Healthcare Sector Spotlight

Healthcare SectorSpotlightIn association with PPM CapitalJanuary 2006

Part of The Mergermarket Group

Contents

Introduction 1Specialist Care Businesses in the UK 2Where Now for UK Biotech? 5Rising Star: Prospects for UK and European Diagnostics 8Diagnostics: Straw Poll 11Case Study: Pharmacia Diagnostics 15Healthcare Sector Statistics 17Regulatory Issues: UK Healthcare Sector 18


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Healthcare Sector Spotlight 1

The UK Healthcare sector continues to generate a rangeof M&A opportunities for both trade and financial investors.According to mergermarket data, last year saw 81 deals wortha combined £5.8bn completed in the UK. The leading subsector in terms of deal volume was ‘hospital managementand healthcare institutions’ which attracted 35% of UK M&Adeal flow. However, other significant areas of deal flow weredrug development (18%), medical equipment (21%) andbiotech research (9%), and this report aims to reflect thediversity of investment areas within UK healthcare.

In this report, our feature articles take a look at three distinctareas within healthcare. The first, ‘Specialist Care Businessesin the UK’, examines one of the most dynamic areas ofhealthcare institutions, where over three quarters of 2005deal flow involved the participation of private equity players.The second feature, ‘Where Now for UK Biotech’, examineswhether the sector can improve deal flow after 2005’s weakperformance. Meanwhile, the third feature, ‘Rising Star:Prospects for UK and European Diagnostics’, reviews an areathat is gaining increasing financial investor interest thanks totechnological advances.

PPM Capital has been a long term investor in the healthcaresector. In a case study feature on page 15 we take an in-depth look at our investment in Pharmacia Diagnostics,acquired for $575 million from Pfizer in 2004, and our role in the post deal development of the business.

Again, we garner the corporate viewpoint of leading CEOsin the industry. This edition looks at the European diagnosticssector: from potential threats to development and the biggestdrivers of diagnostics investment to the main players inmarket consolidation. Also included is deal data on thehealthcare sector in Europe: volume and value trends, dealsizes and sub sector analysis.

Still to come in this series are reports covering the businessservices and retail sectors. Together with the recentlypublished Leisure Sector Spotlight we hope that this seriesof four reports provides a comprehensive insight into trendsin activity, as well as some of the issues affecting M&A andprivate equity in the industry during the past 12 months.

As ever feedback and questions are welcome to SallyFlanagan at PPM Capital in London and Simon Anam at mergermarket.

Sally Flanagan

Director, Healthcare

PPM Capital

IntroductionHealthcare Sector Spotlight is the second of four industry focused reports brought to you by

PPM Capital in association with mergermarket.

Drivers of UK healthcare institution activity

One of the main drivers of the consolidation in the UKhealthcare institution sector is demographics: a growingnumber of elderly people, and an increasing pressure on theNational Health Service to provide specialist elderly, mental,and learning disability care services. All this means anincreasing need for outsourced provision of specialist andsecondary care.

With the UK government spending an estimated £100bn a year on healthcare, and an increased public awareness of health issues, it is unsurprising that many investors in the healthcare sector, and not just elderly care, believe theyare on to a winner. Furthermore, the long-term contractsavailable with the NHS provide a high level of earningsvisibility. In particular, nursing homes are viewed by manysector investors as expensive hotels made more attractive by the fact that there is no need for costly extras such ashealth clubs and gourmet restaurants.

Admittedly, while there is currently a strong demand fornursing homes, there is also a counter-argument thatincreasingly people are entering homes much later in life andtherefore for a shorter period. Furthermore, one can expectgovernment initiatives to improve the provision of shelteredhousing for the elderly in coming years, which, in tandemwith attempts to boost the role of friends and familymembers as carers, will absorb some of the current demand.

Increasingly, therefore, the next year will see astute investorsin health institutions look outside of the melee surroundingnursing homes and into other sub-sectors such as specialistmental healthcare, learning disability care, and privatecosmetic surgery that are currently underserved and offer areal value proposition. Indeed, looking at the large healthcareinstitution deals in 2005 there are signs that this is alreadystarting to happen.

Henry Elphick of UBS who acted for Blackstone on their2004 £1.1bn acquisition of Nursing Homes Properties (NHP),now integrated into Southern Cross Healthcare, believes theelderly care market is highly consolidated: “Assets are nowat such a scale that an IPO is the only exit option in the nextfew years. There simply aren’t many big pieces around.Looking at the UK nursing home market there are now threePremier division players: BUPA, Four Seasons and SouthernCross; one first division player, which is Barchester and thenthere is a big, big drop-off in scale.”

David Jones at Deloitte concurs with this view: “In 2005 wesaw significant consolidation at the top-end of the nursinghomes market.” However, Jones still believes “that whilstthere is now less opportunity for large buyout houses, thereis still significant scope for smaller mid market private equitydeals in the nursing homes market in 2006.”

Indeed, at the time of publication there were two ongoingauctions within the UK nursing home sector likely to attractprivate equity interest. The first is for Paragon HealthcareGroup, put up for sale by its owner Duke Street Capital, andexpected to make between £300m and £400m. The secondauction centres on Robinia Care Group, owned by private-equity firm Bridgepoint, which as well as Ark Care nursinghomes divisions includes Life Links, a business specialisingin patients with autism. The combined Robinia business isexpected to make £80m.

Increasingly though, it seems it is specialist care businesseslike Life Links rather than Ark Care that will attract investors.Looking away from the highly consolidated nursing homemarket, both Jones and Elphick see the clear ongoingattraction of the specialist care market as an area forinvestment in 2006. As Elphick says: “Developments inspecialist care will be very exciting in the next 12 months.I believe in terms of consolidation the specialist care marketis where nursing homes were two years ago.”

Specialist Care Businesses in the UKIn 2005 healthcare institutions were one of the hot areas for UK private equity investment. Indeed,

according to mergermarket data over three quarters of deal flow in healthcare institutions involved the

participation of private equity players. Clearly then, something has been going on, but where exactly has

the money been flowing? Also, after such a busy year what investment opportunities are left for investors

in 2006?


2005 deal flow in specialist care

Of course, the July £875m MBO of the Priory Group loomslarge in a survey of deal flow within healthcare institutionsthis year. The deal saw the Priory’s management agree toacquire the company in a secondary management buyoutbacked by ABN AMRO Structured Capital Markets fromDoughty Hanson, the UK based private equity firm. The saleof Priory Group marks a lucrative exit for Doughty Hanson,which made a return of around four to five times of its initialinvestment in 2002.

Despite a reputation in the media for its occasional celebritypatients there is much more to the Priory Group than meetsthe eye. The Priory operates a chain of health clinics withover 1,700 beds across a network of over 40 facilities,comprising hospitals, care homes, specialist care facilitiesand specialist educational facilities. Furthermore, it claims70% of its work is publicly funded, which means it has agood mix of reliable long-term earnings and higher marginprivate services.

Looking beyond the Priory, 2005’s second largest deal inMarch saw Cinven, the UK private equity firm, win a privateauction for Partnerships in Care, the British provider ofspecialist mental health and related services for £552m net of cash. Partnerships in Care was owned by GeneralHealthcare Group, the UK-based hospital chain and BCPartners portfolio company.

As with the Priory situation, the auction was competitivewith private equity groups Terra Firma Capital Partners,HgCapital, Electra Partners, Candover and Allianz CapitalPartners all participating. No doubt Cinven’s trump card wasits familiarity with the management of Partnerships in Care,which it used to own before selling General Healthcare to BC partners in 2000.

The year’s third largest private equity backed deal in thesubsector, however, was back in nursing homes and sawBank of Scotland Corporate Banking back the managementof Ashbourne Healthcare Services in an SBO from ElectraPartners Europe worth £280m. Since its management buy-inof Ashbourne in 2003, Electra had conducted a buy and buildstrategy with twelve bolt-on acquisitions to the Ashbournecare homes portfolio. Moreover, this strategy is somethingBank of Scotland and management appear to be perpetuatingwith a £88m follow-up acquisition in April 2005 of RidgmontCare Homes from Graphite Capital Management.

More interesting though, is that Electra, following its exitfrom Ashbourne, in April acquired Covenant Healthcare for£170m in a SBO from Phoenix Equity Partners. The deal was interesting because rather than being a pure-play nursing home business like Ashbourne, Covenant comprisesthree companies: Transform, a cosmetic surgery company;Abbey, an owner and operator of six hospitals; and Churchill,a provider of psychiatric services. In fact, looking at themixture of specialist care services in this transaction it can be seen as something of a precursor to July’s larger PrioryGroup deal.

Meanwhile, another noteworthy specialist care deal in Aprilsaw private equity firm 3i pay £119m to increase its stakefrom 38% to 85% in Care Principles Limited, a UK providerof assessment, treatment and specialist care for personswith learning disabilities.

Drivers of specialist care

Clearly, as deals in 2005 show, the UK specialist care marketis receiving a lot of attention from leading buyout housesbased on expectations of strong future growth, and manybelieve this optimism is highly justified. According to DavidJones at Deloitte, “The level of private provision inhealthcare is still a very small percentage of the overall pie.This means there is still a huge potential for the market.”Furthermore, for Jones the ongoing impetus of public toprivate provision within the NHS will continue to drive growthin coming years: “The NHS is such a large gorilla that theywill inevitably put out more and more to the private sector to cope with demand.”

Henry Elphick agrees, pointing out that, “As of today thereare no truly national players in specialist care, so there is a real opportunity to create a national brand.”

Conclusion

Looking over this year’s deal flow in the UK healthcareinstitutions sector it appears that two broad strategies arecurrently being pursued by private equity houses. The first is to go for scale and consolidate in nursing homes, althoughincreasingly it appears opportunities are really only to befound in the middle and lower reaches of the sector.

The second and more favoured option is increasingly topursue deals in the less consolidated specialist care sectorby investing in mental healthcare, learning disabilities orcosmetic surgery. In short, expect to see more deals in 2006 like those witnessed this year involving the Priory,Partnerships in Care, and Covenant.


Deal flow in 2005

After 11 M&A transactions worth £1.8bn in UK biotech in 2004, 2005 has only seen eight transactions worth acumulative £188m. This year’s subdued performance,however, is representative within Europe as a whole.

In value terms, however, the largest European biotech dealof the year was a £225m trade-buy involving a target basedin Switzerland. Nevertheless the total £1.5bn ofbiotechnology deal flow in Europe remains minisculecompared to the £8.8bn that took place in the US in 2005.Furthermore, this year’s largest US biotech deal was overten-times the size of the largest in Europe.

Interestingly though, this deal, brokered in October, involveda European trade buyer – Novartis. The deal saw the Swisspharmaceuticals company make a recommended public offerto acquire the remaining 58% it did not already own in ChironCorp, the US vaccine manufacturer for £3.3bn ($4.9bn).

In a similar vein, in June, US major Pfizer paid £975m($1.8bn) for Vicuron Pharmaceuticals, the US listedbiopharmaceutical company. Both of these transactionsappear to demonstrate that when big pharma wishes toincrease their holdings in biotechnology they favour USassets with the requisite scale rather than bothering withsmaller European companies.

Funding for UK biotech

Another issue for investors in UK biotech is choosing whento enter the development cycle, especially bearing in mindthat it typically takes nine years for a company to go fromstart-up to IPO. Funding for R&D is clearly a major issue inthe UK and wider European biotech sector. As GordonHamilton, Life Sciences Partner at Deloitte says: “Early stagefunding is normally there in the UK. The problem is usuallylater on when biotech companies need serious cheques totake the project further.”

The lack of depth of the UK capital market compared to theUS for backing potentially risky biotech stocks is perhaps notsurprising. However, many believe the government couldplay a stronger role in supporting development of companies.Admittedly, in certain areas of biotech they are trying to playa greater role, indeed, according to Hamilton, “Stem celltechnology is getting government backing, but it is unlikelythis will have any major impact in the next 12 months.”

There is also a clear role for private equity and venture capitalin fostering start-up biotechnology ventures with an eye toeither selling to medium sized European trade buyers in themedium to long term. Furthermore, some believe privateequity support need not be only pre-IPO but could come inthe form of PIPE deals (private investment in public equity).

Indeed, the benefits for publicly quoted biotechs of equitysupport from buyout houses is often compelling. Manybelieve that UK biotechs tend to be undervalued post-IPO,and subsequently receive less attention from investmentbanks. For this reason PIPE deals are often a morefavourable route to further investment than a secondaryoffering because they do not require costly road shows and prospectuses.

Where Now for UK Biotech?The past five years have not been easy for investors in the UK biotechnology sector; indeed, the period

has seen two thirds of its value disappear from the UK stock exchange. Now though, from this low ebb,

it is arguably a good time for backers of biotech to regroup and focus on a sector which offers massive

potential upside – albeit tempered with high risk.

Biotech risks

It is undeniable that the risk profile of the UK biotech sectoris high, with many firms failing to produce a marketableproduct from years of expensive R&D investment.Furthermore, a biotech company will typically be developingonly one or two therapies whereas a big pharma company is able to develop a wide range of drugs. To counter this,buyout firms should probably aim to spread their investmentexposure across a range of biotechs targeting differentdiseases and therapies to improve their odds of backing a winner.

A further risk to UK biotech operations is from fledglingoverseas firms, especially in India and China where there istypically a lower cost of innovation. Admittedly, competitionfrom generic biotech products remains limited at this stagecompared to within mainstream pharmaceuticals, but thiscannot be expected to last forever. Investors in UK andEuropean biotechs should ensure that issues surroundingpatent protection/expiration and intellectual property arewater-tight.

That said, despite the obvious risk profile of the biotechsector, the potential upside of backing a ground breakingvaccine or cure can prove extremely lucrative. Furthermore,the development of increasingly global Indian and Chinesebiotech companies is not inherently bad news. Indeed, incoming years they can be expected to provide a well-fundedexit route for buyout and venture capital firms, or corporateslooking to divest non-core operations.

A recent example of this came in October 2005 whenNicholas Piramal India, the listed Indian pharmaceuticalcompany, agreed to acquire Avecia Limited, the UK basedpharmaceutical company, for £9.5m. For its part NPIL will gain access to the technology besides widergeographical reach.

Meanwhile, the largest UK biotech deal of 2005 sawJapanese bio-pharma company, Sosei, agree to acquireArakis of the UK in July for a total consideration ofapproximately £75m in cash and stock. The Arakis deal was an exit for investors that included 3i Group, MerlinBiosciences, Scottish Equity Partners, Nomura Phase4Ventures, Novo A/S, MB Venture Capital Fund I NV,Bioscience Investment Trust, Finsbury Life SciencesInvestment Trust, Close Finsbury EuroTech Trust and Scottish Widows Investment Partnership. The acquisitionwas in line with Sosei’s strategy to strengthen itsinternational presence and will enable the combined group to have a broad and balanced pipeline with a mix of late andearlier stage products.

According to Gordon Hamilton, “It’s heartening that we’reseeing some M&A in the space that is of quality and not justfailing companies. Arakis was a great deal that willstrengthen the offering.” Hamilton is, however, realisticabout performance of the market, especially in past years.“The market is not without challenges. It’s still a very nichemarket, you need to either be comfortable investing or not. Itis a sector that failed to deliver and serially underperformed.”


Looking forward

Rather than just being targets for overseas buyers, it is alsoto be hoped that the next few years will see UK domesticbiotech firms increasingly look outside of the domestic scene to pursue targets in overseas territories such as NorthAmerica, Central & Eastern Europe, India and China. Indeed,this is what UK biotech firm Vernalis is already doing. Formed in a three-way merger in 2003 with British Biotech,RiboTargets and itself, Vernalis announced in November 2005 the $29m acquisition of cash rich Canadian biotech firm Cita NeuroPharmaceuticals.

This deal fits into Vernalis’ strategy in recent years of buyingup drug licences to shore up its balance sheet with steadyrevenue and thereby fund its R&D of potentially groundbreaking drugs in coming years. It is this more commerciallyminded strategy that aims to balance its revenue mix and not rely solely on unpredictable developments from its labs.“People are sceptical whether Vernalis have the rightmodel”, Hamilton says. “The key question is whether theywill make enough money to pursue their R&D – when doesthe business become too much of a distraction? However, it is heartening that they are taking a commercial approachand not just a ‘blue-sky’ mentality.”

Conclusion

Looking forward to 2006 it seems certain that deal flow inUK biotech will improve on 2005’s weak performance. Bigpharma companies, both European but predominantly US,will continue to strengthen their pipeline. Also, mid-sized US biotechs will make buys, in the vein of Cephalon’s $360m December 2005 buy of European bio-pharma firmZeneus Group.

Meanwhile, at the start-up end of the market, 2006 willwitness fresh investments by financial buyers. As GordonHamilton says: “There are some good UK firms and goodtechnology. It’s whether investors are prepared to back the companies.”

Drivers of diagnostics

In recent years low returns and difficulties with liquidity inmany areas of biotech have further shifted the attention ofinvestors towards the diagnostics space. It is here that someradical and exciting new technologies are being created todeliver point-of-care preventative treatment. Many of thesediagnostics products are being developed in conjunction withbiopharmaceutical medication, and often eliminate the needfor more invasive and costly surgical procedures. In particular,molecular imaging technologies such as positron emissiontomography (PET), and applications of nanotechnology areheld out as key areas for investment.

A compelling factor for investors looking at diagnosticsbusinesses is the generally shorter time to market than withdrugs based businesses. Partly this is because of the lessinvasive nature of diagnostics technologies, which meansthere are usually lower regulatory hurdles compared tobiotech. All this means that it is quicker for investors to get a business to an IPO or trade exit.

Another driver of diagnostics in the UK and worldwide is the compelling cost savings the products promise to offerto state healthcare providers by reducing demand for costlysurgery in ever scarcer beds. Diagnostics can also be used to ascertain in advance with more certainty the mostappropriate medication for a particular patient, leading to cost savings and more effective and swifter treatment.

Designer diagnostics

Furthermore, as Gordon Hamilton, Life Sciences Partner withDeloitte says: “Increasingly molecular diagnostics will proveimportant in the future in helping to justify the prescription ofexpensive biologics.” Indeed, diagnostics will play a crucialsupport role in the development of potentially highly lucrative‘designer’ or ‘personalised’ drugs by major bio-pharmaceuticalcompanies in coming years. The belief is these designerdrugs, seen by many as the ‘holy grail’ of the biotech sector,will be tailored on the individual genetic characteristics ofeach patient, and inevitably, the prescription and dispensing ofthem will require a range of sophisticated diagnostic products.

Indeed, it is based on this promised convergence ofdiagnostics devices with specialty medication that manylarge biotech and pharmaceutical companies have investedheavily in recent years. Companies such as Roche HoldingAG, the listed Swiss pharmaceuticals group, which in July2005 agreed to acquire GlycArt Biotechnology AG, the Swissbiotech company specialising on antibodies and diagnostics-research and development, for £104m (€150m) in cash. Two years ago, in July 2003 Roche acquired US diagnosticsmanufacturer Igen International Inc, the US biological testingtechnology company, for $1.4bn.

Other large buyers of diagnostics assets are establishedmedical devices companies such as Philips Medical Systems,Siemens Medical Devices USA, and General Electric, throughits GE Healthcare Technology Division. The scale of M&A inrecent years has been significant, indeed, in October 2003,GE agreed to acquire Amersham plc, the UK based medicaldiagnostics and life sciences group, for a maximum equityconsideration £5.9bn.

Rising Star: Prospects for UK and EuropeanDiagnosticsMedical devices have traditionally been the ugly sister to pharmaceuticals and biotechnology, but thanks

to current advances in the area of diagnostics, they are now gaining their share of investor attention.

Many in the industry increasingly believe that developments in diagnostics will lead to ever more

personalised medicine. Furthermore, it is expected that convergence will erode the traditional divisions

between diagnostic devices and medication leading to a more symbiotic relationship between diagnosis

and treatment.


However, within the UK diagnostics sector, despite a strongtendency to innovate, most companies remain small and lackthe funding and commercial management ambition tocompete with larger European and US players. Whilst someacquisition activity in 2005 was led by UK firms, more oftenthan not they are the targets for overseas trade buyers.

Deal flow in 2005

Despite the latent potential in European diagnostics, 2005has not witnessed any major deals to match those ofprevious years. Certainly there has been nothing to matchPPM Capital’s $575m acquisition of Swedish firm PharmaciaDiagnostics in January 2004 (for more information see thecase study on page 15). Nor was there anything in 2005close to September’s €1.2bn acquisition of Sirona DentalSystems GmbH, the Germany based manufacturer of dentalequipment and technologies by Schick Technologies of theUS. Apart from the earlier mentioned buyout of Glycart byRoche Holding AG for £104m, all the disclosed diagnosticdeals of the year were below £25m in value.

July saw US private equity firm Warburg Pincus partner withGE Healthcare, the UK based medical technology company,to back the management of Euromedic International NV, theDutch provider of dialysis and diagnostic medical services ina buyout from GE Capital, Dresdner Kleinwort Wassersteinand Global Environment Fund. Financial terms wereundisclosed, but Euromedic employs about 1,500 personnel.Revealingly, Warburg and GE Healthcare plan to developEuromedic further and expand the company from the Central and East European region, where it already has asubstantial market share, to becoming a healthcare providerall around Europe.

Another July deal saw E2V Technologies, the listed UK baseddesigner and manufacturer of radio frequency and imagingcomponents, acquire Gresham Scientific InstrumentsLimited, the UK based manufacturer of X-ray detectors andassociated products, for a consideration of £5.1m. Greshamwas founded by Rob Sareen, Mike Taylor and Tony Bosley in 1997 with backing from 3i, the listed UK based privateequity firm.

June saw ZI Medical, the listed UK based developer ofmedical monitoring devices, agree to acquire OxfordNewtech, the UK based clinical and pharmaceutical deviceand diagnostic company, from Merlin Biosciences Limited in a reverse takeover transaction for £5m in stock.

2005 also saw UK diagnostic companies look outside of thedomestic market for acquisitions. In September, Cozart, thelisted UK based point-of-care diagnostics company, acquiredSpinreact, the Spanish manufacturer of medical diagnostictest kits, reagents and analytical instruments, for a cashconsideration of £9m. According to Cozart’s managementthis is only the start of its plans to expand distribution andproduct lines via acquisitions.

Spain was also the location for the buy of InnogeneticsDiagnostica y Terapeutica (IDT), the Spanish distributor of medical diagnostic products by US medical companyInverness Medical Innovations for £11m (€16m).

Meanwhile, in April, Barclays Ventures, the UK based privateequity firm looked to the US to back the management ofMedical Diagnostic Imaging (MDI), the US based operator of scanning clinics in an MBO worth £10m. Barclays claimthe acquisition is in line with its strategy of taking advantage of the growth potential in the diagnostic scanning market.

Looking back further to 2004, there were two noteworthytransactions. The first was PPM's £177.5m sale of UK based Oxoid, a specialist manufacturer of microbiologydiagnostic products, to US firm Fisher Scientific International.PPM originally acquired Oxoid in 2000 through a secondarybuyout from Cinven. The second other was the successfulIPO of bioMerieux, the French in-vitro diagnostics group.

Prospects for 2006

Admittedly, despite the great potential in the sector, M&Adeal flow in European diagnostics has been subdued in 2005compared to previous years. It was also very small comparedto deal flow in traditional medical devices. The main reasonfor this would seem to be that many large pharmaceuticalcompanies now have extensive diagnostic holdings followingthe consolidation of recent years and are constrained fromfurther major consolidation by antitrust concerns. Meanwhile,on the other side of the market there are small, fledglingbiotech diagnostic companies with lots of potential but plentyof development work still required on their product rangebefore they can attract significant interest from buyers.

In conclusion, like speciality biotech drugs, investment indiagnostics is a long term play with plenty of risk butmassive potential. It remains an area of medical devices towatch with great interest. All the indicators from deal flow in 2005 are that steady interest from both leading trade andprivate equity buyers will drive greater activity in diagnosticsin 2006 and beyond.


• According to our respondents the leading driver ofdiagnostics investment in Europe in the next twelvemonths will be ‘overall drives to improve cost savings’,which is selected by 74% as either a major or main driver.

• Similarly, the ‘awareness of the longer term cost benefitsof earlier diagnosis’ is selected by 50% of respondents aseither a major or main driver of upcoming investment indiagnostics. This displays a clear perception among therespondents that the latest range of diagnosticstechnologies will offer increasingly efficient ways ofanalysing patients. As one respondent says: “Newmultiplexing technology in diagnostics will drive change in the delivery and costing paradigm.”

• Another respondent believes: “The value of diagnostics will rise in the next three to seven years as the governmentwill look for ways to spend less; therefore more efficienttests will be needed. Their price will rise and the drugsproduced will become cheaper; furthermore, the use of ITwill gain importance.” Another respondent puts it morebluntly: “In the UK, cost is all.”

• In addition, 68% of respondents believe efforts by largepharma to develop personalised/ designer drugs will beeither a major or main driver. As one respondent says:“designer drugs is a very interesting area which has seen a steep emergence.”

Diagnostics: Straw PollIn December 2005, mergermarket interviewed a group of leading corporate executives on their views

regarding the European diagnostics sector.

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you believe will receive the most investment/R&D

spending over the next 12 months?

• 56% of respondents believe point of care diagnosticsproducts are either ‘definitely’ or ‘very likely’ to prove theirworth over established diagnostics in the next few years.

• Whilst a further 19% of respondents feel such adevelopment is ‘not likely’, it is also worth noting that notone respondent feels categorically this will not happen.

Not likely

Quite likely

Very likely

Definitely

19%

25%

19%

37%

How confident are you that point-of-care diagnostic

products will start to prove their worth over established

central laboratories over the next few years?


• In terms of the areas within diagnostics that will receivethe most R&D spend, ‘Molecular imaging’ is the leaderwith 44% of respondents believing it will attract the ‘most’or ‘extensive’ investment. Meanwhile, ‘Nanotechnology’ issecond placed with 36% believing it will be a recipient ofthe ‘most’ or ‘extensive’ investment.

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Mo

lecu

lar

imag

ing

Nan

ote

ch

no

log

y

Co

nven

tio

nal

dia

gn

osti

cs

Po

sit

ron

em

issio

nto

mo

gra

ph

y

Most investment


Some investment

Minor investment

No investment

Perc

en

tag

e o

f R

esp

on

den

ts

31 38 31 57

6

31

6

13

37

13

6

13

13

18

18

6

19

19

25

Which diagnostics methods/technologies will receive

the most investment/R&D in the twelve months?

• Perhaps unsurprisingly, 56% of respondents select the US as the territory from which the biggest investors/buyersof European diagnostics businesses will come in the next12 months.

• 25% of respondents believe UK domiciled companies willcontribute the most investment, on a level with the 25%backing companies from the emerging market of China.

• One respondent believes: “European industries will notgrow very much in the next three to five years; mostgrowth will come from non European countries such as the USA, India and China. The trends will be set by theUSA because the European companies are too old-fashioned and the USA is adapting more quickly.”.

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

USA UK China France India Germany

Most investment


Some investment

Minimal investment

No investment

Pe

rce

nta

ge

of

Re

sp

on

de

nts

60

31

18

13

13

25

43

13

13

6

25

55

13

13

13

6

63

6

19

6

6

37

25

19

19

19

19

56

From which territories are the biggest investors/industry

buyers in European diagnostics going to emerge in the

next twelve months?

• In terms of the types of investor expected in diagnosticsM&A, trade buyers are expected to be ‘most active’ or‘very active’ according to 62% of respondents. Next placedwith 44% are venture capital buyers, followed by privateequity with 37%.

• One respondent, however, believes that diagnostics isparticularly appropriate for private equity investment: “TheEuropean markets have many small diagnostics companies.There is scope for private equity players who are preparedto take some risks to consolidate and exploit economies ofscale and geographic expansion in creating value.”

19

19

25

37

12

19

25

25

19

19

44

25

12

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Trade buyers Venture capital Private equity

Most active

Very active

Active

Slightly active

Not active

Pe

rce

nta

ge

of

Re

sp

on

de

nts

How prevalent do you believe the following types of

investors will be in M&A in the diagnostics area in the

next year?

• Unsurprisingly, diagnostic developers are selected by 75% of respondents as likely to be the ‘biggest’ or ‘main’players in market consolidation within diagnostics. Insecond place are ‘big pharma’ – selected by 38% asbiggest or main players in market consolidation.

• Interestingly, one respondent feels that: “In manydiagnostic markets, big pharma plays against the diagnostic companies because better diagnosis means less pharmaceutical treatment. Hence, companies applyingbusiness models where big pharma is stimulated andincentivised of the diagnosis of a certain disease willbecome major winners.”

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Diagnosticdevelopers

Big pharma Biotech CROs (contractresearch

organisations)

Biggest player

Main player

A player

Minor player

Not a player

Pe

rce

nta

ge

of

Re

sp

on

de

nts

19

6

31

44

25

25

12

19

19

31 56

19

19

6

13

13

37

6

In terms of market consolidation within diagnostics

who do you believe will be the main players?


Sally Flanagan, Head of Healthcare, PPM Capital:

In summer 2003, we became aware of Pfizer’s intention to divest a number of businesses including PharmaciaDiagnostics. Earlier in the year the US giant had boughtPharmacia Corporation in a deal worth around $60bn.However, Pharmacia’s diagnostic business was non-core for Pfizer and so it was lined up for disposal followingcompletion of the takeover.

The team at PPM were very interested in Pharmacia’sdiagnostics division. We believed that the allergy marketdemonstrated attractive growth and our experience indiagnostics through our investment in Oxoid, a microbiologydiagnostic business, convinced us of the potential in thissector. Indeed, our track record with Oxoid was a key factor inestablishing our credibility in the bid for the Pharmacia division.

Pharmacia Diagnostics is an in-vitro allergy and auto immune diagnostics business supplying machines under theImmunocap brand to hospital and commercial laboratories.The company supplies 3,000 laboratories in 60 countries and employs 1,100 people worldwide. Most importantly, inthe allergy space it is the clear market leader with around75% of the global market for in vitro testing. The companygenerates revenue from the sale of reagents andconsumables supplied for exclusive use in the Immunocapmachines. The products test for the presence of a specificImmunoglobulin E ('IgE') in a patient's bloodstream indicatingan allergic reaction to that particular allergen. This enables anallergy to be confirmed or excluded in prescribing treatmentfor a wide number of chronic conditions including asthma,eczema and rhinitis. A major factor in Pharmacia’s supremacyin the allergy testing market is due to the wide variety ofallergens it supplies tests for, compared to the very limited range offered by its competitors.

Pharmacia Diagnostics also has a strong presence in theauto-immune diagnostics market which is wider and morefragmented, being the market leader in Europe and numbertwo worldwide with about a 15% market share. Managementexpect to grow this business through the addition of newmarkers enabling tests for other auto immune diseases tobe carried out on the Immunocap platform.

Overall, PPM believed that the increasing prevalence andawareness of allergies and asthma would drive furthergrowth for the company. In addition, the cost efficienciesprovided to the laboratories through the new generation of Immunocap diagnostic machines would consolidate and grow Pharmacia’s position in the allergy and autoimmune markets.

The Bid

In December 2003 we submitted a bid together with TritonPartners. On the back of this bid we were invited to NewYork and we signed a deal to acquire the business fromPfizer for $575m in early January. The next three monthswere involved in finalising finance and arranging theseparation of the division from Pfizer. Pharmacia Diagnosticshad operations in 25 countries, and only two of these wereestablished as stand alone legal entities. In all otherterritories we had to establish stand alone entities and thetransfer of assets and business from Pfizer. The transactionwas completed on the 23 April.

Case Study: Pharmacia DiagnosticsHow It Started

Post Deal Developments

Post completion, the main task was to complete theseparation of Pharmacia Diagnostics from Pfizer. Thisprocess involved most areas of the business – everythingfrom IT infrastructure, regulatory requirements and property.Management’s intention was to take the company away froma ‘big pharma’ culture towards a leaner, more entrepreneurialstand-alone business reflecting their new involvement asshareholders in the company. This included a refocusing of R&D spending on opportunities within the core business and improving the production process to achieve efficiencygains. This resulted in some job losses and significant costsavings in the company’s headquarters in Uppsala.

The business is now performing well with strong salesgrowth. New customers have been gained with the launch of the new instruments and the company continues to winmarket share in most territories. Sales in the US, a markethitherto dominated by in vivo testing, are continuing to growstrongly through an effective campaign marketing to theclinicians and a co-marketing agreement with the US leading lab company Quest. In addition, Pharmacia is alsodeveloping a new allergy point-of-care product. On the auto-immune side, the company is extending its existingrange to include a test for rheumatoid arthritis.

As a result of these factors, the business has generateda significant improvement in EBITDA, enabling PPM, Tritonand the management team to refinance the existing facilities,returning slightly more than 100% of the total originallyinvested to shareholders.

An exit is not on the agenda at present although we see a number of attractive routes for the business. For themoment though, there is still plenty of potential upside to Pharmacia Diagnostics, especially in the US.

www.diagnostics.com


Healthcare SectorStatistics

90 8000

7000

6000

5000

4000

3000

2000

1000

80

70

60

50

40

30

20

10

0 0

2002 2003 2004 2005

Total Numberof Deals

Total Value of Deals (GBP m)

Nu

mb

er

of

De

als

De

als

Va

lue

Value and Volume Trends

Undisclosed

£5m to £14m

£15m to £99m

£100 to £249

£250 to £500

£500 plus

28%

30%

4%4%

5%

29%

Deal Size Analysis

Hospital Management & Health Institutions

Drug Development & Manufacture

Medical Equipment & Services

Biotech research

Handicap Aids & Basic Healthcare Supplies

Business support services, Consulting services (excl. IT consulting)

Biotechnology production equipment

Distribution of Drugs & Medical Equipment

35%

18%

9%1%

1%

6%

9%

21%

Subsector Analysis

Deal Size Analysis 2005 (Volume)

Value and Volume Trends Subsector Analysis 2005 (Volume)

PE Deals

Non-PE Deals

MBO

IBI

IBO

BIMBO

MBI

69% 31%

32%

24%

20%

16%

8%

Private Equity Breakdown

Private Equity Breakdown 2005 (Volume)

Regulatory Issues: UK Healthcare SectorA conversation with Peter Dieners and Mario Schmidt, Partners with Clifford Chance detailing their views

and insights on some of the most significant regulatory issues and drivers facing the corporate activity in

the healthcare sector.

Intellectual property

Considerations around patent term expiry and patentlitigation are the major concerns for legal advisers on deals. Obviously, this is because any significant issues can minimise the value of the target during the due diligence process.

What is increasingly common practice is something called‘patent litigation prevention’. This involves scrutinising thepatent portfolio of a target and buyer during due diligence,and also asking how it sits with the portfolio of current core competitors.

There is often the possibility that parts of the patent portfoliocan be shared or sold to competitors in the form of jointventures or divestitures. Only the earliest generic producerssucceed, so they will often be quite active in seekingcontracts in advance as preferred generic partners.

Counterfeiting

Counterfeiting is a problem. Statistics show almost 7% oftotal pharmaceuticals on the market are counterfeit. Thisaccounts for around $20bn worth of drugs, most of whichcome from China, India and Pakistan.

For this reason trade associations and manufacturers areworking on concepts to reduce the impact of counterfeiting,chiefly in the form of chip technologies such as RFID.

In terms of responsibility, the company whose drugs havebeen counterfeited are of course not responsible for anypatient problems. However, clearly there is a big reputational issue.

Another factor is counterfeit drugs are getting moresophisticated and difficult to identify, and any investigation is by its nature ‘too late’ and after the event.

Bio-generics products

Biogenerics are increasingly of interest, they are higher invalue than chemical generics because of the morecomplicated production process. To manufacture bio-genericsit is not sufficient to just refer to marketing documents, soyou need close cooperation with the originating company. Allthis means that quality control of bio-generics is effectivelyprotected by the rigours of the production process.

The importance or reimbursement

An increasing focus for drug companies is reimbursement.Indeed, reimbursement is becoming as important as patentissues because of the growing need to guarantee a return on the massive outlay required by drug development. Inopposition to this is the fact that healthcare providers in allWestern jurisdictions have the stated intention of trying toreduce the price of drugs, and diminish reimbursement todrug companies wherever possible.

The problem is pharma companies often do not know prior to development exactly how much they will be able tocharge for the end drug. Therefore, there is a big onus ondrug producers to prove their product is far ahead of existingproducts, and this adds yet further costs to development.

It is worth underlining that all major pharma companiesnowadays have very large departments tasked withreimbursement issues, indeed they are now at least as big as their departments focused on broader regulatory issues.

If a product is reimbursable or not is vital. When looking at a target a buyer needs to confirm that the pipeline featuresreimbursable products.


Product liability

Really, there are two different legal regimes. This is far moreof an issue for the US (and partly the UK) than mainlandEurope which tends to be more relaxed.

In my view, the very occasional product ‘crises’ tend to befar less dangerous and widespread in reality than the reactionthe press and media merits. Nevertheless, there is of coursea major reputational risk. At the same time there is noformula or general answer. It is just a facet of this industrythat there is always a constant (albeit low) risk of a problemin this area.

Moreover, ever tighter regulations reduce the risk yet further.For example, we were recently working with a company thathad developed a new product based on a drug first made inthe 1960s. This time though, the costs for introduction were16x higher. This is because many states around the worldrequire individual additional clinical trials based around theeffects the drug may have on the different geneticcharacteristics of patients. All this, of course, pushes up the cost of drug-making.

Manufacturing issues

There is a clear trend towards outsourcing production to verylow cost independent toll companies. This is because thereare now opportunities to produce at high quality in India andChina. Obviously it is a case by case decision. Some drugsare too complicated to be made anywhere other than theoriginator’s labs, but many can be outsourced.

I expect outsourcing to be a major deal driver in the mid-capsector where some firms still have their own R&D andmanufacturing operations and clearly this is unsustainable.

Marketing issues

EFPIA, which is one of the major industry European tradeassociations, has issued new code of conduct which is to be implemented by the national industry associations. Thiswill encompass effective sanctions dealing withpromotions/labelling. It will also scrutinise and restrict howphysicians are remunerated with further training andeducation as well as gifts. Furthermore, governments suchas the UK, are firmly placing pressure on the industry to self regulate by launching commissions to investigate thisarea. The other main driver is health insurance funds, whichare trying to eliminate all factors that are going beyond pure price.

European Competition and parallel imports

This is not a new topic. But UK/EU countries are increasinglytrying to facilitate parallel imports, and there is tremendouspressure from governments to keep prices low. Of course,some markets have quicker payment regimes

Reimbursement is again a major factor. In some areas there is fixed reimbursement for new products. This meanspharma companies are reliant on government bodies andsemi-government organisations (driven by health funds). This means that in some territories there is little or no legal remedy.

The role of Private Equity

Private equity is often the ideal buyer for assets thatpharmaceutical companies no longer want, especiallybecause they have no anti-trust issues. Furthermore, they areefficient at executing deals, which is welcomed by pharmacompanies forced into disposals by regulators.

In particular, I believe there will be major consolidation in themid-cap area where there are excellent opportunities forprivate equity. Private equity will also take an increasinginterest in medical devices and healthcare services.

In particular, medical device companies are particularlyappropriate private equity targets. They are smallercompanies with excellent prospects, but lacking the financialbacking and experience that private equity can bring.

There is also a much easier regulatory environment than for drug manufacturing, with the ability to bypass nationalregulators through European wide approval.


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Healthcare Sector Spotlight

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