By Robbie McLaren & Samantha Peacock, Latham & Watkins
Macroeconomic challenges drove a slight decline in transactions within the healthcare and life sciences market in 2022, but the level of interest in the sector among private equity and venture capital sponsors remains high. In a downturn, investors can favour healthcare and life sciences targets as they seek defensive, stable-revenue opportunities, and the sector has a history as one of the best performing areas of private equity — often well insulated from macroeconomic cycles. Even with an uncertain market, the European pharmaceutical sales market in both Western Europe and Emerging Europe is forecast to grow by nearly 70% by 2031, an increase of a quarter trillion dollars.
In the year ahead, we remain cautiously optimistic and expect the significant dry powder accumulated in the sector (both corporate and financial) to be put to work, and for the industry to count amongst the most active through the downturn and beyond. As parties consider investment opportunities, several aspects of the market should remain top of mind.
The market belongs to buyers
Volatility in the public markets may restrict capacity for larger deals; however, lower public company valuations create an opportunity for public-to-private transactions. Companies with the means to acquire assets such as products, intellectual property, and key employees will encounter attractive prices, given the general depression of valuations in the healthcare and life sciences market. On the other side of the table, acquisition targets struggling to raise equity investments or debt financing will see acquisition as an attractive exit opportunity. This should be especially true in the UK, where the comparative rate of economic recovery and the forecast recession will make UK-based targets particularly attractive to potential acquirers, in light of the region’s historic strength in healthcare and life sciences research and innovation in biotech.
Firepower lies with both industry and non-industry actors
Today’s complex deal-making environment means more specialist private equity and venture funds emerge with a focus on healthcare and life sciences, while generalist buyout funds dedicate more resources to the market. Large pharmaceutical companies will continue to optimise their portfolios and divest non-core assets. Last year’s trends of a slowdown in deal-making and the divestment of non-core businesses have left large industry players with the cash needed to invest in ventures that advance their business goals. We anticipate that divestments will continue over the course of the year, driving deal volume and providing capital for reinvestment as a result.
For non-industry players, the reduced deal-making in 2022 led to an accumulation of capital, as venture capital funds that invest in healthcare and life sciences continued to raise capital. Private equity sponsors also have cash to invest, and we expect that these sponsors will compete with strategic buyers — including big-name tech giants — for attractive companies in the healthcare and life sciences space. However, recent capital raising rounds will lead to a decline over the next year in healthcare venture fundraising; Silicon Valley Bank’s HealthCare Industry Trends 2022 Annual Report predicts fundraising to fall to US$15 billion in 2023, down from US$22 billion last year. Additionally, investments in biotech from venture capital have already shown signs of slowing down after a phenomenally busy 2021, and we predict the volume of investments in this area to settle back to pre-pandemic levels.
Companies lean in to digitisation
Healthcare and life sciences companies will always seek to develop their product pipeline and invest in innovative technology and research. Yet, in line with cross-sector trends, we notice an increased appetite to acquire more than novel drugs and devices, with significant interest in digital and technological capabilities designed to improve efficiency and integration, such as AI, big data, and robotics. For large corporations and private equity investors alike, capability-driven deals for mRNA, gene therapy, and telehealth capabilities will prove attractive. While the pace of digital adoption in the sector has evolved substantially in the past few years, healthcare remains a laggard, and thus digital health in the sector continues to have high potential (and high EBITDA multiples).
The patent cliff fast approaches
Across Europe and the United States, patents on several blockbuster drugs will expire this year, as the “patent cliff” that began in earnest last year continues through 2030. With generic and biosimilar competition on the horizon, originator companies will focus on bringing new drugs to market — both through their own research and development and via acquisition of smaller biotech operations. Biopharma companies on the frontlines of drug innovation, and particularly those completing their Phase III trials, will thus see increasing interest from potential investors or acquirers.
Emerging regulatory considerations bring additional scrutiny
Increased scrutiny under foreign direct investment (FDI) regimes, such as the UK’s National Security and Investment Regime, in effect as of last year, has resulted in more active enforcement of screening regulations. We observe the use of FDI regimes’ broad scope to protect domestic assets and supply, and investors should take note that this trend may lead to greater intervention in acquisitions of strategically important businesses or products in the healthcare and life sciences sector. Acquirers may need to undertake a higher number of smaller transactions to achieve the same outcomes, whether that’s pharma companies acquiring multiple medium-sized biotech operations, or private equity funds creating specialist care platforms through a series of roll-up acquisitions.
Obtaining comprehensive warranty and indemnity insurance may pose an additional potential challenge for private equity sponsors. Insurance premiums run roughly three times higher than other sectors — due to perceived risk, fewer insurers signal a willingness to insure deals in the pharma sector, leaving less opportunity for competition to drive prices down. To obtain full coverage for deals in the coming year, sponsors considering an acquisition should ensure they obtain robust regulatory warranties, and can demonstrate thorough regulatory diligence.
Overall, 2023 will see an uptick in dealmaking as compared to 2022 in the sector as private equity and strategic acquirers, both specialist and generalist, take advantage of emerging opportunities and favourable market conditions for buyers. Healthcare and life sciences companies stand out in today’s challenging macroeconomic environment, despite increased regulatory scrutiny, for delivering consistent value and attractive upside potential. Given these factors, we anticipate competition for healthcare and life sciences assets to remain resilient throughout the year.
About the authors Robbie McLaren is a partner in the London office of Latham & Watkins and Global Vice Chair of the firm’s Healthcare & Life Sciences Industry Group and former Co-Chair of the London Corporate Department. He primarily advises on cross-border mergers and acquisitions, joint ventures, and venture capital investments. Robbie represents clients who operate in the life sciences, healthcare, and technology industries.
Samantha Peacock is an associate in the London office of Latham & Watkins. Samantha advises on a broad range of corporate matters, including mergers and acquisitions, private equity, and venture capital investments, with a particular focus on the life sciences sector.