Beyond M&As: will 2020 by the year of the spin-out?

Allie Nawrat 7 May 2020 (Last Updated April 29th, 2020 11:51)

Last year saw extensive M&A activity in pharma, centred around large scale multi-billion-dollar megamergers. With the year of the megamerger now behind us, what will be the new commercial trend of 2020? Allie Nawrat explores big pharma’s move to spin-off portions of its portfolio and its benefits for the industry.

Beyond M&As: will 2020 by the year of the spin-out?
Could spin-outs be the pharma trend of 2020? Credit: Shutterstock.

Deal making is a key component of how the pharma industry’s conducts its business. This has largely been dominated by merging two companies together or larger companies acquiring smaller biotechs without the necessary capital to compete in an overcrowded marketplace.

The number of pharma deals appears to growyear on year. 2019 started with a bang and that momentum continued throughout the year. It is still too early to know the total value of all the deals initiated in 2019, since some are yet to close, but SVC Leerink has estimated the transaction value for the year to be at least $250bn.

This situation was primarily spurred by a few huge mergers, leading some to call 2019 the year of the megamerger. Examples include Bristol-Myers Squibb’s $74bn acquisition of cancer-focused Celgene and AbbVie buying Allergan for $63bn to counteract an expected decline in revenue from losing its patent for Humira, the world’s best-selling drug.

Consulting firm McKinsey has identified three core reasons why mergers and acquisitions (M&As) are particularly attractive to big pharma: They can be a source of innovation, can scale up complementary product portfolios and realign portfolios by divesting certain pipelines to more appropriate owners.

From divestitures to spin-offs

Instead of divesting their portfolios to an existing company, big pharma is increasingly looking to spin off certain areas of their business into a new company altogether. This is similar in some ways to how university researchers spin out start-ups based upon their novel ideas or technology.

Intellectual property-focused law firm Mewburn Ellis partner Sarah Kostiuk-Smith explains that spin-offs are not a new phenomenon: “Spin-offs have been used by big pharma to provide a vehicle for interesting projects that are no longer core to the company’s business, with numerous notable successes over the past 20 years.”

However, she adds: “Traditionally, spin-offs have been focussed on particular portfolio areas, often relatively earlier stage, and built around a limited number of pipelines and a burgeoning patent portfolio.”

Now some pharma giants, such as Merck, GlaxoSmithKline (GSK), Pfizer and Sanofi, are using the spin-off method differently to create “new companies that will be responsible for older, established products [which] may be off-patent, or soon to come off patent, and are more likely to be seen as steady earners,” notes Kostiuk-Smith. “This builds on and expands the model that was adopted by a limited number of pharma companies in the earlier 2000s of creating or maintaining their own (often inherited) generics divisions.”

This begs the question, could spin-offs replace megamergers and be the pharma business trend of 2020?

NewCo: Merck prioritises innovation with spin-off

In early February this year, Merck announced it would be creating a new company, known in the interim as NewCo, to house its women’s health, well-known legacy brands and biosimilar businesses; these represent around $6.5bn of Merck’s revenue in 2020. Headline products include the patented Nexplanon contraceptive implant, and cardiovascular products, such as Zetia and Vytorin.

Merck’s Kevin Ali has been named the CEO of NewCo. “Built on the foundation of a trusted, high-quality portfolio, NewCo will help people around the world live healthier lives, with a special focus on investing in innovations for the distinct healthcare needs of women,” Ali said in a release.

The aim of this spin-off is to allow Merck to focus on its key growth pillars of oncology, vaccines, as well as hospital and animal health. This will be primarily done through further innovation through research and development (R&D) and a focus on its blockbuster products: Keytruda, Lynparza and Gardasil.

Merck also believes this move will simplify its operating models, allowing more agility to respond to market changes. It hopes the spin-off will achieve more than $1.5bn in operating efficiencies over the next four years.

The spin-off transaction is predicted to be completed in first half of 2021. The company hopes the products spun off to NewCo will generate low single digit growth from the $6.5bn revenue they except to achieve this year while the products remain under Merck’s direct jurisdiction.

GSK and Pfizer’s join forces on consumer health

After its decision to abandon an acquisition attempt of Pfizer’s consumer healthcare business, GSK instead moved to join forces with Pfizer by combining their consumer health businesses into a single, separate spin-off company.

The joint venture would unite GSK’s Sensodyne, Voltaren and Panadol with Pfizer’s Advil, Centrum and Caltrate. These products have combined sales of £9.8bn, making the joint venture the largest over-the-counter medicines company, with a 7.3% share of that market.

Although this spin-off was announced at the end of 2018, in its latest earnings report in February 2020, GSK unveiled a two-year so-called separation plan to create the new company.

GSK estimates the spin-off will cost £2.4bn, but this is expected to be largely covered by divestments of other assets. The company’s two-year plan actually involves a review of the company’s dermatology portfolio for potential future divestment or spin-off.

Like Merck, one of the primary aims of the spin-off is to drive efficiencies and cost synergies, as well as allow more investment into GSK’s pharma pipeline. CEO Emma Walmsley said: “All of this aims to support future growth, deliver significant value creation, and set up two new leading companies in biopharma and consumer healthcare, each with the opportunity to improve the health of hundreds of millions of people.”

Sanofi to create European API business

The vast majority of active pharmaceutical ingredients (APIs) needed to produce drugs are manufactured in India and China. To overcome related issues linked with shortages and impurities and better service the European market, as well as focus and simplify its operations, Sanofi announced in late February it would spin off the commercial and development activities of six of its 11 API production sites in Europe into a standalone company by 2022.

The company’s Global Industrial Affairs executive vice-president Philippe Luscan said: “Based on the expertise and experience built over decades within our industrial network, this new entity would help ensure a greater stability in supplying drugs to millions of patients in Europe and beyond.”

 Sanofi expects the spin-off to be the world’s second largest API company and achieve €1bn in sales by 2022. This will be primarily driven by its newfound ability to work with other pharma companies operating in Europe. However, Sanofi has committed itself to a long-term partnership with the spin-off, as well as hold a 30% stake; the remaining 70% stake will be floated on the Paris stock exchange.C

2020 as the year of the spin-off

A major advantage of spin-offs, compared to divestitures, Kostiuk-Smith notes is “that the revenue, or potential revenue, [of the spin-off] is not necessarily completely decoupled from the parent and investors. With potential delays to R&D pipelines if Covid-19 disruption continues into late 2020, steady legacy brands may become more attractive for stabilising finance and cash flow.” While the spin-off will also be able to take advantage of interest from “different types of investors” and partners. Sanofi clearly intends to take advantage of these two benefits with its spin-off API company.

In addition, Kostiuk-Smith adds that although traditional spin-offs’ success is often “all or nothing” linked with the outcome of a single clinical trial, “recently announced spin-offs from Merck and GSK [for example] it seems, be very different in set up, being based on a larger variety of products, many of them established”. Therefore, minimising the risk and uncertainty previously associated with spin-offs, and suggesting this is a sensible business move.

However, whether 2020 is the year of the spin-offs depends on the success of the examples above, and whether they motivate other large pharma companies, as well as smaller companies, to follow suit.