November 30, 2023

Healthcare Global

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M&A trends in the life sciences and healthcare sector | Global law firm

Due to the multiple ongoing crises we are currently dealing with, stakeholders and key decision makers operate in an environment characterised by volatility, uncertainty, complexity, and ambiguity. If met with resilience these quite difficult times still provide chances and opportunities though.

Biotech funding, outsourcing and re-shoring on the radar for 2023 

Coming out of 2022, many expected a normalization after the pandemic and, especially in the healthcare industry, a phasing out of the COVID-19 effects. However, undertakings still have to deal with increasing energy prices, very high inflation and, from the investor perspective, with a tightening financing environment with rising interest rates and ongoing supply chain challenges.

For 2023, biotech funding is on the radar for the life science and healthcare industry. The relative importance of big pharma, having historically driven product development, is reducing. While such companies held a share of about 40% ten years ago they now account for about 20% and biotech companies have taken a large share of this due to more complexity and specialization.  Biotech is becoming a more important customer and collaboration partner for the rest of the industry. There is still a positive outlook for funding of biotech companies even though they seem to reprioritize their activities leading to a slow-down in clinical trial activity, especially regarding earlier stage clinical trials.

A further trend to watch is the continued outsourcing activity. Clinical trials and work on drug discovery as well as the ensuing development phase are becoming more complex and lengthy. The average time for the completion of clinical trials is now more than 3.5 years. Due to the resulting cost pressure on pharma and biotech customers mandating trials, the incentive to outsource will increase, leading to potential opportunities. 

Regulated markets like Europe and the US, in particular, have been rethinking the geographic set up of their supply chains in the life sciences sector. Whereas historically a majority of molecules was manufactured in India and China recent drug shortages have led to re-shoring of manufacturing. We expect this trend to accelerate in 2023. The US, for example, has been granting subsidies to promote re-shoring. Restrictions for foreign buyers on local assets as well as an easing on regulatory burdens in relation to price caps, for example, could also influence M&A activities. 

2023 could therefore be a year of recovery where companies will want to show stabilisation after the disturbed budgets of last year. In due diligence and transactions it might therefore be harder to find the appropriate cost basis and normal valuation.  Chances for consolidation could still arise.

Chances and risks for financial and strategic investors

Following years of peak valuations a normalisation in this regard and a reduced competition on certain assets, especially as the uncertainty increases and due diligence becomes more complex, will lead to opportunities in the European life science and health care market. Public valuations for CROs (contract research organisations) and CDMOs (contract development and manufacturing organisations) peaked in 2021 but reduced throughout the last year and started to stabilise at the end of 2022. We see this trend for pharma and life sciences but also for the MedTech industries. It will be important to identify strategic areas for midterm and long term growth with a focus on technology and differentiation.

Identifying the sustainable cost basis in due diligence for pharma and life science companies will still pose risks though. Factors in this context include levels of personnel increase, higher rotation and volatility in the personnel base. Strategics but also PE investors, benefitting from improved financing costs, are therefore well advised to recognize the importance of creating assets with strategic value.  For healthcare services additional risks arise such as labour shortages, relatively tight budgets from the care payers and the regulatory environment, in particular, in the French or German markets.

Technical due diligence will have to include a review of ownership of the relevant patents as well as an assessment of the quality of the physicians, practitioners, and engineers involved in the development of the project. Investors in this field are now adding specialists to their team, such as formal practitioners, who understand the project being developed and the market it relates to. Investors will have to carefully assess the right point in time to invest, which means striking the delicate balance between maturity of the target and its stage of value. Especially for MedTech and biotech companies early investments can prove to be risky, also in terms of funding needs, while a later investment can increase costs since the project evolution will have increased the target value. Investors are therefore advised to team up with specialists, who will weigh the chances of obtaining the relevant product authorisation. 

Despite multiple challenges for M&A transactions in the life sciences sector due to uncertainty and planning insecurity, we still see positive factors contributing to a persisting demand such as the pressure to innovate and the demographic factor, which is becoming ever more important. Governmental programs, such as the Cancer Moonshot initiative in the United States, are widely expected to result in further investments in biotech and pharmaceutical growth companies. While the current environment might not be ideal for big M&A transactions, in the low and mid-market section, we see quite a few corporate ventures where pharma and MedTech companies contribute their deep know-how and capacity on clinical trials and regulatory approval processes. The fact that in Germany and also in France the MedTech sector is predominantly made up of SMEs creates chances for private equity investors.

Market dynamics and industries to watch

For investors we advise to focus more on the target’s technological capabilities than on capacity and to identify upcoming technological shifts within the value chain. On the manufacturing side this could, for example, relate to more efficient or more complex manufacturing methods for increasingly complex treatments.  On the IP generation side companies with a strong development pipeline, which have a run rate of additions to the product or service portfolio over the next years will be worth looking out for.  In contrast, targets with highly personnel dependent business models as well as locked in cap payer coverage and reimbursements, such as hospitals, might prove to be more challenging due to pressure on margins and profitability.

Especially on the French market, we expect biotech and MedTech companies to continue attracting investors looking for innovative targets. Another trend to watch is the association of AI with the life sciences sector, notably as regards MetaHealth.  The lack of regulation around AI has to be taken into account, however, and whether it can reproduce human capabilities in all instances remains to be seen. To identify targets investors will need to try to anticipate which underlying technology will take the lead in the coming years and then become market standard. This exercise is especially challenging for Metaverse services.

The markets for health care services and care homes, on which there are very active major operators and small innovative companies, are also attracting investors. It can be expected that these sectors will benefit from the support of innovative digital solutions in the future. Nevertheless, it is advisable to be careful due to the regulations in these sectors that differ from those applicable to medical devices and pharmaceuticals and because of the rules on price caps and reimbursements. Investors need to take these constraints into account and we see that negotiations with the authorities in this regard are becoming more challenging.

In Germany we observe a thriving Start-up community and there have even been investments in Start-ups only to fund the US regulatory side of the clinical trial and FDA approvals. Big pharma companies are likely to acquire Start-ups but the environment is still heavily regulated and reimbursement models need to be checked. The German legislator has triggered additional innovation in the sector by allowing companies to first innovate and the discuss reimbursements. The legalization of cannabis for non-medical purposes is a further area to watch where activity could pick up in the second half of the year. Furthermore, retirement related products and services will be a hot topic considering the increasing needs of elderly people and an ageing population. Private equity backed investors are very interested in the intensive care segment with the buy and build strategy because there’s still a lot of room for market consolidation. Finally, we can observe increased competition from generics since an increased range of products in this segment is coming to the market. 

Collaborations and joint ventures for life science and health care companies

As the supply chains become more and more difficult to manage a trend towards increased collaboration is visible. Joint ventures are seen as a means to secure technology access or to broaden geographical exposure. At the same time investors are surprisingly active on minority investments, which might often arise from founder led businesses wanting to take on a partner without yet being willing to concede fully on majority control. They still want to diversify own wealth and take some liquidity off the table though.
In the French market, due to the lower financing opportunities in the current economical context, achieving R&D synergies through joint ventures is a sensible option. The joint venture contractual documentation will have to be carefully drafted, notably regarding the ownership of the IP. This also applies to the R&D Roadmap of the joint venture, non-compete provisions and the classical governance and exit provisions. 

For Germany and France, it is necessary to distinguish between a contractual joint venture on the one hand and a corporate joint venture, on the other hand. Contractual joint ventures are based on detailed collaboration agreements focusing on R&D, on joint IP and on licensing- in and licensing-out. Corporate joint ventures, on the other hand, are about taking a majority or minority stake and can serve to decrease risks.  

Implications of the EU Medical Devices Regulation for M&A

The European Medical Device Regulation (EU MDR) entered into force in May 2017 and became applicable in May 2021. It introduced major changes regarding pre-market conformity requirements and risk management. It also introduced a European database for medical devices to enable pre and post-market surveillance. The EU MDR’s implementation has turned out to be very challenging for companies. The European Commission has now reacted to concerns by delaying implementation by four years. It is worth noting that the EU MDR will not modify the safety and performance requirements for the operator for the moment. They will therefore have the opportunity to define a strategy for their medical device assets in terms of planning a sale or reinforcing and keeping them. Investors might be able to spot opportunities here. Smaller companies struggling with the new regulatory hurdles as well as with risk and lifecycle management might see an advantage in having a very strong regulatory team on board.

Key takeaways

To conclude we think it is worth noting that windows of opportunity are opening up again for investments in this space. In particular, buy and build strategies could be further rolled out and portfolios that were previously dismissed or have not been recertified so far could get a second chance. Nevertheless, transaction regulatory risks such as tightened legislation and enforcement of the French and German foreign direct investments regulation have to be considered alongside merger control obligations. Finally, the availability of W&I insurance for life science and healthcare transactions as well as the ESG aspects of transactions will continue to play a vital role.