Synergy Pharmaceuticals (NASDAQ:SGYP) is a biopharmaceutical company focused on the treatment of gastrointestinal diseases and disorders. The company has developed and received FDA approval for Trulance to treat chronic idiopathic constipation (CIC) and it is moving forward on a separate sNDA to be submitted for irritable bowel syndrome with constipation (IBS-C). The company is also developing Dolcanatide for the treatment of ulcerative colitis (UC) and opioid-induced constipation (OIC).
In short, Synergy is positioned for success. It has a well-differentiated, FDA approved drug that would only be the third prescription product to enter a market that is expected to grow at double-digit rates. It has a diversified pipeline with multiple growth opportunities, a strong patent portfolio and hold 100% of the worldwide rights.
Critical to drug development and commercialization, having recently increased its cash position, Synergy should have sufficient cash on hand to move forward for some period of time, but how long is a question based on its burn rate and, beyond development, nothing burns cash like creating a commercialization structure from scratch. Still, with a quick ratio over 1.0, the company appears to be in a solid financial position. As with any pharma/biotech, the essential question for Synergy going forward is, how do we accelerate market access and take full advantage of the commercialization potential of our approved products and existing pipeline?
The Small Firm Challenge
The ability to take full advantage of a market opportunity is a big challenge for a small company because it is the small pharma/biotech firms that, while possessing innovative products developed by smart minds, have difficulty fully reaching the potential market because they lack the complete value chain activities required to cultivate the relationships with the healthcare providers needed to promote and sell their products. It is often for this reason that the smaller firms look to the larger ones to partner or be acquired. In truth, the final winning strategy for many larger firms involves making acquisitions early in the life cycle of a new industry or product line, long before most others recognize that it will grow significantly.
For example, Johnson & Johnson (NYSE:JNJ) pursued this strategy in its early acquisitions of medical-device businesses. When Johnson & Johnson bought device manufacturer Cordis in 1996, Cordis had $500 million in revenues. By 2007, its revenues had increased to $3.8 billion, reflecting a twenty percent (20%) annual growth rate. It is not imprudent to suggest it was the professional level capabilities of J&J's marketing and sales arm that made possible what Cordis had not. Further, J&J purchased orthopedic-device manufacturer DePuy in 1998, when DePuy had $900 million in revenues. By 2007, the DePuy sales had grown to $4.6 billion, also at an annual growth rate of twenty percent (20%). Again, suggesting high level commercialization capabilities at play. While based on one company, this is admittedly a narrow view. Still it is illustrative and makes the point that commercialization in the hands of capable, experienced firms offers greater potential success.
But, how does this relate to Synergy, given that the company has received FDA approval for Trulance and appears to be seeking its own path toward full commercialization?
The answer is that going it alone might not be the answer. In fact, the reality is that twenty-six percent (26%) of small- to mid-sized pharma/biotech with new drug approvals were acquired in the past two years.
Further, the evidence is clear that bigger firms are more interested in bolt-on or tuck-in acquisitions than megamergers, as ninety-four percent (94%) of pharma/biotech M&A in those same two years were priced at under $5 billion.
To be sure, there is no magic formula to make acquisitions successful, though there are drug companies like Allergan (NYSE:AGN), J&J, Teva (NYSE:TEVA), and Gilead (NASDAQ:GILD), among others, that have had success in buying and integrating other firms, both big and small. Like any other business process, acquisitions are not inherently good or bad. Each deal must have its own strategic logic when executing. In the most successful deals, acquisitions have specific, well-articulated value creating ideas that drive growth; such as pursuing geographic or product markets, filling portfolio gaps, building up a therapeutic area, or acquiring skills, knowledge or technology. Simply and relevantly, bigger firms with their established commercialization capabilities have the scale that allows an acceleration of the drug into the market.
Still, there are those investors who recognize there is notable value for a small firm to commercialize their own pipeline, either directly by going it alone or more indirectly through a partnership. So when we consider the competitive landscape and the opportunities therein, as was well articulated here, it becomes clear the strategic choices for Synergy are three-fold: 1) Go it alone, 2) partner with a larger firm, or 3) be acquired.
It is important to note and safe to say that these choices infer that management and the Board of Directors for Synergy are at a strategic tipping point that requires choosing from among these scenarios. While I will make my choice apparent and discuss why, I would be remiss if I did not make clear the concept of scenario analysis that I just invoked. I do so because there have been articles about companies that have cited scenarios as the basis for arriving at a decision. Yet, I find there is often an absence of discussion to provide clarity about the concept and how it applies to the analysis rendered. Making a choice and arguing it is based on scenario analysis may be true, but it can also be misunderstood. And, absence of appropriate grounding, it may be little more than flashy inference. My purpose in writing is not to impress or give investment advice. Rather, it is to discuss strategic issues for readers to consider, such as the one Synergy finds itself in.
So, where to begin on scenarios without unnecessarily expanding the discussion or diverging from the point of its value to use in the decision facing Synergy about fully commercializing its product pipeline? Let's start with the concept itself.
The Genesis of Scenarios
World War II created the need to understand that things do not always turn out as planned. Consequently, the Allied powers sought to offer specific descriptions of different futures that might unfold and this led to an effort to suggest multiple and distinct choices for each future that required the need to summarize and synthesize variables into a coherent picture. And, based on the outcome of the war, it seemed to have worked for the Allies.
When we see success we can often expect others will mimic the behaviors that led to the success (after all, that is often the point of benchmarking and best practices review, as people infer the need to mimic the success of others. Of course, where it goes wrong is when people adopt rather than adapt these practices to their uniquely different organization). So, we should not be surprised that the world of business proved very adept at mimicking the concept of scenario analysis.
Post WW II scenarios were first used in a business setting by Shell Oil, as it examined oil price variability and patterns of consumption. Subsequently, it employed scenarios to help decide how to shift financial investments and, among other things, to make decisions about production capacity and whether to upgrade refinery output.
To be clear, scenarios are the means to anticipate the future. But they are not predictions of the future; nor snapshots of end points; generalized views of a single future with a few options; nor the product of experts. Rather, they are descriptions of alternative futures with unfolding stories that are focused on multiple options. They are also the result of management insight and perceptions. So, alas, the quality of management matters.
The power of scenarios is rather simple, they help reduce uncertainty and enable organizations to develop relevant strategy by expanding thinking (what might happen vs. what's expected to happen). They also serve to challenge the current perspective that recognizes the limits of individual experience and they embrace multiple choices that offer greater adaptiveness to the contextual situation.
I suppose we can acknowledge that the only certainty about the future is that it is uncertain and past success does not guarantee future success. Though this may seem somewhat simplistic, bear with me as I offer a few real world examples of people facing scenarios and making choices that, retrospectively, did not work out well because the situations were far from simplistic:
"Come quick, we have them." Dispatch to Major Frederick Benteen from Lt. Col. George Armstrong Custer; June 25, 1876
"The Japanese do not sell cars Americans want." Frederick Donner, Chairman of GM; 1960
"No need for anyone to have a computer at home." Kenneth Olsen, CEO of Digital Equipment Corp; 1977
"Existing home sales to trend up in 2008." National Association of Realtors; 2007
But, as macabre as it may seem, my favorite is this…
"They couldn't hit an elephant at this distance." Reportedly the final words of the highly decorated Union Army Major General John Sedgwick just before being killed by a sniper at the Battle of Spotsylvania.
So, the evidence is clear, prognosticating the future has not worked out for some experts. What about us mere mortals who seek to peer into an elegant algorithm that offers unique data? In the words of Ray Dalio…"He who lives by the crystal ball will eat shattered glass." Or, as the Chinese saying goes, they may suffer "ling chi" (death of a thousand cuts).
Now this does not mean that an effort to forecast the future is entirely futile or that data analytics are inherently bad. In fact, various and different organizations (businesses, governmental agencies and the military) use competitive intelligence and environmental scanning as a means to gather data to inform decisions. However, it is worth noting that all our decisions about the future are based on information and/or data about the past. While we can agree that data analysis is essential, so is the review and consideration of options or choices that aid in problem solving.
It is with an understanding that scenario analysis is a means to problem solve, as it is about the process of exploring multiple possible futures so that we can employ options that make the scenarios valuable and offer logic for a final choice that makes the most sense because it solves our problem. Yet, we can say with impunity that all too many companies make strategic decisions based on a single prediction of the future - what is often deemed to be the "inevitable". This means decisions are being made on single point forecasts that often fail to account for different possible futures, none of which might be inevitable.
Broad examples of statements made about industries based on a single point of view of the future include one of my favorites that came before the advent of Apple's (NASDAQ:AAPL) iPhone in 2007, which revolutionized the cell phone industry. However, up to that point the all-knowing experts had decided that cell phones would always be a commoditized product (based on low negotiated cost), so the purchasing power would always be in the hands of the carriers. Except that creative destruction of that thinking occurred, courtesy of Apple and the maniacal focus of Steve Jobs.
On a more granular level is an interesting example of a misplaced understanding of the future, upon which significant decisions were made. Whether they were ultimately right or wrong is not the point and cannot actually be discerned. What is most notable is the example comes courtesy of a well-respected firm - IBM (NYSE:IBM).
So it was that, on the basis of a single point forecast of 295,000 personal computer sales for the decade of the 1980s, IBM ended up making significant investment decisions that resulted in actions that outsourced the microprocessor to Intel (NASDAQ:INTC); outsourced its operating system to Microsoft (NASDAQ:MSFT); and focused internal efforts toward developing mainframes. To say the forecast was off "slightly" is charitable. In the 1980s, 25 million personal computers were sold (roughly 85 times the forecast).
These changes involved no small decisions, as they altered IBM's strategic direction and required the company undergo radical change. While we see that IBM did adapt and flourish today as a highly profitable company, it is in a different competitive market place. Was the decision the right one? The example is not meant to suggest there was or is a right answer. But it does argue that IBM got the question wrong. Still, one cannot help but wonder how it would have turned out if it had undertaken scenario analysis? (Perhaps Lenovo (OTCPK:LNVGY) would still be a small computer repair shop in China).
I ask that because we know organizational failures occur for very specific reasons: 1) There is a limited perspective (single point views suggesting the inevitable) that fails to understand the key issues, underestimates obstacles, stubbornly relies on what worked in past, and limits the search for information. 2) There is a failure of effective analysis often led by a rush to judgment that is frequently driven by ego, power, greed, or fear of failure. 3) There is an inability or unwillingness to manage ambiguity. 4) There is fear of uncertainty or risk exposure, and a desire for easy answers. 5) There are poor decision-making practices that we see manifested in such failures as an inability to clarify the problem, identify alternatives, involve others in problem solving, and effectively identify the desired outcome.
Scenarios and Synergy
As it relates to Synergy, it is reasonable to argue that we are working on three presumptive scenarios - 1) Go-it-alone; 2) partner with a larger firm; or 3) be acquired. So, which of these scenarios offer the best options for future success? Let's explore the possibilities.
According to management, a robust supply chain has been established and samples of Trulance are ready to be distributed this quarter. Still, management has not provided much further information regarding its manufacturing capacity and this was a point of concern prior to the PDUFA date. As with anyone outside looking in, I do not presume to know the facts, but I do know that management in many companies, across a range of industries, are confident in their ability to achieve goals like an effective product launch - that is, until they are not.
Based on what we know from the discussions promulgated by the company itself at formal presentations, we cannot presume Synergy has the ability to fully commercialize Trulance because it does not possess the internal structural capabilities beyond a small internal effort that is designed to guide rather than lead an outsourced effort.
If the old adage is true - structure follows strategy - the determination of long-term goals and objectives, the adoption of courses of action and the associated allocation of resources required to achieve goals demand the need for a defined structure as the design of the organization determines how strategy is administered. Changes in an organization's strategy, even if merely adaptive, lead to administrative challenges requiring a new or refashioned structure for the implementation of the new strategy. And for small, independent pharma firms it is even more problematic when they lack the structure to control. Therefore, to suggest that commercialization can effectively occur through the use of an outsourced service is to misunderstand the business realities and seems to negatively reflect on management, raising the obvious question - Do they really know what needs to be done?
On that point I will jump to one conclusion. Given the presence on the board of directors of a well-seasoned senior executive in commercialization, it is fair to say the lack of a robust commercialization function should not be lost on the company (as we do expect directors to be interested in results). Perhaps it is why nearly a third of the Leerink presentation deck (February 15, 2017) was focused on the topic.
Still, according to research by Bain, the drug industry has not yet adjusted its launch approach to the new competitive realities. One indication of this is that about half of all launches that arrive at the peak sales range not only miss expected sales levels, but they also miss them by fifty percent (50%) or more, which gives a whole new meaning to 50-50. Now that is some miss and should argue for re-thinking the approach to drug launches.
According to its recent presentation at Leerink, Synergy believes the prescription market is growing significantly (slides 8 & 9), with potential growth over the next few years projected to be 2X or 3X the current market. Driving this growth are changing demographics born of an aging population seeking to have a healthier lifestyle and the reality that there are currently only two prescriptions approved by the FDA, which are garnering a mere 5% of the market. In fact, the bulk of the market is carried by sales of OTC products that include suggested lifestyle changes in diet and exercise. Yet, with this market growth potential, Synergy seems to have suggested employing a tactical approach to an early launch of Trulance that includes packaging. To wit, Synergy intends to have not only bottles, but also blister packs that it suggests will serve as a reminder to patients to take as prescribed and, according to information they received from healthcare professionals, will enable the patient to efficiently use the product to achieve the greatest efficacy. While a reasonable approach, this focus is about the consumer using the product. The real question is how Synergy gets the actual product to the patient in the first place?
Synergy has also said Trulance will be priced on parity with Linzess. Does this make sense? Some observers argue that a truly innovative product is highly differentiated and this generally means that it is clearly superior in some way to the competition and should garner a higher price point. While seemingly grounded in logic, this argument fails to capture the reality that any discussion of differentiation will be dependent upon Synergy's ability to deliver on the promise, as noted in sentence ending the previous paragraph. But can it?
We need to keep in mind that merely having a novel product does not confer a pricing advantage. The whole topic of advantage (competitive and comparative) is worthy of a separate discussion, but is best saved for another time. Still, it is fair to say that even experienced senior managers make mistakes when making these claims. Before I regress, let's return to the point about pricing and its purpose, which is to garner greater profit from the market share captured.
At the Leerink presentation, management cited a variation of Pareto Analysis (aka, the 80/20 rule) and sought to imply that a focused effort on the subset of physicians doing the majority of prescribing would enable a cost-effective approach to gaining market share as a chosen commercialization strategy. This is great information and argues the obvious commercialization opportunity, which is exactly what mature pharma commercialization efforts are noted for, and another reason of concern that if Synergy misses the launch curve, it will find itself in the nether regions inhabited by those potentially great drugs that are ineffectively commercialized. I make this point because it is not merely that a company knows where to sell, it must have the capabilities to execute the sales. And, this raises another issue.
While we can applaud management for the scientific and technical knowledge necessary to enable the company to arrive at this point, it does not mean it possess the requisite skills to run an actual business operation. Beyond product development, the question is whether Synergy's management team possesses the capabilities to manage the entire value chain - all the primary and secondary functions.
Here is the hard truth. All too often the questions about the skills of management get lost when some genius develops a great idea. There is the belief that since they are "geniuses" they can do anything. Usually the caption accompanying that claim includes a picture of Steve Jobs. This is a mistaken impression. The fact is the skills necessary to develop and manage a business go well beyond that required to develop a novel product or service. While Sergey Brin and Larry Page might be conceptual math geniuses and began the development of Google (NASDAQ:GOOG) (NASDAQ:GOOGL) aka Alphabet, as a business, it was the experience of Eric Schmidt that helped the company to fully monetize its intellectual capital. Great ideas and science are essential, but management matters, and it is no less true in pharma/biotech because management is responsible for creating the organizational structure and support staff necessary to engage and enable business success.
Now, there are those who might argue that this effort to commercialize is nothing more than a ruse to help negotiations toward a partnership or acquisition. Perhaps, it is. But it does raise a corollary question: Is Synergy even on the radar screen of bigger pharma?
Of course it is. After FDA approval of a product in a growth market with few competitors, if Synergy is not on the radar screen of bigger pharma firms then the highly paid people in the business development departments within those firms are asleep at the switch and, since identifying said targets is how they earn the big bucks, we can presume they know about Synergy - particularly if they work for Allergan or Ironwood (NASDAQ:IRWD). Part of the job of business development is environmental scanning and collection of competitive intelligence. These efforts include analysis and understanding of all external aspects that relate to the markets, competition, and consumers. In fact, they know chapter and verse about companies that are developing what drugs, particularly those drugs that could be a potential competitor or might offer an opportunity for their big firm to acquire as a means for product line extension, entering new therapeutic areas, or accessing new geographic or product markets.
Having the aforementioned as a predicate, we should explore and discuss the three scenarios that offer a strategic choice for the future.
The Three Scenarios and Supporting Discussion for Making the Best Choice
Scenario #1: Go it alone.
Absent an established commercialization function, Synergy's management has planned to use a contract sales force, but will also include company regional account specialists; ostensibly to provide coordination they believe will give Synergy more control over their sales strategy, yet retain the flexibility to cut the sales team should a appropriate suitor come knocking.
At first blush, one might think this makes sense. But does it really? My experience with outsourced services is that such relationships are not grounded in the organizational mission, vision and values nor can they be because they are a commoditized service born of negotiations - good or bad. However, I would agree outsourcing does offer some flexibility because it does not require a financial commitment beyond the terms of the contract that would have an escape clause should the firm be acquired. Still, without a robust commercialization effort, it remains the company may miss out on the window of opportunity afforded to it by the low barriers to entry, the limited established competition at the script level, and the creative destruction likely with a consumer move from OTC products to prescriptions due to greater awareness and interest.
All too often pharmaceutical companies do not maximize their return when bringing a new drug to market, resulting in a failure to gain or maintain any competitive advantage in the marketplace. This is usually because of the all too common pitfalls in commercialization that include: inadequate or inaccurate competitive intelligence, an unconvincing value proposition, and misguided execution. This brings us to a point about big pharma.
Big pharma has invested internally in developing the requisite means to gather competitive intelligence that informs strategy, business decisions, product development, and marketing plans. They have done so because they know that inadequate data, misunderstanding the competitive market, or misperceiving organizational strengths will hinder or prevent effective commercialization efforts. Strong commercial execution is grounded in competitive intelligence. Without being properly informed, errors can easily occur in any one of the four Ps (product, place, promotion, and price).
Speaking of pricing, the actual pricing of a new product is a major decisional point and elemental to the commercialization effort. Research by Booz Allen Hamilton shows that healthcare providers are unlikely to prescribe a higher priced drug without clear and significant additional benefits. Moreover, insurance companies are unlikely to support reimbursement, which influences consumer decisions, and there is the ever-present government concern about the evils of inappropriate drug pricing.
So a go-it-alone effort by a small firm can be significantly impaired because they simply cannot know what they have not experienced. For example, small and even mid-scale pharma/biotech often will not anticipate that an established competitor will retaliate to protect existing market share. This failure in awareness is a mistake born of inexperience and, not surprisingly, the same aggressiveness occurs in new pharmaceutical product launch campaigns. Savvy, competitive firms - most notably Bristol-Myers Squibb (NYSE:BMY) and Novo Nordisk (NYSE:NVO) - form teams and create plans to "counter-launch" against potential new products that threaten their current or future product sales and market share. Counter-launching companies may deploy many other strategies or actions to preempt new product launches and these can include legal, regulatory, or payer limitations on market access. Is Synergy prepared and able to counter such efforts from an entrenched competitor? In truth, how do we know its capability extends beyond interest?
In looking at the biggest problems facing the pharma industry, one essential way to prepare for counter-launches and overall product launch success is to conduct a series of competitive simulations or business war games (another mimicry of the military). The best pharma competitors start conducting these simulations in late Phase II trials or early Phase III and continue to conduct them every three to six months in key markets to ensure that the entire, extended launch team is fully prepared for both the launch and competitive counter-launches (help me dear reader, if I have missed such a discussion by Synergy). These companies usually take a "Multi-Level Competition" approach by considering ways not only to win at the brand level, but also at their own or their competitor franchise, portfolio, and corporate level. They may also employ simulations for global, regional, or local markets, as well as the use of specific situations such as the release of new clinical data or a major professional conference, or with certain departments/functions or stakeholder groups, such as medical affairs or payers.
Then there is the issue of simply not being able to get the commercialization job done. How about an example?
Developing an extensive clinical-stage cancer pipeline isn't cheap, and, unfortunately, the effort by Merrimack Pharmaceuticals (NASDAQ:MACK) to turn itself into a top player in the pancreatic cancer drug market saddled the company with "profit-busting" ongoing operating expenses and a high-risk balance sheet.
With its cash stockpile expected to run dry in 2018, and following disappointing mid-stage trial results for another one of its drugs in December 2016, the company agreed to a deal in January 2017 to sell its novel drug, Onivyde, and its other oncology assets. The net benefit to Merrimack? It gets money, a good thing because selling Onivyde and its oncology assets returns Merrimack Pharmaceuticals to being a clinical-stage company with all the incumbent problems. This comes after a 2014 partnership with Shire (NASDAQ:SHPG) to commercialize Onivyde. Do we even need to ask how that worked out? No, it is obvious with the sale.
The concluding point on Scenario 1: Should Synergy go-it-alone? Neither the organizational structure nor industry history supports the notion that nascent abilities will win the day. So my answer is no, Synergy should not go it alone.
Scenario #2: Partner with a Larger Firm
Well, from the Merrimack example offered in the previous scenario, we know that partnerships do not always turn out as expected. In looking at an analysis of the worst drug launches of all time, sitting at number one, according to Motley Fool, is MannKind (NASDAQ:MNKD) and its launch of Afrezza.
MannKind has an inhalable insulin product - Afrezza - that will go down as one of biopharma's biggest disappointments of all time. Many believed that Afrezza's inhaled rather than injected dosing was going to catch on like wildfire and be that blockbuster all pharma & biotech dream about. But the reality is the demand has been sadly lacking. Some have suggested the ever-so slow sales stem from worries over lung safety or perhaps that because injections "work just fine" for the vast majority of patients. Interestingly, on the question of lung safety, where was the discussion of this potential "safety" issue during FDA deliberations? But that is a point attempting to mislead. The real question is whether injections really "work fine" for patients. Having had my father contend with injections, I know he would have much preferred an inhalable drug. Still, if made aware of such choices, he would be faced with a decision to substitute one differentiated product, that he had a satisfying experience with (it did what was supposed to do), for another judge based on the manner of its application and based the insights offered by his doctor.
But even absent the deference older patients afford medical professionals how would any patient know this substitution was available unless the healthcare provider told them? And, how would the healthcare professional know unless the sales and marketing rep from the drug company sold them on the product?
Now heretical I am not, but I think this is where it gets interesting from a Machiavellian perspective. The initial commercialization of Afrezza was by MannKind's partner - Sanofi (NYSE:SNY). Yes, the same Sanofi that sells injectable insulin.
Far be it from me to suggest there may well have been some mitigating interests that might have inhibited Sanofi to "go all in" to sell healthcare providers on a drug that could be taking sales away from its own product line. But it is clear that the Sanofi-MannKind relationship ended March 2016 and MannKind sought to commercialize on its own, using a contract sales force. However, less than one year later, specifically on February 1, 2017, MannKind announced a move away from a contract sales force to creating an in-house sales force. It is hard to even look at what is happening with Afrezza. But I hope someone at Synergy is if for no reason other than as a means to inform and educate the company on the tenuousness of commercialization in highly competitive markets.
Still, I would be misleading the reader to not admit there are a number of companies that have used partnerships in various ways to achieve commercial success. So, it can be said that engaging a partner is a viable scenario to examine, particularly if the point is to gain access to a commercialization function rife with experience and replete with established relationships with a range of healthcare providers.
Forming partnerships is much less complicated and significantly less costly than trying to go it alone. Still, it comes down to those three little words - It just depends. Some examples? Of course.
The recent strategic move by Celgene (NASDAQ:CELG) to invest about $1 billion in cash and stock in Juno Therapeutics (NASDAQ:JUNO) underscores the continuing advances in biotechnology that lend themselves toward creating partnerships. Of course, the field of oncology certainly offers partnership opportunities for firms with the right fit for the right price. But the question of partnerships is really informed by the resources desired, such as the competencies possessed by the partner, and the vagaries of the market the drug developer wishes to compete within. When dealing with risky drug development, as in the field of oncology, partnerships do provide management with a reduction in costs and risk exposure. No small issues for smaller firms.
I would argue that a partnership might be less risky than going it alone, as a partnership would offer Synergy an established commercialization operation that would likely perform better in the near term than the go-it-alone approach as currently discussed by the company. Still, the mitigating factor working against partnerships is that smaller firms will not receive the full value of drug development over time that would be gained by going it alone.
The concluding point on Scenario 2: Should Synergy Pursue a Commercialization Partner? The answer is a qualified yes. And the qualification is that a partnership should be pursued only if it offers access to a workforce with established relationships with healthcare professionals that extend the market reach beyond Synergy's current outsourced labor force, guided as they may be by in-house personnel. Further, the negotiated deal should have clear milestones and language about performance issues that might arise, as noted in the MannKind and Merrimack examples. If so, this would be the better choice to going it alone. Still, is it the best choice? Well, let's explore the remaining scenario.
Scenario #3: Be Acquired
While the drug industry will continue to pursue M&A to replenish drug pipelines, the strategies are different this time around (at least in comparison with 2014-2015). Rather than seeking greater scale, drug companies are seeking to focus on their strengths and organizational capabilities. As a result, we see more divestitures, asset swaps and acquisitions. Companies have decided they cannot be all things to all people, so the highly diversified pharma company of yesterday makes less sense today. What the companies are saying is that they want to focus on what they do well. Consequently, this is creating less interest in establishing partnerships and more on completing M&A that can offer growth through cost savings born of a more efficient company. The focus on efficiencies is made obvious by the commercialization capabilities of the pharma firms that want to become a market leader, particularly where the market has strong growth and few entrenched competitors. In truth, the mantra is that a company should become a leader or stay out of the competition. And, it is hard to become a market leader when sharing revenues, and harder still when a partner may not find your success in its own longer-term best interests.
Now to be certain, just because a firm wants to be acquired, and just because it may make sense for a bigger firm to buy it, does not mean it will happen. There are complexities to consider.
Synergy has a product approved by the FDA (Trulance), which removes much of the inherent risk assumed in earlier stage acquisitions. But, with a proof of concept drug, it also means the price to acquire Synergy would be much higher.
Still, M&A is about pricing properly and pricing a business for purchase is very different than pricing a single product or service, or even a group of them. And for acquirers it is not as simplistic as looking at the market cap and adding in some average or above-average premium. Measuring the value of an acquisition is less an exact science and more a manner of "business alchemy." All too often, the measure of value in M&A has been the study of a relatively short-term market reaction; as if what is done in a few weeks according to outside observers really tells us whether a company completing the acquisition, with its particular set of competencies and core capabilities, is able to effectively monetize the value of the assets it has purchased.
I am always struck by analysts who expound on the brilliance of a specific M&A effort from their outside view based on short-term actions and data limited by the past. One such merger involved two companies that were highly respected - Newell and Rubbermaid; now Newell Brands (NYSE:NWL). Yet, this much endorsed and ballyhooed merger crushed shareholder value, created great turnover and organizational upheaval, while also managing to reduce revenues. The grand slam of organizational ineptness. And from the most recent quarterly results, it appears the struggle continues.
As is known by those who have spent time looking at issues in M&A, dysfunctional culture clashes often are a major reason for the failure of M&A efforts to return shareholder value. Yet, investors, analysts, and others seem to think that since the purpose that companies exist is to make money, two good companies with reduced costs and complementary products should drive value because their combination reduced the costs of operation, created productivity gains and seemingly reduced the decisional bureaucracy. Alas, it is not that simple. Organizations and their management cannot be reduced to the outcome of an algorithm made possible by even the most astute financial analysts.
Among other M&A misunderstandings is that, if we buy into the idea of bigger is better because of cost accommodations and synergies (no pun intended), does it make small- or mid-scale firms less attractive to larger firms?
The answer is unequivocally no. In fact, twenty-six percent (26%) of small to mid-sized pharma/biotech with new drug approvals were acquired in the combined years 2014-2015. And, over that same time frame ninety-four percent (94%) of M&A deals were under $5 billion, suggesting that bigger pharma values bolt-on or tuck-in acquisitions rather than megamergers.
We can see this affinity for bolt-on/tuck-in acquisitions when looking at the highly acquisitive firms over the past few years: Allergan, Merck (NYSE:MRK), Pfizer (PFE]]), and Roche (OTCQX:RHHBF), all big proponents of this strategic approach (of course, there was the failed Allergan/Pfizer merger that suffered more from a political defeat than a self-inflicted wound. Still, it may be why they now sing from the same "small bolt-on/tuck in" hymnal). Oh by the way, Allergan has a gastrointestinal regime and it partners with Ironwood Pharma on Linzess.
But Synergy being acquired is not a slam-dunk and it is because of organizational complexities. So, let's talk about this.
While my strategic choice from among the scenarios has Synergy being acquired (or an unlikely merger with a smaller or equal sized firm), the fact is that long-term results in M&A for companies varies because long-term returns vary significantly by deal pattern, by industry, and by market dynamics. The argument by some is that across most industries, companies with the right capabilities can succeed with a pattern of smaller deals. Perhaps so, but in large deals industry structure plays as much of a role in success as the capabilities of a company and its leadership. For pharma, it is usually more about specific product markets. But this should be no surprise. In fact, McKinsey (January 2012) took a look at a decade's worth of non-banking M&A and found some startling results that followers of pharma should grasp.
Specifically, the larger a firm gets, the more it relies on M&A as its vehicle of growth. With the rising costs associated with product development in pharma, the days when established firms committed twenty percent (20%) plus of its revenues to R&D are in the rear-view mirror. Recognizing the long and costly road that begins with a patent and ends with commercialization, companies have come to recognize the ability to grow is enhanced when buying a firm that has already made the leap past development.
In fact, seventy-five percent (75%) of all firms in the Fortune 500 use active M&A to grow and ninety-one percent (91%) of those in the top 100 complete myriad deals that are usually small, bolt-on/tuck-in acquisitions that make for ease of organizational integration (less equally strong organizational cultures to clash) while seeking to accomplish market entry and expansion.
Still, a pharma business is inherently more difficult to value and in no small part because there are more unknowns than one would find in mature manufacturing or consumer products businesses. In those industries, revenue projections are easier to predict. And, as mentioned previously, new drug launches can be notoriously tenuous, with success more uncertain.
With all of this uncertainty, is being acquired the best choice for Synergy from among the scenarios?
I believe it is, and my logic rests on the belief that being acquired is the least perilous option because it immediately reduces uncertainty for shareholders and analysts. The questions of cash burn rates and operational efficiencies go away. Yes, I am talking about enlightened investor self-interest. Therefore, the reduction in or removal of uncertainty is not something to be dismissed lightly.
The concluding point on Scenario 3: Be acquired. In sum, for Synergy to be acquired best manages the strategic challenge at hand, that is to gain access to a learned, capable, robust commercialization effort that transcends a partnership and extends beyond the ability to go it alone. For Synergy the point is to minimize or balance its risk and reach a growth market with a sufficiently differentiated product that enables it to compete on more than price.
This means that management must make the responsible and strategic choice for all stakeholders and "arrange" to be acquired (notice I did not say "seek" to be acquired). I am sure the bankers would line up to help since they get really nice fees for this type of work. And, of course, the management and employees of Synergy will be rewarded handsomely and immediately.
The hope of a big buyout premium has lured many investors into smaller pharma/biotech stocks over the years. Sometimes those deals never transpire, as we learned from 2016 when compared to the previous two years of record M&A. But 2017 is a new and likely different year for M&A, particularly given the changing political landscape. However, we must recognize the competitive dynamics have also changed.
To expect acquirers looking for an opportunity to grow to only be big pharma is to misunderstand the need for growth faced by pharma & biotech of all sizes. Similarly, we need to be clear that in pharma/biotech M&A assumptions drive the valuation. But far from wild guesses that conform to that old adage, assumptions are educated, sometimes intuitive assessments that often include but are not limited to the following:
Analysis of the target's fundamentals, market, tech, IP
Analysis of the target's management - their collective experience, track record, incentive structure, organization, composition and involvement of the Board of Directors
A Five Forces Analysis of the target that includes: dependencies on suppliers (relationships) & customers, substitute products (generics, OTC), rivalry among competitors, barriers to and threats of market entry
Evaluation of the current and future market potential
Review of the financial, political, & legal issues pertinent to the target
Sales estimations (including peak sales models) developed by the really smart development people inside the potential acquirer
An analysis of the delta in time to market under the three scenarios
An analysis of market penetration under the three scenarios
The fact is today strategic buyers are flush with cash and looking to jump start revenue growth or move into adjacent markets. Private equity has huge amounts of capital and leverage available and is looking to acquire or back unique opportunities when there is a projected high growth rate. With banks and hedge funds also willing to lend at five to seven times cash flow in many instances, there is no wonder that equity funds are pursuing available and unavailable assets with such vigor that double-digit multiples are not uncommon. But only when the firms looking to be acquired are well-priced businesses that offer a novel product in a growth market, along with a product pipeline that can be developed at a lower cost than if developed internally, and with fewer barriers to market entry. In short a company like Synergy.
From my perspective as both a strategist and investor, while trying to use facts and analysis to avoid the inherent threats of a crystal ball, it appears the best strategic choice for Synergy is Scenario #3 - Be acquired. And, as with hitting a baseball, timing matters. I suspect current shareholders would be reasonably happy if Synergy were to be acquired right now, at the right price. This as opposed to suffering the potential indignities of competing in a highly competitive environment armed with good intentions, but little experience. With that, I am sure someone is wondering - Acquired at what price and by whom? Well, that is an article for another time or, better yet, someone else to write.
Disclosure: I am/we are long SGYP, GILD, AGN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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