Lilly's ARMO BioSciences Deal: Small But Smart

(Bloomberg) -- Eli Lilly & Co. sees your $62 billion megadeal and raises you a … $1.6 billion purchase of a tiny cancer-drug developer.

Two days after Takeda Pharmaceutical Co. Ltd. announced its seismic acquisition of Shire PLC, Lilly came along with a more modest, and arguably smarter, takeover of ARMO BioSciences Inc. It’s a contrast in M&A philosophies, and the market reaction so far has also been divergent: Lilly’s shares rose about 2 percent after the Thursday morning announcement, while Takeda’s have taken a beating since rumors of its Shire pursuit emerged.

There are benefits to Shire-sized deals — there’s really no other way to rapidly acquire a big set of mature drugs and pipeline projects, geographic diversity, or significant near-term revenue growth. Some big deals, like Merck & Co.’s acquisition of Schering-Plough Corp., have worked out pretty nicely. 

But many others have destroyed value.

Integrating massive companies is tough. Expected cost synergies don’t always materialize, and there’s a large risk of hampering innovation. These deals are expensive and require loading up on debt, which limits the acquiring company’s ability to invest and make future moves if the deal disappoints. It could be as much as half a decade before Takeda is back at a comfortable leverage ratio, and it could take much longer if Shire’s hemophilia franchise deteriorates or its pipeline doesn't deliver. 

By contrast, the type of small, concentrated deal that Lilly’s takeover exemplifies (and which the company has favored) has a lot to recommend it. Deals for large companies come with units and products that are awkward fits, while smaller deals allow pharma firms to target a single drug or technology that fits a specific need.

There are many examples of successful drugs that came from smaller purchases. Take Bristol-Myers Squibb & Co.’s acquisition of Medarex in 2009. The deal cost $2 billion and netted the company two immune-boosting cancer drugs — Opdivo and Yervoy — that have already generated more than $16 billion in total sales.

The most lucrative acquisition in the history of the industry was the purchase of Knoll Pharmaceuticals by Abbot Laboratories in 2001. Abbott was able to parlay the $6.9 billion it paid into $150 billion-plus of revenue. As for Lilly, one of its most successful deals — the 2007 acquisition of erectile dysfunction drug Cialis from ICOS Corp. — didn’t cost all that much, in part because the firm had paid $75 million for part-ownership of the medicine years earlier. 

Of course, there’s a vast boneyard of small deals that have been complete busts. It’s tough to tell if an early-stage medicine is going to be a scientific or commercial success. But if a company whiffs on a $1.6 billion dollar deal, they can do several more, whereas executive heads may roll if $62 billion of someone else’s money is badly spent, and the financial consequences linger.

In Lilly’s case, this particular deal makes sense beyond the fact that it will leave the drugmaker’s balance sheet intact. Lilly’s revenue increased by 7.8 percent last year, and 2018 is looking good, but it relies too heavily on older medicines and on new drugs that are launching into competitive markets. Its cancer-drug pipeline in particular needs a boost. ARMO provides that, and its drug candidates give Lilly a promising foothold in one of the hottest areas in pharma — a new class of medicines that fight cancer by unleashing the immune system. 

Takeda’s deal for Shire will almost certainly be the more impactful transaction. But that’s not guaranteed to be a good thing. 

©2018 Bloomberg L.P.

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