How “fit” is your capital allocation strategy?

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How “fit” is your capital allocation strategy? Vital Signs EY perspectives on life sciences

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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

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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

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Activist investors shake up the status quo – are biopharma companies prepared? 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

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Activists target larger biopharmas over time Source: EY, Capital IQ, FactSet’s SharkRepellent and company filings. Includes only companies with market cap > US$1b. A third of activist campaigns are driven by operational or business portfolio concerns. Market capitalization ($USb)

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The drivers of biopharma value The R&D cycle Capital structure Business portfolio and M&A 2 3 4

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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.

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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.

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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 * Ex-Gilead biotech margins: 41% Q1 2015, 34% 2014 Big pharma Biotech* Specialty pharma (incl. generics) 2012 2013 2014 Q1 2015

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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

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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

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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. Number of NME approvals (FDA) Biopharma pipeline renaissance: analysts project ~ 25% increase in approvals

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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?

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Big pharmas return cash to shareholders; biotechs, specialty pharmas focus on M&A Source: EY, Capital IQ and company financial data. Big pharma Biotech and specialty pharma

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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

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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.

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Robust M&A market continues in 2015 with strong prospects for second half Source: EY, Datamonitor, Company Reports. 2015 data thru 4 June 2015. . 2010 2011 2012 2013 2014 2015 Specialty pharma 2015 pipeline (2H)

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As companies focus on core priorities, more emphasis on divestitures Source: EY, ThomsonOne and Informa’s Strategic Transactions database. 2015 data analyzed through 30 June. Only divestitures valued at > US$500 billion included.

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Creating long-term value

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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

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Value creation comes from holistic deployment of capital agenda The R&D cycle Capital structure Business portfolio and M&A 2 3 4

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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

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Additional information ey.com/vitalsigns http://ow.ly/NTufL

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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