How fit is your capital allocation strategy?
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Transcript of How fit is your capital allocation strategy?
The better the question. The better the answer.The better the world works.
How “fit” is your capital allocation strategy?
Vital SignsEY perspectives on life sciences
Page 2 Vital Signs: EY perspectives on life sciences
Today’s speakers
Ellen LickingSenior Analyst, Global Life Sciences Sector
Andrew FormanGlobal Life Sciences Transaction Advisory Services Sector Resident
Andy LorenzettiTAS Divestitures and IntegrationPrincipal, Ernst & Young LLP
David WomelsdorfGlobal Client Service Partner andPrincipal, Ernst & Young LLP
Page 3 Vital Signs: EY perspectives on life sciences
Pricier targets
Increased execution risk for dealsRepurchase shares or reinvest in the business?
Slowdown in emerging markets
Pricing pressures
Portfolio optimization
Maintaining revenue growth and operating margins Unsustainable R&D costs
Integration challengesInvestors are prepared to take a more aggressive stance. One significant managerial misstep opens the door to activism.
Business pressures increased the importance of getting the capital agenda right
Page 4 Vital Signs: EY perspectives on life sciences
Activist investors shake up the status quo – are biopharma companies prepared?
2010 2011 2012 2013 2014
74
108
132143
136
Source: EY, FactSet’s Shark Repellent and Capital IQ.Number of activist campaigns nearly doubled between 2010 and 2013-14
Number of activist campaigns initiated across all industries
Page 5 Vital Signs: EY perspectives on life sciences
Activists target larger biopharmas over time
Source: EY, Capital IQ, FactSet’s SharkRepellent and company filings. Includes only companies with market cap > US$1b.
A third of activist campaignsare driven by operational or business portfolio concerns.
M
arke
t cap
italiz
atio
n ($
US
b)
Page 6 Vital Signs: EY perspectives on life sciences
The drivers of biopharma value
The R&D cycle
Capital structure
Business portfolioand M&A
2
3 4
Operational performance
1
Page 7
1. Operational performance
Vital signs: EY perspectives on life sciences
Key considerations:
► Revenue growth
► Operating margins
► Shareholder return
► Other: SG&A, effective tax rates
Simply put, “good enough” operational performance is less relevant if shareholders believe more could be done.
Page 8 Vital Signs: EY perspectives on life sciences
2013 2014 2015E 2016E0
100
200
300
400
500
600
700
800
Big pharma Biotech Specialty Generics
Sal
es in
US
$b
-1%
+18%+15%+14%
+14%
-0.6%
+16%
+34%
-0.6%
+10%+12%
+15%
+3%+10%
+11%
+4%
Revenue growth: big pharma underperforms relative to biotech, specialty pharma peers ► Big pharma: growth expected to revive in 2016► Specialty pharma/generics: growth via M&A► Biotech: growth hard to maintain organically
Source: EY, Capital IQ and company filings.
Page 9 Vital Signs: EY perspectives on life sciences
Operating margins: big pharma rebounds but still lags biotech
Generics companies have been included in specialty pharma for this comparison.Source: EY and Capital IQ
0%
10%
20%
30%
40%
50%
60%
Com
pany
repo
rted
EBIT
mar
gins
* Ex-Gilead biotech margins: 41% Q1 2015, 34% 2014
Big pharma Biotech* Specialty pharma
(incl. generics)
2012 2013 2014 Q1 2015
Page 10 Vital Signs: EY perspectives on life sciences
Total shareholder return as a performance measure: bottom tier at greater risk of activism
Source: EY and Capital IQ. Company financials were calculated through 31 December 2014. See ey.com/vitalsigns for full analysis.
► 31 biopharma companies in data set, including four that were targets of activism in 2013 or 2014
Page 11 Vital Signs: EY perspectives on life sciences
2. The R&D cycle
Key considerations:
► R&D as percentage of sales
► Estimated ROIC for pipeline
► Use of milestone or gating mechanisms to improve R&D decisions
The biopharmas that drive the greatest value and productivity from their R&D organizations are the ones that have the most options with respect to capital allocation.▬ Paul Clancy, CFO, Biogen
Page 12 Vital Signs: EY perspectives on life sciences
Nearly 200 new drugs are forecasted to be launched in the next five years …
… continuing a second wave of innovation similar to levels seen in the mid-2000s.
Source: “Global Outlook for Medicines Through 2018,” IMS Health and FDA’s Center for Drug Evaluation and Research.
2006 2007 2008 2009 2010 2011 2012 2013 2014
22
18
2426
21
30
39
27
41
Number of NME approvals (FDA)
Biopharma pipeline renaissance: analysts project ~ 25% increase in approvals
Page 13 Vital Signs: EY perspectives on life sciences
3. Capital structure
Key considerations:
►Current available cash balance
►Leverage
►Excess working capital
Are management teams pulling this lever when it is most likely to create the greatest value for shareholders – or to get a short-term “pop” in earnings?
Page 14 Vital Signs: EY perspectives on life sciences
Big pharmas return cash to shareholders; biotechs, specialty pharmas focus on M&A
-120
-100
-80
-60
-40
-20
0
20
40
60
80
100
120
US$
b
20142013201220112010200920082007 -40
-20
0
20
40
60
80
100
120
140
US$
b
2007 2008 2009 2010 2011 2012 2013 2014
Source: EY, Capital IQ and company financial data.
Big pharma Biotech and specialty pharma
M&A Dividends and buybacks
Page 15 Vital Signs: EY perspectives on life sciences
Working capital key to development of more cost-effective, less risky business models
► Big pharma companies have as much as US$50billion in excess working capital (WC)
► Big pharma’s 2014 WC performance stronger than in 2007, but …
► … WC varies widely overall along the metrics we track (e.g., DSO, DIO, DPO and C2C)
► Individual opportunities for improvement, especially by adopting practices of leading WC performers in other industries
Page 16 Vital Signs: EY perspectives on life sciences
4. Business portfolio and M&A
Key considerations:
► Is there critical mass in a business or therapeutic area?
► Perform sum-of-the-parts analyses
Financial data is not generally captured in ways that make it easy to assess the business implications of different kinds of carve-outs.
Page 17 Vital Signs: EY perspectives on life sciences
Robust M&A market continues in 2015 with strong prospects for second half
0
50000
100000
150000
200000
250000
300000
350000Big pharma Big biotech Specialty PharmaMedtech 2015 Pipeline (2H)
Dea
l val
ue ($
US
b)
Source: EY, Datamonitor, Company Reports. 2015 data thru 4 June 2015.
. 2010 2011 2012 2013 2014 2015
Specialty pharma 2015 pipeline (2H)
Page 18 Vital Signs: EY perspectives on life sciences
As companies focus on core priorities, more emphasis on divestitures
2010 2011 2012 2013 2014 20150
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
0
2
4
6
8
10
12
14
16
Total deal value Number of divestitures
Tota
l dea
l val
ue (U
S$m
)
Num
ber o
f div
estit
ures
Source: EY, ThomsonOne and Informa’s Strategic Transactions database.
2015 data analyzed through 30 June. Only divestitures valued at > US$500 billion included .
Page 19 Vital Signs: EY perspectives on life sciences
Creating long-term value
Page 20 Vital Signs: EY perspectives on life sciences
At each stage of the life cycle, new opportunities and challenges
► Innovative science; no clear path to profitability
► Concerns:► Financial runway► Business
development► Proof-of-concept
Emergent► Growing rapidly;
profitable or likely to be soon
► Concerns:► Expanding operations ► Meeting changing
expectations of stakeholders
Growth► Measurable profits, due
to marketed products► Concerns:
► Maintaining growth► Balancing R&D,
SG&A and other expenses with long-term growth
Mature
Page 21 Vital Signs: EY perspectives on life sciences
Value creation comes from holistic deployment of capital agenda
The R&D cycle
Capital structure
Business portfolio and M&A
2
3 4
Operational performance
1
Page 22 Vital Signs: EY perspectives on life sciences
Summary: Build these 5 steps into strategic planning initiatives
Review cost structures to determine if they are optimized.
Operational performance1
Use milestone and “gating” mechanisms to improve R&D investment decisions.
R&D2
Are capital allocation decisions based on the right metrics? Do they enable optimal use of the balance sheet?
Capital structure3
Perform virtual carve-outs to assess the value of potential divestment opportunities.
Business portfolio and M&A4
Communicate relentlessly with investors about strategic objectives.
Communications strategy5
Page 23 Vital Signs: EY perspectives on life sciences
Additional information
ey.com/vitalsignshttp://ow.ly/NTufL
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About EYEY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.
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1509-1697453
EYG No. FN0234ED none
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