Equities  

Big pharma provides boost to healthcare sector

This article is part of
UK Equity Investing - May 2014

Although the past five years, since the lows of the financial crisis, have witnessed an extreme and prolonged rally for equities, particularly developed market equities, one of the major components normally seen in a rally, merger and acquisition activity, has been largely absent.

In a buoyant market companies tend to be confident, tend to have a lot of cash to spend and tend to use that cash to buy other companies.

But that has not been happening since the financial crisis as, in spite of the improvement in equity markets and the gradual recovery in the global macro economic conditions, businesses have remained very hesitant to actually spend their cash in fear of another market crash or a recession.

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However, in recent months M&A has returned to the markets, especially western developed markets, and it has been driven by the healthcare sector in particular.

Proposed deals, and other rumoured deals, have combined to boost sentiment to the healthcare sector - and have dominated headline to such an extent that debates have even extended to parliament. Most of the UK healthcare stocks have been propelled upwards in the process.

This movement in the healthcare sector has proved a significant boon to many UK-focused equity funds, especially equity income funds which tend to have quite a high weighting in the large pharmaceutical firms.

Deal-doing

The M&A activity began with a huge deal between UK-listed drug giant GlaxoSmithKline and Swiss pharmaceutical firm Novartis. The two firms decided to swap certain divisions between them and also to form a joint venture between their consumer health units.

As part of the deal, GlaxoSmithKline bought Novartis’ vaccines division for $7.1bn while Novartis took control of Glaxo’s cancer business for $16bn, with the two firm’s swapping divisions to both focus on their core, profit-generating activities.

Because GlaxoSmithKline received much more money from the deal from Novartis, it has pledged to return a significant amount of cash from the deal, around £4bn, to shareholders in the form of a special dividend.

The combination of the cash returned to shareholders and the positive reaction to the tie-up with Novartis from analysts meant that shares in GlaxoSmithKline rose substantially after the deal was announced, though it has since given back some of those gains.

Glaxo’s fellow pharmaceutical giant on the FTSE 100, AstraZeneca, has risen by far more in recent weeks following a potential takeover bid from US firm Pfizer.

The shares rose as soon as the first rumours came out that Pfizer would be interested in making a bid, but they have since surged even higher when Pfizer revealed it would look to make a bid that valued AstraZeneca at $100bn, which was a significant premium to AstraZeneca’s share price at the time.

The shares are now at £46, 24 per cent higher than when the rumours first hit the markets one month ago. The company continues to resist the advances for now, as politicians mumour about potentially intervening to protect a key source of jobs and demand assurance from Pfizer of benign intentions.