Pharmaceutical M&A

Diligence Due

Despite heavy regulation, many pharma acquisitions fail from a lack of due diligence.
By: | February 22, 2016 • 6 min read

Pharmaceutical and life science companies plowed billions of dollars into acquisitions over the last two years, just to maintain revenue growth and stay ahead of the competition.

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Additional pressure from shareholders seeking a quick return, a surplus of cheap capital and persistently low interest rates only fueled the growth in mergers and acquisitions (M&A) activity.

Meanwhile big corporations are selling off or divesting the slow-growing and less profitable parts of their business in order to focus on their core market instead. The result is that brokers and attorneys in the life science/pharma space are staying very busy.

“In the last couple of years we have seen really good deal conditions in terms of the cheap financing available because of low interest rates,” said Damian Arguello, a partner at law firm Davis Graham & Stubbs.

Damian Arguello, partner, Davis Graham & Stubbs

Damian Arguello, partner, Davis Graham & Stubbs

“Many companies are also looking to get away from a focus on short-term profitability and to refocus on their core business and divesting those parts that aren’t core.

“At the end of the day, it comes down to a feeding frenzy — everyone’s doing something so what opportunities are you missing out on if you are not acquiring or divesting your assets?”

Since the start of 2014, more than $860 billion worth of pharma M&A deals have been announced, according to analysts Dealogic.

In the last year alone, the industry spent a record $677.5 billion on M&A, led by Teva’s announced $40 billion purchase of Allergan’s generics business, and Pfizer’s $160 billion merger with Allergan.

“In the last couple of years we have seen really good deal conditions in terms of the cheap financing available because of low interest rates.” — Damian Arguello, partner, Davis Graham & Stubbs

That trend is set to continue through 2016, with companies taking advantage of lower valuations and access to new geographical areas, lines of business, products and customer bases.

Other benefits include the cost and efficiency synergies that can be gained through building scale and tax inversions if the target operates in a more favorable jurisdiction.

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However, experts warned that at least 75 percent of companies that bought a new business over the last year failed to execute proper due diligence.

That has left them exposed to a host of unforeseen risks including shareholder lawsuits and directors and officers (D&O) liability claims, or worse still, the collapse of the deal.

Due diligence has, therefore, become a vital part of the M&A process, with risk managers being required to carry out thorough checks at every stage of the deal.

Due Diligence Risks

Arguello said that the biggest risk for the acquirer was overlooking a key part of the due diligence process because of the pressures of a short timeframe to get the deal done.

Alexander Moscho, managing director, Bayer UK/Ireland

Alexander Moscho, managing director, Bayer UK/Ireland

He said that risk managers also have to be aware of the increasing risk of class-action lawsuits resulting from products in the development pipeline that fail to deliver on their initial promise or to gain regulatory approval.

Product liability claims can also extend to design and manufacturing defects, and failure to warn customers about the possible side effects of a drug or product after it has been developed, he added.

“This industry, in particular, faces a lot of regulatory risks, as well as safety issues that won’t necessarily reveal themselves until further down the road,” he said.

“There are any number of long-term product claims that could come out that are only exacerbated by insurance companies pushing to limit the ability of corporate successors to tap into their predecessor’s insurance.”

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Arguello estimated that less than one-quarter of companies do their proper due diligence when acquiring a new entity or product.

The worst case scenario for companies if they get it wrong, he said, is an asbestos-type fallout with serious long-term or intergenerational effects for the customer further down the line.

Alexander Moscho, managing director of Bayer’s UK and Ireland business, estimated that two-thirds of all M&A deals over the last year have failed to deliver on their initial financial targets because of post-merger integration problems — a knock-on effect from not having done thorough due diligence.

“It’s really the big picture issues that you need to look at when doing your due diligence, such as the company’s culture.” — Gordon Zellers, Colorado practice leader, Woodruff-Sawyer & Co.

He cited the example of Daiichi Sankyo’s acquisition of Ranbaxy for $4.6 billion in 2008, shortly after which the U.S. Food and Drug Administration launched an investigation into the newly acquired company over concerns about its manufacturing processes.

A year later, Daiichi was forced to write off $1 billion, and in 2013 it paid out $500 million to settle claims with the U.S. Department of Justice, before selling its remaining stake in Ranbaxy to Sun Pharmaceuticals for $3.2 billion in 2014.

“They lost a lot of money over a short period of time because they neglected some of the risks that due diligence could have addressed,” Moscho said.

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Gordon Zellers, Colorado practice leader, Woodruff-Sawyer & Co

Gordon Zellers, Colorado practice leader at Woodruff-Sawyer & Co., said that joining the two companies’ cultures together is often one of the biggest stumbling blocks in the M&A process.

“You can almost always get the insurance-related parts of the deal right like the carrier relationship, program structure and collateral — it’s really the big picture issues that you need to look at when doing your due diligence, such as the company’s culture,” he said.

Jim Walters, a managing director with Aon, added that among the biggest risks that need to be recognized when buying a company were the potential effects that cost synergies will have on the new company in the future, including layoffs and plant closures.

Risk Management Involvement

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Zellers said that the main problem with due diligence is in many cases risk managers don’t get involved until the transaction has been completed, because management is so keen to push the deal through.

He said that it is vital to assemble an experienced team including financial, legal, tax and risk experts that can sort out the key details of the deal in advance such as dispute resolution mechanisms, performance goals and monitoring.

“Often the finance and legal departments aren’t aware of the types of insurance solutions available to cover them against unforeseen risks.”

John Connolly, North American practice leader, life science and pharmaceuticals, Willis Towers Watson

John Connolly, North American practice leader, life science and pharmaceuticals, Willis Towers Watson

John Connolly, North American practice leader, life science and pharmaceuticals at Willis Towers Watson, said that it is essential to put a valuation on any potential net exposure that your company may incur as a result of the acquisition, as well as looking at settlement opportunities.

He added that it is also important to ensure that the target’s insurance programs are fully compliant with the law from day one, in addition to reviewing and understanding its risk management procedures, reporting guidelines and communications, and loss control.

“Look to create protocols that embrace the best of both approaches but, above all, ensure that the new operations and people are able to meet your existing standards at minimum,” he said.

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at [email protected]

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The R&I Editorial Team can be reached at [email protected]