This article is an extract from GTDT Healthcare M&A 2023. Click here for the full guide.
Introduction
The healthcare or life sciences sector is one of the most active and rapidly growing sectors in the global economy. The sector is characterised by complex and dynamic business models, a higher-than-average level of business risk, permanent technological development and a demanding and evolving regulatory landscape, but usually also the availability of venture capital, subsidies and tax incentives, a supporting environment (such as universities, research institutions and incubators) and, growingly, regulatory incentives (such as for orphan drugs, access to clinical trials data and streamlined market authorisations).
Mergers and acquisitions (M&A) have become an attractive way for companies to expand their market shares, replenish their pipelines by acquiring key technologies and intellectual property, diversify risks and tap the potential for cost savings and increased efficiencies. Target companies remain available, not the least because of the venture capital funding model of most start-up companies, which aims at providing an exit to early investors.
Recent developments
Over the past decade, the healthcare sector has witnessed a significant increase in M&A activity globally. Even the more recent slowdown resulting from the covid-19 pandemic, the war in Ukraine and their consequences has been softer in the healthcare sector, which is driven by longer term considerations, than in other sectors.
Numbers of deals and average deal sizes have varied over the years and between regions, but they have been broadly on the rise everywhere.
However, even if there has been significant consolidation in the healthcare sector, including a more recent trend of vertical integration (such as one of the biggest recent transactions in the sector when CVS Health acquired Aetna, a leading health insurance provider, for US$69 billion in 2018), the sector remains more fragmented than others, leaving more opportunities to find targets and acquirers (and avoid merger control hurdles).
Key market drivers
One fundamental, worldwide and long-term development has been and will continue to be the aging population, the increasing availability of financial resources and the readiness to commit them to improve healthcare, particularly in developed countries but in the longer term also in developing countries.
A more recent key market developments in the healthcare sector has been the emergence of new technologies, such as gene editing and cell therapy, which have already transformed the industry. These technologies have shown potential to revolutionise the way diseases are identified and treated, and they are also creating new opportunities for companies to develop innovative therapies and products. As a result, companies are increasingly investing in these technologies and acquiring companies that have expertise in these areas.
The rise of digital health has also created new opportunities for companies to develop innovative products and services, such as telemedicine, remote monitoring and electronic health records. Digital health companies are focused on developing innovative technologies that can improve patient outcomes and reduce costs. These companies are attractive targets for more traditional players aiming at staying competitive in a rapidly evolving industry.
Another key market development is the increasing focus on personalised medicine. Personalised medicine involves tailoring treatments to individual patients based on their genetic makeup, lifestyle and other factors. This approach is expected to improve the efficiency and safety of treatments, and reduce healthcare costs. As a result, companies are increasingly investing in personalised medicine and acquiring companies that have expertise in this area.
Regulatory developments
The healthcare sector is highly regulated, and regulatory developments can have a significant impact on M&A activity.
Beyond the existing regulatory constraints, which mainly affect clinical trials and market authorisations, one key, more recent, regulatory development is the increasing emphasis on drug pricing and reimbursement. Governments and payers are under pressure to reduce healthcare costs, and they are therefore increasingly demanding that drugs demonstrate value for money. This has led to increased scrutiny of drug prices and reimbursement rates, which can impact the profitability of healthcare companies. The coming into force of the Inflation Reduction Act in the United States is generally assessed to have a major negative factor on the future profitability of the healthcare sector. As a result, companies are increasingly focused on developing drugs that demonstrate value for money, and they are considering the potential impact on drug pricing and reimbursement on deal valuations.
Another indirect key regulatory development in recent years has been the implementation of various data protection regulations across the world, such as the General Data Protection Regulation (GDPR) in Europe. The GDPR has increased the regulatory burden on companies that handle personal data, especially in the healthcare sector as it significantly relies on sensitive data, and this has led to increased scrutiny of data protection practices during M&A due diligence.
Transactional developments
M&A transactions in the healthcare sector involve complex contracts that need to address the more complex issues of the healthcare sector, such as intellectual property, regulatory compliance and product liability. Beyond the traditional tools of in-depth due diligence investigations and comprehensive representations and warranties, one of the main, more recent, contractual developments has been the increasing use of earn-out structures. Earn-outs are contingent payments that are based on future development milestones or performance of a company or product. This structure can be particularly useful in the healthcare sector, where the value of a company or product can be difficult to determine.
Due diligence investigations are and will remain particularly concentrated on the traditional IP and regulatory concerns, with an increased attention on data protection, especially for companies in the digital health sector. The practice for sellers to offer the support of a so-called vendor due diligence report and reliance on representations and warranties insurance, on the seller and/or buyer side (the so-called W&I insurance), are seen more and more often.
Another development has been the rise of cross-border M&A activity. Healthcare is a global industry, and companies are increasingly looking to expand into new markets. This has led to an increase in cross-border M&A activity, particularly in Europe where there are still many different healthcare systems and regulatory environments. This creates additional legal complexities that need to be dealt with, not the least in respect of their tax implications.
While healthcare M&A deals have less often drawn attention from anti-trust regulators, this is likely to change in the future with increasing concentration. The growing trend to regulate foreign direct investments is already slowing down transactions, as healthcare is frequently listed as a sensitive sector in those regulations. The growing set of foreign subsidies monitoring regimes is also likely to have that effect.
Forecast trends
Looking ahead, and beyond the continuing effect of the above-mentioned recent developments, several trends are expected to shape M&A activity in the healthcare sector.
One of the key trends is the increasing focus on digital health. Digital health involves the use of digital technologies, such as mobile apps, wearables, and telemedicine, to improve healthcare outcomes. As a result, companies are increasingly investing in digital health and acquiring companies that have expertise in this area.
Another key trend should be an increasing focus on emerging markets. Emerging markets, such as China and India, represent a significant growth opportunity for healthcare companies. These markets are characterised by large and growing populations, increasing healthcare spending, and a growing demand for innovative therapies and products. As a result, companies are increasingly focused on expanding their presence in these markets through M&A. Some of those markets, however, remain challenging to approach and penetrate and the final outcome is not yet completely clear.
Another trend that is likely to shape the healthcare M&A landscape in the coming years is the increasing role of private equity and other financial investors. With healthcare providers facing mounting pressure to deliver high-quality care at lower costs, many are turning to private equity and other investors to provide the capital needed to fund growth initiatives and drive operational efficiencies. However, private equity investors are usually looking at companies with positive cash-flows and this could limit the availability of private equity money for companies that are still in a classical drug development phase.
Conclusion
M&A activity in the healthcare sector is expected to continue growing, driven by various fundamental factors, such as evolving demographics, technological advancements, regulatory changes and growing demand for healthcare services. To navigate this increasingly complex and regulated sector, healthcare companies, their investors and buyers will need to consider even more carefully the legal, regulatory and contractual dimensions of M&A transactions in that sector.
