On Monday, August 17th, Sanofi, a French drugmaker, announced it would acquire its partner, Principia Biopharma, for $3.68 billion with an expected close date in Q4, 2020. Sanofi is set to pay $100 per share under the terms of the deal, a 10% premium over Principia’s August 14th close.  Sanofi is not alone, as Johnson & Johnson agreed on August 19th to pay $6.5 billion to acquire Momenta.  To understand why pharmaceutical companies are willing to spend billions of dollars on M&A in the face of a global pandemic and one of the worst recessions in recent years, it is crucial to look at the industry’s M&A history.
The advent of the 21st century ushered in the golden age of pharma M&A when Pfizer acquired Warner-Lambert for $111.8 billion ($172 billion adjusting for inflation), the largest deal of its kind in history.  Following that deal, 41 of the 45 largest pharma M&As, adjusting for inflation, occurred during or after 2000.  In recent years, M&A growth skyrocketed due to tax policy reforms in 2017, which led to tax-cut benefits for sellers. Beyond reducing the corporate tax rate from 35% to 21%, the reforms allow companies to deduct the full cost of investment in certain tangible property and limit interest deductibility. The Boston Consulting Group explains these changes will likely stimulate M&A activity by increasing corporate earnings power and quality while also providing companies an unprecedented level of liquidity.  This could allow M&A parties to structure deals as asset acquisitions to decrease capital burdens. In addition to tax reforms opening the gates for M&A, three core drivers exist: innovation, the need to refresh portfolios, and optimizing operations.
Recent McKinsey research indicates that revenue sourced from outside Big Pharma has increased from 25% in 2001 to over 50% in 2016.  Large pharma companies want to outmaneuver their competition to bring new products to market and capitalize on their proprietary status. However, they also want to avoid the high investment, high risk nature of developing new drugs independently. Thus, Big Pharma allows smaller research companies to undertake the risk involved in early-stage trials, and acquires those companies during late-stage operations, offering to cover the capital and regulatory red tape involved in making products commercially available.
Although incredibly lucrative when they hit the market, the proprietary nature of new drugs is temporary. In the United States, pharma companies can file patents and gain exclusivity rights governed by the FDA. Patents refer to the property rights a company has to a specific drug formula, whereas exclusivity refers to prohibitions on competitor drugs’ approval. According to the FDA, the term of a new patent is 20 years from the filing date and can be affected by varying statutes.  By contrast, exclusivity ranges anywhere from 6 months to 7 years.  Once exclusivity and patents expire, companies receive significantly diminished returns. Market forecasts project that, on average, from 2020 to 2024, 3% of all pharma revenue per year is at risk due to patent expiration.  Consequently, M&A acts as a way for pharma companies to renew their drug pipelines and ensure their revenue streams remain steady after their patents or exclusivity expire.
Additionally, pharma companies acquire other organizations to improve the efficiency of their operations. Haig Armaghanian, a management consultant at Haig Barrett, explains that M&As targeting organizations with similar portfolios and structures provide critical benefits.  First, mergers allow significant cost-cutting by consolidating operations in overlapping functions. Moreover, increasing R&D operations enables a company to expand drug trials and test multiple products concurrently, decreasing the time to bring new drugs to market. Similarly, in the case of an acquisition of a large firm, the combination of marketing teams can provide a distinct advantage over smaller competitors by allowing a company to exert influence over the market more readily. For example, acquisitions can provide research synergies by combining R&D teams at different stages of development on similar drugs. Along these lines, merging firms can provide economies of scale and scope to a company, which improves their ability to capture market share either on price, accessibility, or number of product offerings. Economies of scale occur when a company has the ability to manufacture at large volumes to push down unit costs whereas economies of scope occur when companies have the resources to launch related product lines.
These guiding principles apply to the aforementioned Sanofi transaction. The transaction follows two key drivers. First, Sanofi’s primary interest is acquiring the full rights to Principia’s SAR442168, a multiple sclerosis drug. The acquisition frees Sanofi from paying royalties on Principia’s global license and, according to Jefferies analysts, could result in up to $2 billion in annual revenue if the drug passes its phase 3 testing.  Considering innovation, Sanofi hopes to use Principia’s research to expand SAR442168 to other central nervous system diseases and therapeutic areas. Additionally, Sanofi expands its portfolio pipeline through the deal by acquiring other clinical-phase BTK inhibitors that Principia is developing. Moreover, Sanofi believes the acquisition will yield operational synergies, improving the distribution of their products.
Sanofi’s planned acquisition of Principia is only the beginning of the warpath pursued by CEO Paul Hudson. According to inside sources, fueled by offloading a $11.1 billion stake in Regeneron, Sanofi has compiled a $50 billion acquisition war chest.  Rumors suggest Sanofi will continue acquiring rare disease pharma companies using its excess cash to fill out its pipeline further.
Although the aforementioned tax reforms encouraged companies to pursue cash-laden transactions, Sanofi’s acquisition strategy seems unusual given its sector’s climate; PwC released statistics detailing that deal values in pharma and biotech between H2 2019, and H1 2020 are down 56% and 74%, respectively.  Moreover, overall pharma and life sciences deal volume is down ~23% over the same period.  To no one’s surprise, COVID-19 drove this historic dip. Karen Young, a pharma expert at PwC, explained, “Whether they’re focusing on vaccine development or prioritizing a pivot in their supply chain, these companies are having to redirect resources.” 
Despite partnering with UK-based firm GSK to develop a COVID-19 vaccine, Sanofi’s war chest reflects its commitment to Paul Hudson’s original model when he entered as CEO: divest weak R&D teams, minimize external reliance, and reinforce rare disease and cancer R&D.  Unlike many other major companies, Sanofi has taken advantage of this unrest to optimize its operations and make cheap acquisitions. For instance, the Principia deal is only set to be a 10% premium1, compared to a 97% average premium for public biopharma M&As in 2019.  1Premiums are the difference between the estimated real value of a company and the price paid to acquire it. Thus, a 10% premium represents paying 10% above market value for Principia. Although COVID-19 will continue to cause turbulence in the pharmaceutical industry, Sanofi will cement its name as a frequent M&A player over the course of the next few years as it pines to continue being a top player in the field.
Undergraduate at the University of Virginia, McIntire School of Commerce, studying Quantitative Finance and Management