Global Healthcare M&A 2022: Recalibration of Expectations
The global healthcare industry, typically considered a recession safe haven, is still facing financial strain in some pockets due to the knock-on effects of COVID-19 and labour force displacement. Deal-making has been relatively slow in 2022, compared with a blockbuster 2021. Investors were primarily forced to hold off on deal-making because of the uncertainty regarding the global growth outlook, especially in the current rising interest rate environment.
The industry witnessed limited deal closures and is yet to see the conclusion of some ‘big ticket’ deals. The volume of deals withdrawn to date is comparable to that at the onset of the pandemic. As a result, dealmakers are having to amend their strategies to bridge the valuation gaps. They are conducting deeper analyses of the targets, thereby extending the duration of negotiations and due diligence. The ability to recognise, negotiate, and realise value from increasingly complex partnerships and alternative collaboration models has become a key competitive differentiator. Considering these developments, we expect the following themes to impact M&A sentiments in 2022:
- Uncertain geopolitical environment and higher interest cycle puts pressure on justifying synergies and ROIs.
- Sponsors are turning cautious and revising their expectations to factor in the changing deal-making landscape.
- There is a continued focus on ramping up digital capabilities
- Portfolio realignment is happening among the strategies to divest non-core or underperforming assets.
- There is a rapid paradigm shift towards utilising data and actionable insights to implement person-centric network strategies across sub-sectors.
Global Healthcare Regional M&A YTD 2022 (US$ bn)
Source: Refinitiv; deals as of October 13, 2022
Healthcare Funding: Geopolitics and Volatility Curbing Demand
The financial equity and debt capital markets (ECM and DCM) witnessed contrasting demand this year. In Q1’22, the DCM witnessed borrowers rushing to refinance and extend debt maturities before the potential rate hikes later in the year. However, the momentum was short-lived, with volumes reverting to pre-pandemic levels as seen by the 78% fall in high-yield instrument issuances in H1’22 (indicating a ‘flight to quality’). The syndicated loans market almost came to a halt due to the geopolitical crisis, with investors pausing to review their portfolios and the related primary and secondary risks. The recent scrutiny of SPAC IPOs and its redemption pressure plus the lack of investor demand for traditional IPOs have essentially stalled global ECM activities. The revival of market sentiments, inflationary pressure, fear of recession, geo-political scenario, and impact of rising interest rates are expected to be the key factors determining capital market activity for the rest of the year.
Global Healthcare Capital Markets Activity YTD 2022 (US$ bn)
Source: Refinitiv; deals as of October 13, 2022
Healthcare SPACs: Deal Innovation to Counter Regulatory Headwinds
The heightened regulatory scrutiny has put the brakes on SPAC IPOs. In March 2022, the Securities and Exchange Commission (SEC) of the U.S. proposed new rules and amendments to enhance disclosure and investor protections in SPAC IPOs and business combination transactions between shell companies, such as SPACs and private operating companies. Along with concerns around mixed post-deal performance, rising redemptions during De-SPAC, a weak PIPE market, and overcrowding have resulted in growing investors’ doubts about SPACs’ ability to deliver high-quality companies. Though funding has dried up this year, innovative deal structures can still revive investors’ faith and stability.
Source: Refinitiv; deals as of October 13, 2022
ESG in Healthcare: Crisis-resilient Long-term Value Creation
In the healthcare industry, an environmental, social, and governance (ESG) framework aims to create sustainable energy and waste management systems, encourage investments in community health, and address unmet medical needs; it also requires leaders to embrace diversity and inclusion as their foremost duties. The COVID-19 pandemic has demonstrated that adhering to ESG factors is key to crisis-resilient long-term value creation. Companies with dynamic business cultures were relatively more resilient during the shutdowns, given their ability to absorb the shock. Globally, investors have started to recognise the potential benefits of announcing an acquisition that is ESG accretive. By directly linking ESG factors to long-term value creation, companies can substantially alleviate investor concerns by de-risking their investments.
The Advent of an ‘ESG premium’ is Expected to Directly Impact Due Diligence
From a funding standpoint, the cost of capital for companies with better ESG scores is lower than for companies with lesser scores. For example, there is greater investor demand and better pricing for issuers of many green, social, or sustainable bonds versus traditional (non-ESG) issuances. This trend has also gained prevalence among shareholder activists, who have started to include ESG improvements as an important criterion when targeting companies. Since the start of the pandemic global issuance of sustainable debt capital across all industries are at an all-time high. As a result, companies are upgrading their disclosures, culture, and practices towards a more ESG-friendly approach.
In the context of M&A, understanding the disparities between buyers’ and sellers’ ESG profiles has become essential for a successful deal. As a result, deal makers continue to place greater emphasis on ESG criteria while screening out assets and determining valuations across geographies and sub-sectors.
Outlook: Spotlight on Resilience and Transformation
As we start to navigate the last quarter of the year, deal activity is expected to pick up, especially in the pharma/biotech sub-sectors, given the availability of large dry powder among the major consolidators. Dealmakers, who have been side-lined due to geo-political uncertainty and market volatility, will be eager to structure deals that enable both buyer and seller to transform their business models for the future.
More normalised valuations levels across the healthcare industry, aided by healthy demand from sponsors, the need for replenishing drug pipelines, the buy-and-build approach of major companies, and the revival of the credit market should drive volumes higher compared to what we have witnessed to date in 2022.
In light of these developments, we foresee the following key M&A trends to define the overall deal-making for 2022 and the start of 2023:
- Geopolitical tensions continue to dominate client discussions: An unstable political landscape has disrupted the global supply chains and had ‘put the brakes on the record deal activity that we had witnessed last year. For deal makers, market timing has become the strongest headwind in the current environment. Dialogues with related parties should carefully weigh in on the challenges of value-creation post-merger.
- Innovation continues to be rewarded: We continue to foresee any incremental M&A push to be broad-based across major healthcare sub-sectors, as innovation gets rewarded by investors. These include companies that are still directly involved in addressing the spread of COVID-19, like those focused on diagnostics and vaccine development, as well as consolidation among medical device manufacturers, which were severely impacted by restrictions on electives during the start of the pandemic.
- Estimated dry powder of ~USD1.8tr among private equity firms: The strong capital position of private equity firms continues to create opportunities for them to assess and capture resilient healthcare assets. Dealmakers have always found a way to navigate uncertainty and make profitable investments even during high market volatility.
- Scarcity of attractive assets may serve as a ‘deal-breaker’: Unprecedented surge in deals in the last year backed by a ‘liquidity flush’ may result in an overheated market in 2022. Investment banks might find it tougher to negotiate terms between the parties due to a lack of available white space and a valuation gap between buyer and seller, especially during high market volatility.
- Vaccine developers continue to gain market share: Successful vaccine developers will continue to earn a windfall of excess cash and market positioning given the enormous demand for their products. These companies will be able to reshape the competitive landscape of the pharmaceutical industry. Additionally, the companies which have utilized the new mRNA technology to develop their vaccines have earned an important first-mover advantage in the innovation process of applying mRNA to other therapeutic areas.
- Scrutiny on the rise for mega M&As: Governments and antitrust enforcers across the globe are teaming up to rethink their approach toward large mergers review. This is expected to curb ‘mega-deals’ which are that are responsible for raising prices or dampening innovation across the sub-sectors.
- Heightened shareholder activism: Given the market developments, shareholder activism should continue to be focused on M&A, strategic operations, and shifts in capital allocation. The activist investors are in a strong position to identify and target companies ripe for activist involvement with a focus on extracting value and generating ‘alpha’ returns.
Key M&A Trends Across Sub-sectors in 2022
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