Winnie Cheng, CFA, Principal Credit Analyst 

We expect a wave of small to mid-sized acquisitions by the large pharmaceutical companies in our coverage universe over the coming three to four years. The acquisition activity will be driven by the large number of blockbuster drugs facing patent expirations and generic/biosimilar competition within the next few years. 

Developing a new drug is a costly and time-intensive affair. The cost of developing a new drug can range from the tens of millions to billions of dollars, and that assumes the development program is successful. Only 10% of drugs that enter phase 1 clinical trials are approved in the U.S. For some hard-to-treat indications, like those that affect the central nervous system, success rates are often lower. Sometimes it can take decades to develop a drug before sending it for regulatory approval. Once the Food and Drug Administration (FDA) begins its review, it often takes more than a year on average to receive approval as the FDA may ask for extra information that requires further data analysis or additional testing. 

One of the issues facing companies is the difficulty in securing enough volunteers for clinical trials, as each phase requires increasing patient populations and a need to expand beyond U.S. borders. Ukraine was a popular place to recruit volunteers previously, but the war disrupted multiple trials and companies needed to find new places for trials. 

A company’s drug pipeline indicates potential revenue. We review the number of mid- and late-stage clinical trials featuring new compounds versus additional indications of existing products. The combination strengthens potential sales of existing products while the number of new compounds in development is a positive sign of the company’s R&D efforts and potential new products. 

Most drugs that receive regulatory approval need a ramp up period after launch, with marketing support to educate doctors on the drug to increase prescriptions and revenues. In addition, the drug company would need to create or adapt existing manufacturing capacity for the new medicine. Peak sales usually happen five or more years after launch. 

Examination of drugs losing exclusivity and their contribution to total revenues provides a view of revenue at risk for each company. While generic/biosimilar competition may not ensue for a few years after patent expiration, sometimes it happens almost immediately. Biosimilar competition tends to be slower given the difficulty in drug development and manufacturing. 

Our analysis indicates multiple companies have 20% or more of their 2023 revenues from drugs with patent expirations by 2027. Given the long lead time from product development to regulatory approval to mass adoption of medicines, and the looming loss of exclusivity for a large percentage of revenues, we expect many companies to escalate their acquisition activity for small- to mid-sized competitors to gain promising clinical stage assets and money-making commercial drugs that would benefit from greater R&D resources and larger global sales and marketing platforms. However, we expect few, if any, blockbuster mergers of equals given regulatory scrutiny and general unwillingness to lose control as the lessor of equals. Given significant free cash flows and cash hoards available to finance acquisitions of small to medium sized companies, we do not expect leverage inducing rating downgrades. On the other hand, significantly higher leverage caused by sizable acquisition prices required for any merger of equals would likely result in rating downgrades.

Sources

Moody’s Investors Service

Pharmaceutical Research and Manufacturers of America

S&P Capital IQ

USBAM Research