address this by acquiring drugs with high growth potential,” S&P Global Ratings said in its report.
The report also points to low interest rates and easy access to debt capital as a driver of M&A activity.
“Indeed, over the past few years financial policies among many Big Pharma companies have moderately eroded from the very conservative leverage they once maintained. We anticipate this trend may influence shareholder expectations and increase the tolerance for higher leverage among pharma company boards,” the report authors added.
The S&P report also included the divestiture of assets in its M&A analytics. The divestiture of non-core assets, such as generics, consumer health, and animal health businesses, as well as batches of smaller more mature product, are expected to continue throughout 2021. Divestitures were included in the analytics because they typically reduce profits and company scale, which can weaken business strength and stability, S&P said.
In the report, S&P pointed to two significant such moves over the past year, Pfizer’s divestiture of its Upjohn to Mylan, which formed Viatris. While Pfizer is expected to redeploy the $12 billion from the deal to acquire new assets that boost its pipeline, S&P said it moderately weakened the pharma giant’s business strength. When that is added with the company’s consumer health joint venture with GlaxoSmithKline, S&P said that results in a downgrade of credit rating from A++ to A+. Merck also suffered from divestitures of smaller drugs that generated about $6.5 billion in annual revenue. While the proceeds will likely be used for future M&A, such as this morning’s deal for Pandion, S&P said it resulted in a downgrade to AA-.
Another area that affects credit ratings is the drug pricing and public perception. Scrutiny from government leaders, pharmacy benefits managers (PBMs) and watchdog organizations has hindered the increase of patented drug prices. That’s likely to remain the case this year, S&P said. The consolidation of several PBMs, pharmacies, and insurance companies in recent years has given them greater negotiating power in setting the price of prescription drugs, S&P said.
That lack of ability to increase prices feeds right back into the pharma industry’s need to engage in more M&A, S&P said.
“Companies unable to achieve growth through price increases need to spend more on M&A for that same growth so important to equity investors and equity valuations. In fact, with M&A effectively a substitute for internal R&D expense, that need to spend more on M&A could be viewed as a form of margin pressure,” S&P said.
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