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Bayer: betting that big M&A can deliver more value than partnerships and organic growth (The Pharma Letter)

Chris Pettigrew’s invited commentary in The Pharma Letter 29th September 2016

Bayer’s huge intended purchase of Monsanto for $66 billion indicates a renewed focus on crop science and ipso facto a relative deprioritisation of investment in its healthcare business. As Bayer’s crop science sales swing from ~30% currently to ~50% pro forma for the merged entity, investors who once considered Bayer a healthcare company may question this new emphasis. The fact that this has occurred through purchase of a company that many in the general public consider to have a severely tarnished reputation may make this even more unpalatable, and diminish the goodwill sought by Bayer CEO Werner Baumann when he stated this deal was about saving the world by boosting sustenance for a growing population. However, there is undoubtedly a strategic logic in this potentially transformative deal: the challenge for Bayer now is to execute on it without harming the healthcare business.

A boost in innovation

The greatest advantage of the acquisition is that Bayer can benefit from Monsanto’s innovation and position itself as a leader in food and healthcare advancement. As a company that has always prided itself on innovation, Bayer has decided to make a forward-looking move to excel in crop science innovation, gaining access to Monsanto’s near-term pipeline of biologicals, Climate platform, and Nemastrike. Additionally, not only does Bayer gain access to Monsanto’s novel products, it also will build additional innovation capability into its legacy crop science business. For instance, through Climate and other tech Bayer gains access to an emerging ‘big data’ offering that can inform R&D and improve productivity.

Bayer justified this deal to investors as a way to profit from major demographic trends, feeding as well as providing healthcare to a growing and ageing population. Indeed, a long-term and substantial innovator in the agrochemical space could condemn competitors to being low cost commodity providers. However, a major factor in the long run success of this strategy and resultant deal will be how the merged entity manages scale. Although the pharma industry has a long history of growth from M&A, scale brings problems rooted in complexity, as well as a reduction in an entrepreneurial mind-set (especially if two incompatible cultures are combined). Excessive scale and complexity has been known to damage innovation, potentially negating one of the benefits of the acquisition, because innovation requires focus and agility. This is demonstrated by the common trend in healthcare towards innovation originating in nimble biotechs rather than massive conglomerates. In Bayer’s case, the complexity of R&D across crop protection, seeds, and traits risks creating diseconomies of scale.

Healthcare sharing the limelight

An unfortunate by-product of this deal may be that Bayer’s healthcare business suffers. Pharmaceuticals is a highly competitive sector when it comes to innovation, requiring a long-term investment perspective. As the company becomes increasingly leveraged and utilises its pharmaceutical earnings to service debt, pressure may be put on the R&D investment needed to maintain long-term pharmaceutical value. Bayer has committed itself to sustaining organic investment in healthcare post-deal, but healthcare needs both organic and non-organic growth to thrive. A high level of debt may limit Bayer’s ability to execute future high-value healthcare partnerships and M&A, reducing its strategic flexibility in non-organic growth initiatives. Bayer’s management will need to retain the focus they had on healthcare success while operating from a very different balance sheet.

An alternative to M&A

Many consider the resounding subtext of this deal to be Bayer defending itself against prospective industry consolidation. However, in today’s climate of high M&A prices and increased competition for deals, might a partnership have been a better idea to build value than pure M&A? In healthcare, it is extremely common for pharma companies to partner with smaller businesses with great success. For example, Novasecta’s analysis has demonstrated that, in 2015, 75% of new molecular entities approved by the FDA were the result of partnerships or deals, with the majority of this value created through co-development, joint ventures, and licensing deals rather than M&A.

Successful partnering is therefore critical for companies in healthcare and related industries. Partnerships allow a company to get the most out of its assets and capabilities, without the significant risk and ‘culture shock’ of M&A. In Novasecta’s experience, the fundamental properties of successful, mutually-beneficial partnerships are: 1) a bespoke partnering strategy emphasising corporate goals, 2) creativity in deal making, and 3) re-configured internal capabilities to reduce silos. Novasecta’s full analysis on these key traits for partnering success can be viewed here.

Prudently, some companies partner before taking the M&A ‘plunge’ in an effort to ascertain potential fit – for example, Ipsen’s partnership with Syntaxin prior to full acquisition. Monsanto and Bayer have partnered before, in the joint venture formation of Mobay Chemical in 1954, as well as various licensing agreements in more recent years. However, for a deal of this magnitude, a more substantial and long-term partnership with an emphasis on working together (a series of co-development or capability-sharing deals, perhaps) prior to the acquisition may have de-risked this deal substantially, providing an early intimation of probable success and reassuring investors.   It is now up to Bayer to make its big M&A move work where many have failed.

Christopher Pettigrew is an Associate at specialist pharmaceutical strategy consultants, Novasecta.

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