University of Groningen
Faculty of Economics and Business
The short-term performance of mergers and
acquisitions in pharmaceutical and biotechnology
industries
Author: Adriana POSEA
Student No: s1938940
Supervisors: K.J.McCarthy, PhD.
W.A.Dolfsma, Prof. Dr.
Abstract
This paper analysis the short-term performance of M&As in pharmaceutical and biotechnology industries. It focuses on a recent period of time: January 2008-December 2009, a period affected by the economic crisis, which led in most of the industries in adopting different ways of acting in order to remain competitive. Using a sample of 125 deals with acquirers from North America and Europe, and tagets from all over the world, we show that 44.8% of the acquiring companies registered positive abnormal returns. Moreover M&As where cash is used as a method of payment lead to higher abnormal returns than those where shares or combinations are used in order to finance the deal. Short-term performance is also influenced by the amount paid for the transaction. Large deals seem to outperform small and medium-size deals. The study also finds that target innovation capacity has a negative impact on the cumulative performance of acquirers.
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Table of Contents
1. 2.
Introduction………... Pharma-biotech markets’overview and M&A activity within the two industries………..
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6
3. Literature review………...………... 9
3.1 Why do M&As occur in pharmaceutical and biotechnology industries?... 9
3.2 The performance of M&As……… 10
3.3 Method of payment……… 14
3.4 Deal size ……… 3.5 Cross-border vs. domestic M&As ………. 15 16 3.6 Targets’innovation capabilities……….……….. 17 4. Methodology……… 18 4.1 Data………... 19 4.2 Methods……….. 21
4.2.1 Acquirers’ performance (CARs)………....
4.2.2 Variables that can influence cumulative abnormal returns …………...
21 23 5. Results……….. 255.1 CARs for acquirers………. 5.2 Univariate analysis………….………... 5.2.1 CARs by method of payment………... 5.2.2 CARs by deal value………..……… 5.2.3 CARs by deal type (Cross-border vs. domestic)……….. 5.2.4 CARs by Target’s innovative capacity………..………... 5.3 Interaction effects………... 5.4 Multivariate analysis……….. ………... 25 26 26 26 27 28 29 30 6. Discussion……… 32
5.1 Implications of the paper……… 5.2 Limitations and further research………. 35 36 6. Conclusions………. 36
1. Introduction
The main purpose of this study is to find out whether factors like method of payment, deal value and the innovation capacity of the target companies influence the shareholders value of acquirers acting in pharmaceutical and biotechnology industries.
The pharmaceutical sector is going through significant changes, driven by factors such as: patent expiration, declining drug pipelines, increased penetration of generic competition, stricter regulation or reduced healthcare spending in core markets (KPMG Report, 2009). Several "blockbuster" medicines, which account for a substantial part of the sales and profits of large companies, have lost patent protection in recent years. At the same time, in spite of increasing investments in R&D, it appears to be a challenge for many companies to refill the product pipeline and the number of novel medicines reaching the market has been decreasing (European Commission Report, 2009). The worldwide financial crisis had not influenced only the amount of drugs being sold but had also put lot of pressure on the pharmaceutical industry’s pricing. In addition, the drug pipelines are quite low and many blockbuster drugs will soon be disappearing as a source of revenue for the pharmaceutical giants. During recent years an intensified consolidation had been observed in these two sectors. Thus, the development of ‘disruptive’ technologies by nontraditional firms, and broader challenges to the conventional drug discovery model have been important drivers of M&A activity.
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Biotechnology sector was also included, because many biotech companies have been targeted by big pharma companies in order for the last ones to be able to find new innovative capacities.
When talking about pharmaceutical and biotechnology industries there are not too many studies focusing on short-term performance of M&As. Most of the research papers in this field have used innovation inputs or outputs in order to define the performance of M&As. Pharmaceutical and biotechnology industries are two of the most innovative. Innovation is what can make a clear difference between success and failure. Focusing on innovation performance has limited the researches to use in their data samples deals completed few years ago, because the effects of innovation will most likely be visible over three or more years (Ornaghi, 2004). Although there were published several reports on the recent M&A activity in pharmaceutical and biotechnology industries, and although questions regarding the performance of these deals were raised, the answers are still to be found. This is why this study will focus on a recent period (January 2008-December 2009), and will use event windows in order to estimate the short-term performance of the acquirers involved in M&As in both industries mentioned above.
Given all these, the research question I proposed for this study is the following:
To which extent do factors like method of payment, deal value and targets innovation capacities influence the performance of the acquiring companies in pharmaceutical and biotechnology industries?
The performance of the acquiring companies will be measured using cumulative abnormal returns for a three day event window, with day 0 being the announcement day. As said before the influence of different methods of payment, deal value and target innovation capacities will be included as independent variables, in order to see if they have a significant influence on cumulative abnormal returns experienced by acquirers. Relevant data about the deals have been collected from three databases: Zephyr, Thomson One Banker and Capital IQ. Data regarding target innovation was collected from USPTO database.
acquiring company, instead of paying it to shareholders, the research showed that cash financed deals registered the highest cumulative abnormal returns.
Even if in the literature have been often stated that large-deals do not perform well, this study have registered positive CARs for deals with a value over 1bn EUR.
The paper will be structured as follows. Chapter 2 summarizes the main results published in different studies and an overview of the two industries and the M&A activity. Further Chapter 3 presents the data and methodology used. Next chapter presents the empirical results while the last chapter is dedicated to conclusions, limitations and further research.
2. Pharma-biotech markets’ overview and M&A activity within the two
industries
When talking about pharmaceuticals market, specialists include only ethical drugs and not also consumer healthcare and animal healthcare. Regarding the biotechnology market, this consists of companies involved in the development, manufacturing and/or marketing of products based on advanced biotechnology research (Datamonitor, 2009).
If 2008 generated a global revenue of $625.6 billion, in 2009 this increased with $18.6 billion. Despite the economic crisis, pharmaceuticals and biotechnology industries showed each year an increase in revenue, having a compound annual growth rate (CAGR) of 4.3% for the period 2005-2009 (Datamonitor, 2009).
Table 2.1: Global Pharmaceuticals, Biotechnology and Life Sciences Industry Group Value
Year $ billion %Growth
2005 545.3 2006 571.5 4.80 2007 601.4 5.20 2008 625.6 4.00 2009 644.2 3.00 CAGR 2004-2008 4.30 Source: Datamonitor, 2009
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Plc (4.9%) and Roche Holding (4.6%), the industry is quite fragmented and in continuous change (Datamonitor, 2009). Even though the power relationships and strategic interactions between biotech and pharmaceutical companies appear at times to be shifting, the large pharmaceutical companies are still the dominant force in therapeutic R&D and therefore largely dictate the strategies of the smaller firms (Mittra, 2007).
Innovation is the is one of the key determinants of the success or failure of the companies in these industries. Therefore, companies spend lot of money on R&D projects. Although United States of America dominates the market (Fig.1) Europe seems to spend more money on R&D (Fig.2).
Fig.1 51.9 28.9 19.2 51.6 29.1 19.3 0% 20% 40% 60% 80% 100% 2008 2009
Global Pharmaceutical Market Segmentation (% Share by value)
Asia-Pacific Europe Americas
Source: Datamonitor, 2009
Fig.2: Pharamceutical R&D Expenditure in Europe and USA (EUR Million)
Source: European Federation of Pharmaceutical Industries and Association, 2010
Regarding the possibilities of substitution within these industries, it depends on the different segments. For example for branded drugs, generics are the principal substitutes, while for the medical biotechnology market, conventional therapeutic drugs
are the main substitutes (Datamonitor, 2009). The distinction between branded and generic products is also important. If a branded product is the original version, produced by the innovative company that developed the product, a generic product is a copy of the original, produced by another company (Weyzig, 2004).
Another important characteristic of these industries is given by the level of regulation that exists, and which sets difficult barriers to entry. These markets are perhaps the most tightly regulated marketplaces in the world (Hutchings, 2009). These regulations include adherence to written standardized procedures during the conduct of studies and several rules governing recording, reporting and retention of data and records. For example in some countries governments restricted the use of some agriculture biotech products.
Despite the regulations and the financial turmoil, in the period 2008-2009 the pharmaceuticals and biotechnology industries have faced an increased M&A activity, compared to the previous two years (KPMG, Report, 2009a). The total value of the transactions made in 2008 was $50.1 billion (Fig.3), which represented a slightly increase compared to the previous year. Even if the number of deals in 2009 has decreased, comparing with 2008, we can’t say the same about the total value, which has reached $174.4 billion. The most important role during 2009 was played by the mega-mergers, only three transactions: Pfizer-Wyeth ( $68 billion), Roche-Genentech ($46.8 billion and Merck&Co -Schering-Plough ($42 billion), being able to reach a value of $156.8 billion (http://www.hbmpartners.com).
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3.Literature review
3.1 Why do M&As occur in pharmaceutical and biotechnology industries?
In existing literature there are two main theories which have explained the motivation behind the decision to merger or acquire. The first theory is the monopoly theory and states that firms use M&As in order to raise their market power . The second theory, known also as the efficiency theory postulates that companies engage in M&As to reduce costs and achieve economies of scale (Steiner, 1975).
As suggested by various researchers (Heracleous and Murray 2001, Morgan 2001, Javalgi and Wright 2003, Danzón et al. 2004 in Demibarg, 2007), the main factors that drive the M&A activity in the pharmaceutical industry are:
• the escalating R&D investment costs; • patent expirations;
• rising marketing costs.
During the last wave, pharmaceutical companies got involved in M&As mainly because of the expiration of the patents for their “blockbuster” drugs, developed in 1990s and the increased competition from the generic drugs. An area where companies can recoup their money quite fast and of course with less threat from generic companies, is in biotechnology industry. For example Pfizer’s cholesterol-lowering drug, Lipitor, will become open to generic competition starting next year (Platt, 2009). Therefore during the recent years, more and more big pharmaceutical companies have acquired or merged with biotech companies in order to bolster their research and development. Small biotech companies are acquired also because pharmaceuticals firms cannot successfully capture and disruptive knowledge, technologies and products that they do not have the capacity to develop in-house. Most of the time, biotech companies are viewed by the big pharmaceutical companies as a rich source of innovation that can be exploited to supplement internal R&D efforts and add-in capabilities that they are unable or unwilling to develop internally (Mittra, 2007).
merge or acquire is contingent on its prevailing therapeutic priorities, in-house research capacity and technological capabilities.
Among large firms, mergers are a response to excess capacity due to anticipated patent expirations and gaps in a company’s product pipeline, while for small firms, mergers are primarily an exit strategy for firms in financial trouble (Danzon et. al, 2003). Another research’s findings showed that innovating firms are significantly more involved in acquisition activities than non-innovating firms, which suggests that acquisitions are a strategy to gain access to resources relevant for innovation. Also the lack of knowledge as a barrier to innovate increases the chance of acquiring assets of other firms although not significantly (Van Beers, 2009). The existence and the perception of innovation deficit have induced large firms to exploit various strategic options for capturing both incremental innovations and new disruptive technologies. Firms were required to successfully combine M&A activities, strategic alliances, and licensing deals alongside conventional in-house R&D (Mittra, 2007). As both of the analyzed industries are characterized by a very intense competition, which has at its base the continual drug discovery, firms try to patent every new idea they have. This happens mainly because their future profit depends on their ability to retain competitive advantage, which comes from their capacity to innovate (Nerkar and Robert, 2004, in Purchuri, 2006). While individual R&D skills often need to be cultivated over time within the firms, as they are rarely available on the market (Dierickx and Cool 1989, in Purchuri, 2006), firms found the opportunity to resort to acquisitions in order to obtain the scientific capabilities of other organizations (Ruckman, 2005 in Purchuri, 2006).
From a strategic management point of view, the majority of M&As deals in the pharmaceutical industry, are stimulated by intense competitive pressures within the industry. Therefore, in order to better respond to the global competitive pressures, companies in the sector have been making big bets on achieving economies of scale and scope through M&As (Demibarg et al, 2007).
11 3.2 The performance of M&As
Whether M&As create or destroy shareholder value has been researched by several scholars. According to a study published by A.T. Kearney, which covers 135 large-scale international deals from 1993 until 1996, 58% destroy shareholder value, two years after the merger (Breggren 2003). Coles (2002) showed that although the volume and value of M&As across all industries, have considerably increased, only 17% of these M&A have created significant value for the shareholders, while 50% have reduced it. In addition it seems that the costs of failed M&As are higher than the gains of successful deals (Hedberg, 1998-in Breggren, 2003).
There have been written and published lots of studies regarding the performance of M&As but not so many focusing especially on pharmaceutical and biotechnology industries.
Danzon et al. (2005) state in one of their studies that drugs developed in pharma-biotech alliances perform much better than drugs developed solely in-house by a pharmaceutical or biotechnology company.
Being able to continuously innovate is crucial in both industries: pharmaceutical and biotechnology, therefore it is an important factor to be considered when deciding whether to merge/acquire or not. The effects of M&As on the innovation performance have been discussed over the past years in a controversial way (Prange & Opgenhoff, 2007). Most of the studies have found that the acquisition have a negative impact on the innovation performance of the acquiring firm (Ahuja & Katila, 2001, Ornaghi, 2004). Sometimes companies involved in a merger or acquisition tend to decrease their investments in their internal development of innovation, as they tend to focus more on standardization and formalization (Prange & Opgenhoff, 2007). Even if the M&As is successful in terms of integration of R&D and innovation processes, it may fail in other areas of business, which may lead to a disintegration of the new company (de Man & Duysters, 2005). On the other hand, M&As may raise the R&D budgets of firms involves, allowing them to reap economies of scale and enabling them to get proceed in developing larger R&D projects (de Man & Duysters, 2005).
aspect, because it can impact the performance or the failure of the deal. The findings of their study reveal that companies that engage in gathering pre-acquisition information, will generate positive abnormal returns for the shareholders. Thus, by using a three day event window, the two authors mentioned above, find an average abnormal return of 3.91% (significant at 1%) for acquirers and an average abnormal returns of 16.0% for the targets. Same findings regarding the importance of pre-acquisition information were also published by Prabhu et al. (2005). Contrary to these results, the research done by Ravencraft and Long (2000) showed that only the target companies register positive abnormal returns, why the acquirers experience negative returns.
By making use of event studies, Mendiratta and Singh (2008) prove that M&As lower shareholder value and increase market risk. Even more they compare the deals that aim to specialize vs. those signed with the aim of diversification, and they find out that the first category experience declining stock performance.
3.3 Method of payment
Choosing between the existing methods of payment is important because it will affect the performance of the deal. Only few studies have researched the impact of method of payment on the performance of M&As in the pharmaceutical and biotechnology industries. Though the chosen way to finance a deal in this industry may be a crucial fact for its further success or failure.
The financial crisis impacted the M&As activity in all the industries. One of the main impacts of the crisis was the unavailability of cheap credit. Pharmaceutical industry seemed to be one of the “safest”, as 2008 brought some mega-deals (Mittaranda and Singh, 2008). The reason behind this was the fact pharmaceutical companies are cash rich, but if that amount of cash was or was not properly have yet be researched more in detailed.
According to the multitude of empirical studies in different industries, conducted until now, cash offers are generally associated with stronger improvements than deals involving other forms of payment (Linn and Switzer, 2001; Ghosh, 2001; Moeller and Schlingemann, 2004 –from Martynova et al., 2006). One possible explanation could be that a cash payment is frequently financed with debt and debt financing restricts the availability of corporate funds at the managers’ disposal and hence minimizes the scope for free cash flow problems (Martynova et al., 2006). Although several researchers came up with findings indicating that cash-financed deals are more beneficial to bidding firm’s shareholder, there were also authors (Healy et. al-1992) who suggested that the method of payment has no effect on bidder accounting performance (Haleblian et al., 2009). Other authors (Haleblian et al., 2009), reported no material differences in operating performance between cash-financed and stock-financed deals. Still some differences were found in the announcement and post-acquisition market returns; these were lower for stock-financed deals.
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rich companies, and managers may tend to find different projects to invest in, like expanding the firm beyond the size that maximize the shareholder wealth (Jensen, 1983), which will lead to value destruction. Another explanation comes from the Free Cash Flow Theory. Paying the cash to shareholders may reduce the resources that are under managers’ control, which means that their power is also reduced, and this is why managers will try to spend cash no matter what and on companies which don’t properly address they real needs, instead of directing that money towards projects that may enhance the innovation capabilities of the firm (Chaudhuri and Tabrizi, 1999).
Regarding the importance of the method of payment in pharmaceutical and biotechnology industries, the following hypothesis will be tested:
H1: Acquirers that choose cash as a method of payment outperform acquirers
choosing other methods of financing. .
3.4. Deal Size
The impact of transaction value on the performance of the deal was well researched and almost all the findings suggested the same: that mega-mergers will destroy value. A recent study have shown that mega-mergers, which account for 43% of mergers outlays destroy value, while the medium- and small-size deals create value. (Bayazitova et al., 2010). This is significant for the two industries analyzed in this paper, as in 2008 mega-mergers have played a leading role in these sectors.
Harding and Rovit (2004) have examined more than 1700 public companies (including pharma and biotech firms) and their deal history between 1986 and 2001. They have found out that the most successful companies have been involved in several small deals, rather that few mega-deals.
strategic innovation, which may lead to failure. Managers also tend to forget that getting involved in mega-deals is not easy as most of the time they face problems like having to bring together two large companies with two different structures and not necessary like-minded (Skarzynski & Caccini )
Focusing on pharmaceutical and biotechnology industries, a study by KPMG International concluded that 83% of the 700 most expensive acquisitions during the period 1996 to 1998 were unsuccessful in producing any major benefit with regard to shareholder value (KPMG, Report, 2009b)
Given all these, and especially given the current situation in pharmaceutical and biotechnology sectors, the scholars are asking themselves why do managers still choose to get involved in mega-mergers. The second part of this paper will attempt answering this question by researching if the latest mega-mergers have registered positive or negative returns. Therefore we have decided to state the following hypothesis:
H2: Small and medium deals perform better than mega-mergers.
3.5 Cross-border vs. domestic M&As
Cross-border M&As have been always considered much more complex than domestic deals, as they have to take into consideration the differences in the economic and political environments or culture (Sudarsanam, 2003). According to existing literature review, cross-border M&As represent a way of entry in a foreign market or a strategic way of creating value by taking advantage of the target’s knowledge base (Shimizu et al, 2004). The second scenario is also applicable to pharmaceutical companies, as they are searching for new ways to maintain and further develop their innovative capabilities in order to be able to remain competitive.
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from cross-border M&As, but only if they can apply superior management techniques. Performing a study on 65 pharmaceutical and biotechnology mergers and acquisitions, Ravencraft and Long (2000) registered positive abnormal returns (4.25%) for acquirers involved in cross-border deals. Danzon et al. (2004) assume in their research focusing on pharmaceutical and biotechnology M&As, that is more efficient and also cheaper for the acquiring companies to get involved in cross-border deals than to try and build a foreign subsidiary. Therefore it is expected for the cross-border M&As to create value for the shareholders of the acquiring companies.
On the other hand, authors like Seth et al.(2000) or Eckbo and Thorburn (2000) showed that cross-border acquisitions are not generating higher abnormal returns for acquirers.
Considering that pharmaceutical and biotechnology firms, by entering foreign markets are trying to find new ways to improve their innovative capacities, I am expecting that cross-border M&As. will have a positive influence on the short-term performance of acquiring firms.
H3: Cross-border M&As will have a positive influence on the short-term
performance of M&As in pharmaceutical and biotechnology industries.
3.6 Target’s innovation capabilities
Considering this, the knowledge base of the acquired company plays an important role in the future performance of the deal. According to Ahuja and Katila (2001), acquiring a larger knowledge base may enhance a firm's absorptive capacity, which may lead to a better performance. Other studies have also showed that as a firm will expand its internal knowledge base and technological capability, it will also enhance its ability to better absorb the external knowledge (Cohen and Levinthal, 1989).
As said before, innovation is a key factor in both industries analyzed. Therefore the last hypothesis tested is:
H4: Target’s innovation capabilities will have a positive impact on the
performance of acquirers.
4. Methodology
In this section I will present how data was collected ad the applied methodology in order for the above mentioned hypothesis to be tested.
4.1 Data
Information about the deals, such as acquirers’ and targets’ location, method of payment and deal value were collected from the following databases: Zephyr, Thomson One Banker and Capital IQ. The adjusted stock prices were also taken from these databases.
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targets there were no restriction on geographic area, because of the patent expiration issue, and also due to the fact that some markets relaxed their regulation regarding foreign investment, pharmaceutical companies from North America and Europe became interested in emergent markets, such as India or Brazil.
The following deals were excluded from the sample:
1. Deals including acquirers with stock prices not available in the used databases. 2. Deals where the deal value was not published.
Given the above mentioned criteria, the final sample consists of 125 deals. For some of the deals the method of payment was not available in neither of the used databases. Furthermore, Tables 3.1, and 3.2 offer an overview of the total sample and of the acquirers characteristics.
Table 4.1: Sample characteristics
Variable
No. of deals (%)TOTAL
Domestic 64 ( 51.2%) 125 (100%) Cross-border 61 (48.8%) Cash payments 60 (48.0%) 125 (100%) Stock payments 15 (12.0%) Mixed payments 38 (30.4%) Unknown payments* 12 (9.6%) 100% acquisitions 110 (88.0%) 125 (100%) Minor acquisitions 15 (12.0%)
Table 4.2: Sample characteristics of acquirers
*North America consists of Canada and US, and domestic deals were considered only if both the acquirer and target were from US or for Canada.Same for Europe.;
** For some transaction the method of payment was not specified in the three databases used.
As it can be seen in Table 4.2 the majority of the acquirers are based in United States of America and Canada. When talking about M&As in pharmaceutical and biotechnology sectors, the biggest role is playing by US companies.
Furthermore, Table 4.3 is presenting the sample characteristics regarding the size of acquirers and targets, taking into consideration the number of employees each company has. Given the existing literature the firms are being split into four categories: micro-firms (having less than 10 employees), small firms (with more than 10 employees, but less than 49), medium firms (with no more than 249 employees) and large firms (which have more than 250 employees) (Benkert, 2004). For a better classification of the large firms and in order to find a more clear relationship between acquirers’ size and targets’ size, in this paper we have split them into three sub-categories: 251 to 500 employees, 501 to 1000 employees and firms with more than 1000 employees. Data
Variable
North America(% of total deals) Europe (% of total deals) Domestic* 59( 47.2%) 5 (4.0%) Cross-border 27 (20.8%) 34 (27.2%) Cash payments 38 (30.4%) 22 (17.6%) Stock payments 12 (9.6%) 3 (2.4%) Mixed payments 28 (22.4%) 10 (8.0%) Unknown payments** 7 (5.6%) 5 (4.0%) 100% acquisitions 78 (62.4%) 32 (25.6%) Minor acquisitions 8 (6.4%) 7 (5.6%)
Deal value >=1 bn EUR 8 (6.4%) 5 (4.0%) Deal value< 1 bn EUR 77 (61.6%) 34 (35.2%)
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about the number of employees was collected from Zephyr and Amadeus Databases but also from official websites of the companies.
Table 4.3: Firms’ size
*for some companies the number of employees couldn’t be found
Data about target innovation performance was collected from USPTO database.
4.2 Methods
4.2.1 Acquirers performance (CARs)
In order to estimate the wealth effects for acquires, the short-term event window method had been used, and more specifically I have chosen to use the three-day event window. According to Andrade et al. (2001), this is one of the most commonly used event windows for M&As studies. One advantage for using the short-term event window is that its results are not so sensitive to the model hosen for expected returns. Another aspect is the positive correlation between the short-term abnormal stock returns and long-term post-acquisitions increases in operating cash flows (Healy et al., 1992).
Cumulative abnormal returns (CAR) for the event windows (-1,+1), where day 0 represents the announcement day provided by the above mentioned databases, are calculated in order to express the performance of the deal. In order to calculate CARs, first abnormal returns are calculated, using the market model (MacKinley, 1997).
Abnormal returns are defined as the difference between the actual return and the expected return of an individual stock. Therefore an estimation window has also been used. The estimation window, represents the period preceding the event window. The event window itself is not included in the estimation window, because if it would have benn, it might influence the normal performance model parameters estimates (MacKinley, 1997).
For any stock i, the market model is defined as:
R
it= α
i+ β
i* R
mt+ε
itt=-285…-20 and E(ε
it=0) (1)Rit and Rmt represent the returns for the stock i and the market portfolio for time t.
The benchmarkt for this research si the FTSE World total return index. It has been chosen at it comprises 2700 Large/Mid Cap stocks from FTSE Global Equity Index Series and it covers 90-95% of the invested market capitalization in the world (www.ftse.com).
In order to find the values of parameters αi and βi the market model regressions for
each acquirer company in the sample. Then the abnormal returns were calculated as:
AR
it= R
it– (α
i+ β
i* R
mt)
t=(-1,+1) (2) , where • ARit represents the abnormal returns for stock i at the time t.• Rit represents the return of stock i for time t
• Rmt represents the market return for time t
After calculating the abnormal returns, cumulative abnormal returns for the three-day event windows are defined as :
CAR
[-1,+1]= Σ
(-1,+1)AR
ii=-(1,+1) (3)
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prices. If by applying the t-test we see that the null hypothesis has been rejected, than it means the announcement of the deal has a significant impact on the share prices.
4.2.2 Variables that can influence cumulative abnormal returns
In this study three factors that may have a great impact on cumulative abnormal returns have been taken into consideration: method of payment (MoP), deal value (DV), type of deal (cross-border vs. domestic deals) and target’s innovation performance (Tinn). These variables have been selected as, according to the majority of studies in the area of M&As, they have a big influence on the performance of the deals. Having a positive or a negative impact on the returns gained by shareholder, they much be taken into consideration when choosing to research the performance of M&As. Of course other variables have been included in past researches, but I have chosen only these for my research, mainly because I strongly believe these are the most relevant for the industries and the time-period I am focusing on.
It is interesting to study the impact of method of payment because it is known that pharmaceutical companies are cash rich. Because of this, together with the fact that they need to find quick solution to innovate and remain competitive on the market, they may use their cash in order to acquire other companies, even if those don’t really meet their needs. Method of payment consists of three main categories:
1. cash payments , when only cash or debt is used to finance the deal; 2. stock payments, when only shares are used for the deal to be financed. 3. mixed payments include a combination of stock, cash and/or debt. Furthermore, method of payment is divided into the following control variables: 1 if the deal is paid with cash, 0 otherwise.
used as an independent variable as according to the literature very large deals will have a greater impact on CARs, which doesn’t meat it has to be a positive one. Therefore M&As with a transaction value over 1bn EUR will be codified with 1, and the small or medium deals with 0.
The third variable used is the innovation performance of the targets. Target’s innovative capacity is relevant as pharmaceutical and biotech are two of the most innovative industries. Moreover, innovation is one of the key driver of M&As in these two sectors. Some of the most used variables in the existing literature in order to measure the innovation performance are: patent applications, R&D expenses or revenue growth from new products. This paper will use the number of patent applications as an indicator for innovation performance. Data about patent applications was collected for targets, for the last five years before the announcement of the deal. Because the study is applied to two of the most innovative industries, pharmaceutical and biotechnology, it is expected that the innovation performance of the acquired company to impact the CARs.
The fourth variable that could have an impact on the CARs of acquiring firms is the type of deal: cross-border or domestic. In my sample the number of cross-border deals is almost equal to the number of domestic deals, but because of the need to discover new drugs and to find new innovative ways of doing that, pharmaceutical and biotechnology companies seem to explore more and more foreign markets, and especially emergent markets. For cross-border M&As a dummy variable has been created. Therefore 1 has been attributed to cross-border deals, and 0 to domestic deals.
In order to be able to see the influence of these variables on CARs, univariate analysis, interaction effects between each two independent variables and a multivariate analysis are applied, using the ordinary least square regression (OLS). For the multivariate analysis the following formula was used:
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5. Results
5.1 Results CARs for acquirers
This section describes the empirical results of the study. First Table 5.1 is presenting the descriptive statistics of cumulative abnormal returns (CAR).
Table 5.1 Descriptive statistics of CARs registered by acquirers CARs for Acquirers
Mean 0.0056534
Maximum 0.5374044
Minimum -0.2614937
Std. deviation 0.1056475
%positive 44.8%
According to the descriptive statistics, 44.8% (56 out of 125) of the acquirer companies have registered positive cumulative abnormal returns. The mean is 0.56% and it is also positive, which suggests that many of the acquirers have registered positive abnormal returns, associated with a better performance.
5.2 Univariate analysis
5.2.1 CARs by method of payment
Table 5.2 is presenting the descriptive statistics for acquirers’ CARs taking into account the chosen way of financing their deals.
Table 5.2 Means of CARs for acquiring firms by method of payment
Although all the three results are positive, when comparing the mean of CARs for the above presented methods of payment, cash financed deals generate higher CARs for the acquirers than stock or mixed payments. While mean of CARs registered by acquirers who paid only with cash are 0.9%, the one registered by acquires who decided to pay using only shares is 0.3%. For the mixed payments the outcome is only 0.04%. Even if the average CARs for cash is higher than for stock or mixed payments, by calculating the t-statistics, it resulted that the differences between these is not significant.
27 5.2.2 CARs by deal values
The next table, Table 5.3 presents the means of CARs by deal values.
Table 5.3 Means of CARs by deal values
Taking into consideration the average CARs for acquirers, it can be stated that those who get involved in larger deals do benefit more than those who prefer small and medium-size deals. With an average CAR of 6.35% large deals outperform small and medium deals. Applying a mean-comparison test, a t-statistic value of 2.13 resulted, and with a p=0.04, the difference between the two variables is significant at 5% level. Although most of the literature has shown that in time large deals do not perform well, the results from this study may be explained by the usage of a short-window event and also by the fact that it comprises deals completed less than 3 years ago. The results represent the market reaction to the announcement of two valuable companies, and it may be expected that by joining such valuable capabilities to perform even better. Instead integration problems may appear and it may also be impossible to make to different large organizations, with two different cultures to perform at maximum level (Skarzynski & Caccini). This is why the overall performance of mega-deals may change after a longer period of time.
5.2.3 CARs by deal type (Cross-border vs. domestic)
Table 5.4 presents the means of CARs when splitting the deals into cross-border and domestic deals.
No. of observations
Mean of CARs
Deals >=1 bn EUR 13 0.063511
Table 5.4 Means of CARs by deal type
As it can be seen, domestic deals registered a higher mean of CARs (1.89%) compared with cross-border deals (0.82%). After applying a mean-comparison test, it can be stated that the difference between cross-border and domestic deals is not significant (p=0.78, t=0.26).
In order to see if cross-border deals have a positive or negative impact on CARs, a linear regression model has been used. Therefore, the results obtained showed that domestic acquisitions have positive influence on short term performance of acquiring firms, while cross-border have a negative influence, but the results are not statistically significant (coef.=-0.0292, t=-1.55, p=0.125).
5.2.4 CARs by Target’s innovative capacity
Target’s innovative capacity is an important factor when talking about the performance of M&As in pharmaceutical and biotechnology companies, mainly because these are two of the most innovative industries.
Using the sample of 125 deals presented in section 4.1, the impact of target’s innovative performance on CARs was tested using a linear regression model. The results obtained showed that this variables has a significant (5% level) positive impact on short-term performance of the acquiring firms (coef.=0.03767, t=2.21, p=0.029).
Because innovation is one of the key drivers of M&As in pharmaceutical and biotechnology sectors, and because the period analyzed has been characterized by the return of mega-deals, the impact of target’s innovative performance on the deal value was also tested. The results showed that target’s innovative performance indeed has a highly
No. of observations
Mean of CARs
Cross-border deals 61 0.008273
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significant (at 1% level) positive influence (coef.=0.0087, t=3.57, p=0.001) on the amount spent by the acquiring firms.
These results show that targets with better innovative capacities will produce higher abnormal returns for the acquiring firms. In the same time the acquiring firms will also spend more money in order to buy a company that had developed a larger knowledge base and innovative capacity.
5.3 Interaction Effects
Following the univariate analysis, it was interesting to see if the interaction between the used variables change the impact on the cumulative abnormal returns in a significant way.
Table 5.5 presents the results obtained by interaction of each two independent variables used in this paper.
Table 5.5: Interaction Effects
*Significance at 5% level ** Significance at 1% level
As the results in the above table point out, there are only two cases which are statistically significant. These apply to the interactions between shares and deal value and to deal value and target innovation. Both have a positive influence on cumulative abnormal returns gained by acquiring companies.
CARs Coef. T-value P>[t]
Cash X CrossB. -0.01004 -0.43 0.667 Shares X CrossB. -0.07089 -1.42 0.159 Cash X Deal Value 0.04538 1.13 0.262 Shares X Deal Value 0.21879 2.01 0.047* Cash X TInn 0.02780 1.12 0.266
Shares X TInn 0.09621 1.23 0.221
Also except the cases in which method of payment (cash or shares) interacts with the Cross Border variables, all the other new created variables have positive effects on cumulative abnormal returns. When applying a univariate analysis the variable Cross Border had a negative impact on CARs, but when interacting it with variables like Target Innovative capacities or Deal Value, shows a positive impact on CARs.
As it had been shown before, shares, as method of payment has a negative influence on CARs. Though, when interacting it with other variables like target innovative capacities or deal value creates a positive influence on CARs.
5.4 Multivariate analysis
After testing the impact of each variable on CARs, last part of this section will focus on the multivariate analysis. Here all the variables mentioned above are included. The dependent variable is represented CAR. The other variables used are Method of Payment (MoP), Deal Value (DV), Type of the deal (Cross_border) and Target innovativeness (TInn).
Before getting to see the impact of the independent variables on CARs a correlation has been made in order to verify if any two variables exhibit linear dependence. In order to see the dependence between the variables several correlation coefficients may be used. The most common, and also the one used in this research is Pearson correlation coefficient. I have used this coefficient as it seems to be more sensitive to linear relationship between any two variables, while the other coefficients are more sensitive to non-linear relationship.
Because for 12 deals method of payment was not specified, the sample was resized to 113 transactions.
31 Table 5.6: Correlation matrix
CARs Cash Shares DV Cross-B. TInn
CARs 1.0000 Cash 0.0399 1.0000 Shares -0.0097 -0.4163 1.0000 DV 0.1899 0.0610 -0.0593 1.0000 Cross-B. 0.0610 -0.0826 0.0610 -0.0437 1.0000 TInn. 0.0251 -0.1238 0.2560 0.1109 -0.1244 1.0000
Table 5.7 presents the results obtained from the linear regression.
The only significant results are for deal value (5% level of significance) and target innovative performance.
The results show that large-deals have a significant positive impact on CARs registered by acquirers. Hypothesis two is therefore also rejected, when we take into account the short-term three day event window. As mentioned before, this result is the market reaction to the announcement of the deals. Therefore M&As with higher transaction values, may be seen as powerful companies, which have all the resources to succeed. Despite this, as studies using longer event studies have shown after a period from the start of the integration process, the situation may change, and large-deals may fail (Harding and Rovit, 2004, Skarzynski & Caccini).
The results on target’s innovative capacity are the expected ones. As shown by the univariate analysis, this variable has a positive and highly significant impact on the short-term performance of acquiring company. Therefore hypothesis four is fully supported.
Comparing the results for all cash payments and shares payments, it can be stated that cash finance deals have a stronger impact on CARs. Although both all cash and shares have a positive influence on CARs, the results are not significant.
Table 5.7: OLS Regression Results
CARs Coef. T-value P>[t]
Cash 0.00568 0.25 0.801 Adjusted R-squared =0.04
Shares 0.00290 0.09 0.930 Deal Value 0.06603 2.07 0.041* Cross-B. 0.01381 0.68 0.500 Tinn 0.03721 2.18 0.031* Const. -0.02979 -1.34 0.182 *significance at 5% level
6. Discussion
Following Chapter 5., this section will discuss more the results obtained, the implications and limitations of the research, as also it will point out further research directions.
Starting with the short-term performance of the acquiring firms, this study showed that almost half of the companies included, generated positive abnormal returns. The overall average of the cumulative abnormal returns was also positive (0.56%). This result supports prior studies, which also concluded that mergers and acquisitions create shareholder value (Andrade et. al, 2001, Danzon et. al 2004, Higgins and Rodriguez, 2004). With a mean of cumulative abnormal returns of only 0.56%, comes in supporting also the study done by Mendiratta and Singh (2008), who showed that acquiring pharmaceutical companies involved in M&As register overall low abnormal returns, but it doesn’t support the research done by Ravencraft and Long (2000), as they registered negative abnormal returns (-2.1%) for their sample of 65 pharmaceutical mergers and acquisitions.
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other authors in prior researches focusing on pharmaceutical and biotechnology industries, but also on other industries, like for example telecommunication industry (Linn and Switzer, 2001, Martynova et al., 2006). Although these findings support prior literature, they contradict the results found by Higgins and Rodriguez (2005), who applied their study to pharmaceutical and biotechnology sectors, and who registered higher abnormal returns for deals finance with equity than for those financed with cash only. As shown in the literature review part, the issue created by the method of payment is not yet solved. The opinions are different and while some studies showed that cash finance deals outperform equity finance deals, other concluded the opposite, while a third category came up with findings showing that there is no significant difference between the method of payment (Haleblian et.al, 2009). Although, by using short-term event windows, it had been demonstrated by several authors that cash financed deals outperform deals financed using other methods of payment, further research should be conducted, using also long-term event windows in order to see if the results are the same. Even then the conclusions may be contradictory, as the success or failure of M&As are impacted by other factors also.
The stated before, the results from the univariate analysis showed that Shares as a method of payment has a negative influence on acquirers’ cumulative abnormal returns. Still, as the interaction effects proved, using shares as a way of financing large deals, has a positive and statistically significant influence on cumulative abnormal returns of acquiring companies.
If cash has proved to have a positive impact on cumulative abnormal returns, interacting the method of payment with type of deal the results showed that no matter which method of payment (cash or shares) had been chosen, there will be a negative influence on the performance of the deal.
with a foreign company with a totally different culture. As Aw. and Chatterjee (2004) also state that acquiring firms gain more from cross-border M&As, only if they can apply superior management techniques.
The fact that Cross-border as an independent variable has a negative influence on cumulative abnormal returns when being analyzed separately, and a positive influence when interacting with other variables such as target innovative capacities or deal value, indicates in a clear way that acquiring companies should take into consideration factors like the ones mentioned above when deciding whether to get involved or not in cross-border mergers and acquisitions.
The results for deal value and target’s innovative capacity were the only significant (at 5% level). The hypothesis regarding small and medium size deals outperforming large deals was not supported. This study registered higher abnormal returns for large deals than for the others, which in one way contradicts the former studies done by Skarzynski & Caccini or different consultants from KPMG. The difference between this research and the above mentioned ones, which can also explain the contradictory results, is the event-time taken into consideration. While this paper focuses on a three day event window, which mainly show us how the market reacts to the announcement of a merger or acquisitions, the other focused more on post-acquisition period. Even though in the beginning a merger or acquisition involving two large companies may have all the chances to succeed, as it can be assumed that they have for example large knowledge bases, which can further lead to innovative products, after a period these could fail, because of not being able to properly integrate their technologies and to accumulate their knowledge. During the period included in this research (2008-2009), pharmaceutical and biotechnology industries have experienced the return of mega-mergers (Pfizer and Wyeth, Merck and Co. and Schering-Plough , Roche and Genentech), which raised the average size of deals and which may force other important players in the market to get involved in large deals in the near future.
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(univariate and multivariate) this variable showed a positive impact on cumulative abnormal returns gained by acquiring firms, which is a logical reaction taking into consideration the fact that innovation plays a key role in both of the analyzed industries. Moreover acquiring new innovative technologies and developing the R&D process is crucial for pharmaceutical companies, considering that lots of their blockbuster drugs face the loss of patent protection.
Also interacting deal value with target innovative capacities, it was proved once more time the positive impact on the cumulative abnormal returns. This comes one more time as a support of the existing literature and of the univariate and multivariate analysis. Both variables are key factors that can significantly influence the success or failure of mergers and acquisitions in pharmaceutical and biotechnology industries.
6.1 Implications of the research
Because of the industries, the time frame and the chosen variables this study : • comes as a support to the existing literature review in the area of
short-term performance of acquiring firms involved in pharmaceutical and biotechnology M&A;
• brings new results, by applying the research to a recent period of time (2008-2009);
• takes a new approach by including variables such as target’s innovative capacity and method of payment or deal value, while the majority of prior research papers focused either on innovative performance or on short-term financial performance;
• offers a perspective on how M&As in pharmaceutical and biotechnology performed during the economic crisis, as they acted differently from the others industries, mostly because of their characteristics (cash rich, so that financing was not an issue, and the accurate need to innovate in order to face the patents expiration problem);
performance of the acquiring companies who got involved in deals recently announced. Therefore they can have a perspective about how things evolved in the area of M&As in the two sectors, and about how the market perceived it.
6.2 Limitations and further research
One first limitation of the study may be the fact that this paper does not take into account all the determinants that could have a significant impact on acquirers’ abnormal returns. Some of the variables were excluded due to lack of available data, mainly because the studied period is a recent one. Therefore, a further research would be necessary in order to include also factors like acquirers’ and targets’ existing knowledge base or R&D expenditures. I have suggested these two factors because they are relevant in order to measure the innovation performance of the companies from pharmaceutical and biotechnology industries.
A second limitation may come from the methodology used. According to Zollo and Meier (2007) short-term market reaction to the announcement of horizontal acquisitions is positive whereas the long term equivalent is negative and significant. Therefore it would be interesting to do the same research using a longer period of time, in order to see the differences.
This is an empirical study, but it would be interesting also to combine it with a qualitative one. As further research it can be examined how managers or the employees from the key departments of the companies (mostly R&D in the case of pharmaceutical and biotech), see and perceive the announcement of the deals.
7. Conclusions
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because they have not followed the patterns during the economic crisis. Being cash reached and dealing with problems regarding patent expirations for important drugs, M&As activity in these sectors has not been slowed down.
The sample I used consisted of 125 deals from North America and Europe, deals announced between January 2008-December 2009. Based on existing literature I have formed four main hypothesis related to the influence of cash payments, deal value, deal type and target innovation on cumulative abnormal returns for acquirers.
From calculating the cumulative abnormal returns for the event period (-1,+1) with day 0 the announcement day, the overall results showed that despite the economic situation for that period of time, almost half of the acquiring companies have registered positive cumulative abnormal returns (44.8%). As stated in the results and discussion chapters, three out of four hypothesis were supported. The fact that one of the hypothesis (the one regarding the deal value) was rejected, may have an explication in the type of the event window used.
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