Treasury in the healthcare sector: relieving the headache
Published: Jun 2012
In this Sector Profile we look at the challenges and opportunities in the healthcare sector today – from patent expiries and generic competition eroding the value chain, to funding the M&A frenzy. We also examine ways in which the treasurer can add real value to the company, whether it be through strategic financing or improved internal communication.
One of the most diverse industry sectors, ‘healthcare’ encompasses everything from pharmaceuticals to MedTech companies and continuing care names, including private hospital groups. Western economies remain the leaders in the healthcare industry, with healthcare spending in most developed economies representing at least 9% of total GDP.
Generally viewed by investors as ‘defensive’ play, the healthcare sector navigated the financial crisis relatively well. Although revenues have dipped slightly from the 6-7% CAGR seen pre-crisis, healthcare companies are, by and large, bolstered by solid fundamentals and some positive headwinds.
“Pharmaceuticals in particular continue to generate sufficient cash to support their operations and expansion plans,” says Carlos Lopez, Director, Global Healthcare Coverage at Lloyds Bank Wholesale Banking & Markets. “Most of the major players have very good credit metrics; they also have ample capacity to absorb more debt to fund acquisitions. In addition, they have reliable and loyal banking groups. So really there are a lot of factors in their favour.”
Overarching trends, such as the ageing global population, obesity and diabetes epidemics, the growth of the middle classes in emerging economies and innovative technologies also point to the long-term sustainability of the healthcare sector. “Over the next 30 years, changing demographics will most definitely be a pillar of support for healthcare,” agrees Lopez. “In the short term however, the industry faces a number of obstacles.”
The patent cliff
A widely publicised challenge facing the pharmaceuticals sector is the ‘patent cliff’. For the last 25 years, the pharmaceuticals industry has been focused on driving revenue through the research and development (R&D) of a range of drugs. “What has been happening since the mid-2000s is that most of the major players in the industry have relied on just one or two drugs per company from a revenue and income point of view, whilst continuing to materialise their pipeline,” explains Lopez. “These drugs are patent protected for a given time and once the patent expires, then generic companies enter the market with the same drug, but significantly cheaper. It just so happens that we are approaching a period when a number of ‘blockbuster’ drugs will be coming out of their patent protection, hence the ‘cliff’ analogy.”
Pfizer’s Lipitor, the top-selling cholesterol drug, suffered patent expiry in November 2011. At the beginning of May 2012, the company reported a 19% drop in net earnings in its Q1 results. The fall from $2.2 billion to $1.79 billion was attributed in large part to Lipitor losing its patent exclusivity. The company also had a handful of other patents expiring around the same time, including those on Xalatan (for glaucoma) and Geodon (for bipolar disorder). Bristol-Myers Squibb Sanofi’s Plavix, a blood thinner and the world’s best-selling medicine, also lost its patent protection recently. Like many other players, the company is expecting a sharp drop in revenue (approximately $8 billion) from that product alone. In fact, estimates suggest that across the industry, in the region of $70 billion of income is currently in jeopardy from patent expiries.
Government austerity measures and generics impacting the value chain
What tended to happen before Lipitor – which Pfizer is still marketing under its brand name and selling directly to patients – is that when the drug patent expired, the branded pharmaceutical either stopped making it or sold the rights to another company. The generic pharmaceutical companies then bring that drug to market at a much reduced price. They are able to do this as they have not invested in the R&D for the product. However, even the generic companies are coming under pressure, as Lopez explains:
“With the troubles in the Eurozone, countries are starting to feel the pinch on their balance sheets. This means that austerity measures are being put in place. Spending is being cut and naturally healthcare budgets are under extremely close scrutiny. This is an incentive for governments to work on bringing cheaper drugs into the system. Since they control the licences, they are able to control the price of the generics through the use of caps.”
“In turn this is making it difficult for the generic companies to make a margin. Governments are therefore going to have to look again at caps and think about the absolute minimum level at which things can work effectively. This may revolve around determining the price of each drug based on its clinical benefits and value – but that will of course be difficult to implement. Things are very different in the US, for example, where the healthcare system is not so heavily subsidised and distributors tend to have a little more pricing power.”
An additional concern in Europe is that government balance sheets are only going to become more stretched. Greece must continue to support its healthcare system but the majority of providers will have a question mark over how/whether they will be paid. “It’s going to be a very fine line between what’s morally right as a pharmaceutical company and what’s in the best interests of your shareholders,” warns Lopez.
Biosimilars loom on the horizon
It is not only the big branded pharmaceuticals and generics that are feeling the pain though. Speciality pharmaceuticals are also facing their own challenges. These speciality pharmaceuticals deal mainly with rare diseases and their manufacturing processes are very different from those of their branded counterparts: a branded pharmaceutical tends to mix compounds via a synthetic process, whereas a specialist pharmaceutical company tends to produce drugs through a biotechnology process.
These ‘biologic’ drugs are also subject to patents – and therefore the dangers of patent expiry. At the moment, however, they continue to have exclusivity because of a lack of competition. But according to Lopez, “it’s not a question of if generic speciality drugs, or ‘biosimilars’, will come to the market, but when. Since the population that the speciality drugs are aimed at is significantly lower, producing a generic form will require a massive investment by the existing generic pharmaceuticals. However, there will no doubt be oncology or diabetes drugs that appeal to the generic manufacturers. What this means is that in the not too distant future the speciality pharmaceuticals will have exactly the same problems as the branded ones are facing now.”
Mid-market healthcare M&A by target nation
Deal value USD million
Deal value USD million
Easing the pain
Faced with these challenges, what are healthcare companies to do to ensure growth? “Essentially, everything that can happen is happening in the space right now,” says Lopez. The pharmaceuticals sub sector as a whole has gone through a significant amount of change and a large degree of cost cutting, restructuring and, most notably, consolidation has resulted from that.
“We have seen branded drugs companies buying up other branded drugs companies, or specialty pharmaceuticals companies and in some instances they have bought generic companies too. Certain players have even branched out into areas such as consumer and animal health.”
Recent activity in the M&A space has included:
AstraZeneca buying Ardea for $1 billion.
Watson Pharmaceuticals agreeing to buy Actavis, a European generic company, for $5.6 billion.
Nestlé purchasing Pfizer’s infant nutritional business for $12 billion.
There have also been some unsuccessful bids, such as Glaxo’s attempt to purchase Human Genome Sciences for $2.6 billion (still ongoing). Roche also abandoned its hostile $6 billion takeover bid for Illumina, a gene sequencing firm.
“The main driver for consolidation continues to be that the pharmaceuticals are trying to replace some of the revenue that will be lost when the patents of their blockbuster drugs expire. Of course, there are still plenty of new drug applications that are being filed with the regulators but R&D is becoming very expensive due to the arduous regulatory approval process. This consists of several different phases and it can take up to ten years to see any return on investment. The process of acquiring innovation by buying a single drug company and bringing their product to market is therefore increasingly appealing. The industry calls this cheaper route ‘search and development’.”
The role of the treasurer
Funding M&A transactions is dependent on the company’s own specific circumstances and where they are in their business cycle. However, a number of the large pharmaceuticals have cash available and good credit profiles, making the process a little easier. Nevertheless, the credit crisis left a lasting impact on the industry and how it conducts its deals, while also highlighting the importance of having a strong, reliable banking group in place.
“Before the credit crisis, you could identify a target, agree the purchase price or T&Cs with the target and then worry about the financing. Changes to the UK Takeover Code, coupled with the current market conditions mean that conversations with the financing banks happen much sooner now. This is because you need certainty of funding early in the M&A process,” Lopez notes.
In addition, Lopez is also seeing an increased level of dialogue taking place around structuring and financing the acquisition successfully considering the state of the capital markets. This could be around capital structure, foreign exchange risk or interest rate risk, for example, and how those are best managed. So the bank is playing much more of a debt and risk management advisory role today, making the most of relationships and sharing knowledge.
“At Lloyds Bank, we take a very active role in the financing of an acquisition – from inception all the way through to the ‘sell down’ to the various markets. We also look at the management of any risks that arise from the transaction itself. This is something the bank has been doing for a number of years, but the discussions are happening much earlier in the M&A cycle now.”
The right medicine
Director, Global Healthcare Coverage
Director, Debt Capital Markets
Given the sheer size of some of the M&A deals in the healthcare sector, borrowers need to look at multiple markets in which to raise capital. Carlos Lopez and Rovert Greene from Lloyds Bank explain the bank’s capabilities in helping global pharma companies find alternative funding.
What qualifies Lloyds Bank to look after clients in the healthcare sector?
CL: As a relationship-focused bank with extensive healthcare knowledge, we take the time to understand the issues that our clients face. The concept of the ‘one stop shop’ bank was never one that Lloyds Bank embraced – we have specific areas of expertise and we have been very prescriptive in determining which industry sectors the bank wants to support. Healthcare is an extremely important focus for Lloyds Bank and we have a complete offering, from sector specialists through to debt capital market, risk and FX specialists, as well as a full suite of tailored solutions.
Of course we are involved in the financing of M&A deals for our healthcare clients but there are financial requirements in the normal course of business that we help clients with too. This could be selling a subsidiary or undertaking a large scale project. Such activity will give rise to the same questions around FX risk, interest rate risk or in some cases commodity risk. Also, some companies will need to take on more debt to complete these projects. We can assist them in analysing the optimum level of debt and what the ideal fixed/floating rate ratio would be for them. This all forms part of the solutions-based approach that we offer our clients.
Moreover, because of the position that we have in Europe and the number of hospitals that we work with as clients, this actually gives us a very good insight into the end-users of pharmaceuticals and medical technology. In turn, this helps us to have in-depth conversations with our healthcare clients and identify key trends in the sector. So, more than just offering financial capital, we are able to offer intellectual capital to help our clients strategically.
How are clients using the debt capital markets (DCM) to raise capital at the moment? Also, what capabilities does Lloyds Bank offer in the DCM space?
RG: A key responsibility of treasurers is to ensure liquidity and provide access to capital at times of need or opportunity. The current iteration of the financial crisis reinforces the view that taking advantage of markets when they are open is prudent. Whilst only 10% of corporate borrowing in the US comes from banks, it is 70% in the Eurozone and the UK. However it is arguable that many of Europe’s banks are in a much weaker state than their US counterparts. As a result, many conservative corporates here are shifting the balance of bond and loan debt in their capital structures. European loan volume is down 49%, year-on-year. In contrast, European corporates raised a record 61% of all of their loan and bond refinancings in the bond market.
At Lloyds Bank, we provide a broad range of debt and risk management solutions. Augmenting our leading loan markets business we have a complete DCM offering for our customers across the public bond markets, primarily in Europe. The bank has a growing capability in the US dollar market through our broker-dealer business, Lloyds Securities Inc. We also have an experienced US-based private placement team, further enhancing our solutions offering, largely to enable access to the capital markets for unrated issuers.
Lloyds Bank is currently the number one bookrunner for UK corporate issuers in the Sterling and Euro bond markets combined. So far in 2012 alone we have been the boookrunner on around £20 billion equivalent of issuance for our corporate customers in the European bond markets.
Looking specifically at the global pharma companies, they tend to raise capital in the US dollar bond market. In fact, since the credit crunch, 80% of all debt raised by these groups has been in US dollars, with 18% in Euros and 2% in sterling. That activity totalled more than $300 billion since 2008, so it’s an extremely deep and liquid market. Given the sheer size of some of the M&A deals in this sector though, take for example Roche’s acquisition of Genentech and Pfizer’s acquisition of Wyeth in 2009, borrowers need to look at multiple markets. Those two deals between them saw $25 billion equivalent raised. Since no single market would have been able to provide that amount in the short term, it was termed out into a variety of different bond markets, including sterling and euros, which also offer diversification, flexibility in duration and from time-to-time, pricing advantages.
Notwithstanding the economic backdrop, corporate bonds really do remain the asset class of choice for credit investors today. Issuance is however at a relatively low level, owing to companies reigning back M&A and investment expenditure, leading to a demand/supply imbalance. This, combined with historically low government yields, makes corporate bonds an even more attractive liquidity tool for the treasurer, with coupons at all-time low levels and the potential for huge oversubscriptions.
FX risk is a significant challenge for many healthcare companies. What tools does Lloyds Bank have available to help clients manage and mitigate this?
CL: In September 2011, we launched our latest FX offering for clients: Arena. It is an e-trading platform with a holistic attitude. In addition to FX and money market deal execution, the platform provides access to a wealth of Lloyds Bank information, including proprietary economic research, market commentary, interactive charting and risk analytic toolkits. Reputable market data and live news are also being provided from well-known third-party sources.
We recognise that in catering for the banks’ diverse client sectors, it is important to offer functionalities that will suit each of these. As such, we held consultative workshops with clients from a range of industry sectors to help identify their different needs and priorities when developing Arena. Cash management capabilities are being rolled out across the platform this year, giving the treasurer even greater visibility over their holdings and exposures.
While technical, economic and risk tools are available on the platform, clients can also use interactive chat functionalities to speak with Lloyds Bank’s experts, or simply pick up the phone to discuss risk management challenges or structuring techniques, for example.
Finally, how have clients’ views on bank counterparty risk changed in the healthcare sector?
CL: The credit metrics for the banks are constantly being reassessed and therefore companies – in all sectors, not just healthcare – are very aware of bank counterparty risk today. We are seeing clients actively re-evaluating their banking groups and looking to keep their relationships with banking partners that offer them more than just products. Equally, where companies have excess cash, as many of the pharmaceuticals do, investment policies are being revisited and rewritten, with much attention being paid to the concentration of deposits.
Adding value to the company
Another interesting sector trend that Lopez has observed is the increasingly strategic role of the treasurer. “Treasurers operating in the pharmaceuticals space have always been conscious of the fact that their sales are dependent on clients being able to buy their product. But the crisis in Europe has changed this from a thought in the back of their minds to a plan for ensuring revenue sustainability.” In other words, treasurers are becoming far more engaged with the ‘front line’ of the company.
They are gathering data on what customers are thinking, what their buying behaviour or patterns are, and how they are shifting. How to recognise sales as quickly as possible is another key area of focus here as treasurers consider the extent to which financing the company’s customers would be beneficial.
“In those dialogues, banks such as Lloyds Bank can come in and propose solutions which would allow the end-users (ie hospitals) to continue paying in instalments for example and allow the pharmaceuticals or medical equipment company to recognise its sales from day one,” says Lopez. “Lloyds Bank has a great deal of experience in this area. We can recommend financing strategies that not only overcome an immediate challenge but that look to support the growth strategy of the corporate and add value over the long term.”
Lloyds Bank Wholesale Banking & Markets
Lloyds Bank, part of the Wholesale division at Lloyds Banking Group, provides comprehensive expert financial services to businesses, from those with over £15m annual turnover to those with turnover in the billions. It has over 26,000 corporate clients, ranging from privately-owned firms to FTSE 100 PLCs, multinational corporations and financial institutions.
It has a network of relationship teams across the UK, as well as internationally, with the mix of local understanding and global expertise necessary to provide long-term support and advice to its customers.
Lloyds Bank offers a broad range of finance, spanning structured and asset finance, import and export trade finance; securitisation facilities and capital market funding. Its product specialists provide bespoke financial services and solutions including tailored cash management, international trade, treasury and risk management services.
Its heritage means it has an unrivalled understanding of business needs and a proven track record of supporting customers across the sectors and regions. Taking a relationship approach, it provides support to its customers throughout the economic cycle.