Simple criteria for a biopharma to never lose licensing deals post-acquisition
By S.L.
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Executive Summary
According to JP Morgan’s annual biopharma licensing report, R&D alliances have become far more lucrative than ever before, totaling $156 billion in value with the upfront payments of just $12.8 billion. Thus biopharma retaining these alliances post-acquisition holds the key financial benefit from the potential later milestone and royalty payments.
Research published in the Strategic Management Journal suggests that biopharmaceutical acquirers are 11% more likely to fail to retain a pre-existing partnership of the acquired firm within two years post-acquisition than those unengaged in acquisition. The effect is emphasized for acquirers with stressed “managerial capacity” meaning they take on more new partnerships than they had previously.
Therefore, all else being equal senior management of biopharma seeking acquisition should screen biotech targets for excessive partnership deals that far exceed their own, and preferably focus on those firms with overlapping partnerships to those they already maintain as that was shown to mitigate that partnership loss.
Financial Impact: the value of alliances is in the billions every year, and growing
The importance of R&D partnerships and licensing deals is highlighted alongside how technologically intensive the biopharma industry is, and the fact that an average drug takes at least 10-15 years for the R&D process that could cost over a billion dollars of cash. With the immense importance of intellectual property and R&D, these alliances must be viewed as important ‘call-options’ that allow the licensor to hedge the developmental risk while accessing a huge revenue potential that opens doors to niche markets and keeps the competitors across the economic moat. Therefore, should one be terminated prematurely due to any reason irrelevant to the actual result of the R&D, the impact on the financial potential would be extreme.
Collectively, the biopharma industry recorded a total of 484 new R&D partnership or licensing deals in the year of 2023 alone, with the total deal size adding to $156 billion with the upfront payments at $12.8 billion (“2023 Annual Biopharma Licensing and Venture Report”, J.P.Morgan, December 2023). That means on average, one partnership deal was valued at $26.4 million upfront and $322 million in future milestone and potential licensing payments. That number is an average and was significantly higher for the “blockbuster” drug deals in 2023: the top 10 deals in 2023 had an average total size of $5.2 billion according to Bloomberg reports.
Importantly, a recent trend shows that there are fewer deals, but each deal has higher total value, leading to increasing deal size on average. At the same time, although the M&A activity is hit by the skyrocketing cost of capital in 2023, it remains strong and is expected to rebound in 2024 according to an industry survey by KPMG (“2024 Healthcare and Life Sciences Investment Outlook”, KPMG, January 2024). Therefore, senior managements of pharmaceutical companies must focus on the retention of these licensing deals post-acquisition now more than ever.
Quantitative Findings: post-acquisition loss of R&D partnerships can be mitigated
Pharmaceutical companies often seek technology transfer from pre-commercial biotech ventures via alliances in the form of R&D collaborations and/or licensing partnerships. Subsequently, pharmaceutical companies may hold many such research alliances and become better acquisition expressly because of them – and the potential revenues of successful products from R&D licensing deals may be a significant part of the value. An important question then becomes how to predict if these alliances will be retained post-merger as it greatly informs the value of the acquisition.
To understand the effect of acquisition events on pre-existing alliances, a recent study in the Strategy Management Journal focused on 67 global transactions in the biopharmaceutical industry from 1989 to 2000 – a period of fierce competition and technological advancements in the industry. The study tracked the resulting number of terminated R&D collaborations or licensing partnerships up to two years after those deals (on either the acquiree or acquirer side), hoping to determine what about the nature of the companies lead to those terminations. They proposed two potential determinants: (1) the “managerial capacity” of the acquirer (ie how much they were already used to maintaining alliance relationships, measured as the ratio of the inherited alliances to their pre-existing alliances), and (2) the familiarity of the alliances to the acquirer (ie the # of common partners in deals held by the acquirer shared across those of the acquiree). That second measure reflected how much the acquirer and the acquisition target were in a similar therapeutic field how well the inherited deals fit the normal scope of the acquirer’s business.
On average, the acquired biopharma companies in the study held 7.5 R&D collaborations or licensing partnerships, while an average acquirer held 27.4. The average “managerial capacity”, ie the ratio of one to the other, was thus 27.4 divided by 7.5, which is 27%. The undisclosed median of the managerial capacity ratio was used to identify acquiring firms that are under “high-stress” (managerial capacity > median) and “low-stress” (managerial capacity ≤ median). The control group included 246 companies that did not engage in acquisition, each holding 9.7 R&D collaborations or licensing deals on average. Although the control companies held less alliances on average, the companies and their deals were statistically indifferent from the experimental group in a comprehensive set of covariates.
The study found that overall biopharma companies terminated alliances at 11% higher odds after acquisition event within 24 months in prior compared to their non-acquirer peers. The terminated deals were inherited from their acquisition targets rather than the original deals held by the acquirers. As expected, the effect was primarily due to stress imposed on the managerial capacity. The 11% increase in the termination odds was driven by the high-stress acquirers, while the low-stress companies were indifferent from the control group. Further analysis showed that having a common alliance partner across the acquirer and the acquiree lowered the odds of termination shown in the high-stress group by 1.54% per one increase in the number of common partners.
In simple terms, a typical acquired biotech with 9 alliances will likely lose one once being acquired if the acquiring biopharma company had fewer than 36 alliances of their own (ie adding more stress to their existing capacity to maintain alliances above a 25% threshold). But if over 7 of those 9 were already shared alliances (75% in a typical case), it is unlikely any of the acquired biotech’s alliances will be lost.
Strategic Recommendations: screen for alliance retention when acquiring targets
In 2023, the collective value of biopharma M&A deals increased 79% y-o-y. The tailwind is expected to continue in 2024 with a steady growth in deal values, especially after the recent success of GLP-1 obesity and diabetes drugs by Novo Nordisk and Eli Lilly as an important catalyst in the overall biopharma industry. The findings of this study deliver critical lessons for the senior managements that may seek acquisition targets:
Initially, the finding suggests management might avoid acquisition targets with a significantly higher number (likely 20-25% above the number of the acquirers’ preexisting deals) in order to avoid a potential 11% increase in premature termination of partnerships. This is somewhat counterintuitive as a biotech with many licensing deals is an interesting acquisition target for a potential acquirer expressly because they can (1) expand their pipeline with proven entities that licensing deals indicate, and/or to (2) gain exposure to additional revenue streams from these licensing deals.
Next, if management still wants to go forward they are encouraged to aim for targets that share many common partners, in which case the inherited alliances are more likely to be retained after acquisition. This screening would stop them from “overpaying” for a biotech that could become less valuable after a potential alliance revenue stream is lost. It also suggests this screen can preserve acquired alliances without any need to invest in additional management capacity (if that could even help, which the study did not address).
Finally, biopharma licensing deals have become increasingly larger and more contingency weighted while the industry is expecting a positive outlook for M&A activities in the upcoming 2024. So while presently management in the biopharma industry must pay particular focus on alliance retention post-acquisition, should the nature of those alliance milestone and royalty fees change and become less of a biotech’s value, that management focus may be best served elsewhere.
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S.L. is a PhD candidate at the University of Toronto and a member of the Graduate Management Consulting Association (GMCA Canada). The research applications proposed in this article are solely the views of the author and do not necessarily reflect the views of the original academic journal article authors nor any individual member of our Editorial Board.