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The better the question. The better the answer.
The better the world works.
How “fit” is your
capital allocation
strategy?
Vital Signs
EY perspectives on life sciences
Page 2 Vital Signs: EY perspectives on life sciences
Today’s speakers
Ellen Licking
Senior Analyst, Global Life Sciences Sector
Andrew Forman
Global Life Sciences Transaction Advisory
Services Sector Resident
Andy Lorenzetti
TAS Divestitures and Integration
Principal, Ernst & Young LLP
David Womelsdorf
Global Client Service Partner and
Principal, Ernst & Young LLP
Page 3 Vital Signs: EY perspectives on life sciences
Pricier targets
Increased execution risk for deals
Repurchase 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 challenges
Investors 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?
74
108
132
143
136
2010 2011 2012 2013 2014
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$1b.
A third of activist
campaigns
are driven by
operational or
business portfolio
concerns.
Marketcapitalization($USb)
Page 6 Vital Signs: EY perspectives on life sciences
The drivers of biopharma value
The R&D cycle
Capital
structure
Business portfolio
and 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
0
100
200
300
400
500
600
700
800
2013 2014 2015E 2016E
SalesinUS$b
Big pharma Biotech Specialty Generics
-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%
CompanyreportedEBITmargins
* 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.
22
18
24
26
21
30
39
27
41
2006 2007 2008 2009 2010 2011 2012 2013 2014
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$50billion in excess
working capital (WC)
► Big pharma’s 2014 WC
performance stronger than in 2007,
but …
► … WC varies widely overall along
the metrics we track (e.g., DSO,
DIO, DPO and C2C)
► Individual opportunities for
improvement, especially by
adopting practices of leading WC
performers in other industries
Page 16 Vital Signs: EY perspectives on life sciences
4. Business portfolio and M&A
Key considerations:
► Is there critical mass in a business or
therapeutic area?
► Perform sum-of-the-parts analyses
Financial data is not generally captured in ways that make it easy to
assess the business implications of different kinds of carve-outs.
Page 17 Vital Signs: EY perspectives on life sciences
Robust M&A market continues in 2015 with
strong prospects for second half
0
50
100
150
200
250
300
350
Dealvalue($USb)
Big pharma Big biotech Specialty Pharma Medtech 2015 Pipeline (2H)
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
0
2
4
6
8
10
12
14
16
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
2010 2011 2012 2013 2014 2015
Numberofdivestitures
Totaldealvalue(US$m)
Total deal value Number of divestitures
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 performance
1
Use milestone and “gating” mechanisms to improve R&D investment decisions.
R&D
2
Are capital allocation decisions based on the right metrics? Do they enable optimal use
of the balance sheet?
Capital structure
3
Perform virtual carve-outs to assess the value of potential divestment opportunities.
Business portfolio and M&A
4
Communicate relentlessly with investors about strategic objectives.
Communications strategy
5
Page 23 Vital Signs: EY perspectives on life sciences
Additional information
ey.com/vitalsignshttp://ow.ly/NTufL
EY | Assurance | Tax | Transactions | Advisory
About EY
EY 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.
EY refers to the global organization, and may refer to
one or more, of the member firms of Ernst & Young
Global Limited, each of which is a separate legal entity.
Ernst & Young Global Limited, a UK company limited
by guarantee, does not provide services to clients. For
more information about our organization, please visit
ey.com.
Ernst & Young LLP is a client-serving member firm of
Ernst & Young Global Limited operating in the US.
© 2015 Ernst & Young LLP.
All Rights Reserved.
1509-1697453
EYG No. FN0234
ED none
ey.com/vitalsigns
ey.com/lifesciences

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How fit is your capital allocation strategy?

  • 1. The better the question. The better the answer. The better the world works. How “fit” is your capital allocation strategy? Vital Signs EY perspectives on life sciences
  • 2. Page 2 Vital Signs: EY perspectives on life sciences Today’s speakers Ellen Licking Senior Analyst, Global Life Sciences Sector Andrew Forman Global Life Sciences Transaction Advisory Services Sector Resident Andy Lorenzetti TAS Divestitures and Integration Principal, Ernst & Young LLP David Womelsdorf Global Client Service Partner and Principal, Ernst & Young LLP
  • 3. Page 3 Vital Signs: EY perspectives on life sciences Pricier targets Increased execution risk for deals Repurchase 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 challenges Investors 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
  • 4. Page 4 Vital Signs: EY perspectives on life sciences Activist investors shake up the status quo – are biopharma companies prepared? 74 108 132 143 136 2010 2011 2012 2013 2014 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
  • 5. 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$1b. A third of activist campaigns are driven by operational or business portfolio concerns. Marketcapitalization($USb)
  • 6. Page 6 Vital Signs: EY perspectives on life sciences The drivers of biopharma value The R&D cycle Capital structure Business portfolio and M&A 2 3 4 Operational performance 1
  • 7. 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.
  • 8. Page 8 Vital Signs: EY perspectives on life sciences 0 100 200 300 400 500 600 700 800 2013 2014 2015E 2016E SalesinUS$b Big pharma Biotech Specialty Generics -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.
  • 9. 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% CompanyreportedEBITmargins * Ex-Gilead biotech margins: 41% Q1 2015, 34% 2014  Big pharma  Biotech*  Specialty pharma (incl. generics) 2012 2013 2014 Q1 2015
  • 10. 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
  • 11. 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
  • 12. 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. 22 18 24 26 21 30 39 27 41 2006 2007 2008 2009 2010 2011 2012 2013 2014 Number of NME approvals (FDA) Biopharma pipeline renaissance: analysts project ~ 25% increase in approvals
  • 13. 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?
  • 14. 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
  • 15. 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$50billion in excess working capital (WC) ► Big pharma’s 2014 WC performance stronger than in 2007, but … ► … WC varies widely overall along the metrics we track (e.g., DSO, DIO, DPO and C2C) ► Individual opportunities for improvement, especially by adopting practices of leading WC performers in other industries
  • 16. Page 16 Vital Signs: EY perspectives on life sciences 4. Business portfolio and M&A Key considerations: ► Is there critical mass in a business or therapeutic area? ► Perform sum-of-the-parts analyses Financial data is not generally captured in ways that make it easy to assess the business implications of different kinds of carve-outs.
  • 17. Page 17 Vital Signs: EY perspectives on life sciences Robust M&A market continues in 2015 with strong prospects for second half 0 50 100 150 200 250 300 350 Dealvalue($USb) Big pharma Big biotech Specialty Pharma Medtech 2015 Pipeline (2H) Source: EY, Datamonitor, Company Reports. 2015 data thru 4 June 2015. . 2010 2011 2012 2013 2014 2015 Specialty pharma 2015 pipeline (2H)
  • 18. Page 18 Vital Signs: EY perspectives on life sciences As companies focus on core priorities, more emphasis on divestitures 0 2 4 6 8 10 12 14 16 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 2010 2011 2012 2013 2014 2015 Numberofdivestitures Totaldealvalue(US$m) Total deal value Number of divestitures Source: EY, ThomsonOne and Informa’s Strategic Transactions database. 2015 data analyzed through 30 June. Only divestitures valued at > US$500 billion included.
  • 19. Page 19 Vital Signs: EY perspectives on life sciences Creating long-term value
  • 20. 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
  • 21. 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
  • 22. 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 performance 1 Use milestone and “gating” mechanisms to improve R&D investment decisions. R&D 2 Are capital allocation decisions based on the right metrics? Do they enable optimal use of the balance sheet? Capital structure 3 Perform virtual carve-outs to assess the value of potential divestment opportunities. Business portfolio and M&A 4 Communicate relentlessly with investors about strategic objectives. Communications strategy 5
  • 23. Page 23 Vital Signs: EY perspectives on life sciences Additional information ey.com/vitalsignshttp://ow.ly/NTufL
  • 24. EY | Assurance | Tax | Transactions | Advisory About EY EY 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. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. © 2015 Ernst & Young LLP. All Rights Reserved. 1509-1697453 EYG No. FN0234 ED none ey.com/vitalsigns ey.com/lifesciences