Determinants and Consequences of M&a Activity in the Pharmaceutical Biotechnological Industry

Determinants and consequences of M&A activity in the pharmaceutical – biotechnological industry

Alisher Saydalikhodjayev

March 30, 2008

Industrial Organization

Professor J. Likens

ABSTRACT

Traditionally, pharmaceutical firms with large R&D platforms dominated the space of drug innovation; however, the last 30 years produced a large number of smaller research-oriented biotech firms. Advances in the human genome project opened doors to the field of drug innovation to many new players. This event caused a change in the structure of the pharmaceutical-biotech industry, primarily through a hike in M&A activity during the 80’s and the 90’s. The examined study found that large pharmaceutical firms that had gaps in their drug development pipeline tended to engage in acquisitions, while small biotech firms that experienced financial trouble tended to participate in M&A as targets. At the same time, small biotech firms that had promising drug development pipelines and healthy financials chose to grow organically. No significant positive effects of the event of the merger on operations were found after controlling for company’s merger propensity score.

INTRODUCTION

“Formerly, when religion was strong and science weak, men mistook magic for medicine; now, when science is strong and religion weak, men mistake medicine for magic”

- Thomas Szasz

In the capitalist societies of the western world people have become increasingly aware of the importance of healthy life. Anecdotal evidence says that Americans spend most of their medical insurance funds during the last three months of their life. Thus, it’s easy to see why pharmaceutical and healthcare-related business would strive to deliver the best, most effective and reliable products to the consumers. Any proprietary or patented drug that battled cancer or any other feared disease could be sold at high markups in a state of inexhaustible demand. Focusing on life prolongation, healthcare-related industries boosted research in the field of medical science during the twentieth century. The germ theory of disease, which states that microorganisms are the causes of many diseases, was a highly controversial proposal at the beginning of the century but, eventually, it lead to the discovery of antibiotics and hygienic practices. Chemo-therapeutic revolution, which originated during WWII, has lead to major advances in cancer treatment. In the second half of the century, advances in synthetic organic chemistry allowed for controlled synthesis of complex molecular compounds and brought new opportunities to the field of pharmaceutical innovation. During each of these changes in the industry there were both losers and winners in the market, but generally, pharmaceutical firms with large R&D platforms dominated the space of drug innovation.

This status quo changed dramatically with the unraveling of the human genome research. The effort to identify all existing genes, along with their functionalities in human DNA, lead to many new research targets in drug development. Breakthrough in this field would allow scanning a patient’s genes in normal and damaged cells, delivering accurate diagnosis and prescribing customized medicines with a minimal amount of side-effects. Identification of these genes proved to be relatively easy; however, discovering their properties is much more difficult and costlier. Therefore, the immense breadth of possible research makes the investment in R&D a sizeable and very risky commitment. However, it also allows smaller firms to focus on one particular molecule or a set of molecules, which can be developed into a product (vaccine, treatment medication, etc.). Such firms have virtually no assets and consist of a very small management team along with a lab filled with the best researchers in the field. They start up with no sales force and no product. Their hope is to convert the research done in a lab into something marketable and producible at a larger scale. Because bigger pharmaceutical firms have established sales and advertising platforms, it seems reasonable to ask a question, whether some kind of a partnership between a small research-focused firm and a pharmaceutical power player would add value to both. Presumably, the bigger firm would benefit from the transfer of investment risk onto the research company and the latter would benefit from the growth opportunities through the established platforms of a bigger firm.

This reasoning seems to be supported by the consensus in