OVERVIEW OF THE DEAL
Thermo Fisher Scientific Inc and PPD have signed a definitive agreement leading to the acquisition of PPD Inc. PPD offers a broad range of clinical research and laboratory services aiming at accelerating innovation and increasing drug development productivity of clients. PPD is one of the most significant leaders in the $50 billion clinical research services industry, which is growing faster and faster. PPD has more than 26,000 employees working in more than 50 countries. In 2020, the company generated revenue of $4.7 billion. Once the deal is over, PPD will become a huge asset of Thermo Fisher's Laboratory Products and Services Segment.
Thermo Fisher's shares increased by 3.46% after it was official that the two companies' boards had reached an agreement concerning the proposed $20.9 billion cash and debt acquisition. Thermo Fisher will buy PDD at $47.50 a share; paying $17.4 billion in cash and will take over an estimated debt of $3.5 billion. The purchase price represents a 24% premium to PPD‘s common stock price as on April 13, 2020.
As PPD is a leader in the clinical research services industry, PPD should strengthen Thermo Fisher's scientific prospects and ambitions in a growing and highly competitive industry. The acquisition should enable Thermo-Fisher to invest more in high added value departments. “The acquisition of PPD is a natural extension for Thermo Fisher and will enable us to provide these customers with important clinical research services and partner with them in new and exciting ways as they move a scientific idea to an approved medicine quickly, reliably and cost effectively," said Marc N. Casper, CEO of Thermo Fisher.
Company Details: Acquirer – Thermo Fischer Scientific
Founded: 2006
Headquarters: Waltham, MA, United States
CEO: Marc N. Casper
Status: Public
Number of Employees: 80,000+
Market Cap: $124 billion
Revenue: $30 billion
EBITDA: $10.1 billion
Thermo Fisher Scientific Inc. is an American healthcare company created in 2006 after the merger of Thermo Electron Corporation and Fisher Scientific and run by Marc N. Casper since then. Thermo Fisher Scientific specializes in the design, manufacture and marketing of laboratory equipment and scientific instruments. Its products and services break down as follows: laboratory equipment (65%) which includes chemical products, consumables as well as packaging, warehousing and storage services, scientific analysis instruments (21%) which encompasses analyzers, mass spectrometers, molecular spectroscopes and so on and diagnostic equipment and products (14%). The US makes up for 50% of the revenues, followed by the EU for 25%. Thermo Fisher has grown very fast through many acquisitions. Among these subsidiaries, Thermo Scientific, Applied Biosystems, Invitrogen, Fisher Scientific, Unity Lab Services and Patheon are the most important one. Among its major shareholders are The Vanguard Group, which holds nearly 7.5% of the equity, followed by Capital Research & Management Co and SSgA Funds Management, which hold 4%.
Company Details: Target - PPD
Founded: 1985
Headquarters: Wilmington, NC, US
CEO: David Simmons
Status: Public (Private 2011-2020)
Number of Employees: 26,000+
Market Cap: $16 billion
Revenue: $4.99 billion (TTM)
EBITDA: $0.76 billion (TTM)
PPD, which went public on the Nasdaq last year, is a Contract Research Organization (CRO). CROs are helping biopharmaceutical companies through research outsourcing. More precisely, PPD helps make the drug development process shorter and cheaper through clinical development and laboratory services thanks to its more than 26,000 employees across 46 countries. It proposes solutions to make all four phases of drug development, from the start of development to the approval of the medicine more efficient.
The market on which PPD is involved is said to be around $55 billion, with all of its services being in sectors expected to grow by 6 to 9% per year. In this market, PPD is one of few consolidated and global competitors, also competing against niche CROs and biopharmaceutical companies’ R&D services. The company relies on a large and diversified customer base, its responsible operational approach, its scale and its reputation to be competitive. PPD’s operations span America, Europe, Asia and Oceania, for instance with facilities in the US, Germany, Singapore or Australia among tens of others.
The company went private when it was bought by two private equity firms, The Carlyle Group and Hellman & Friedman, in 2011 for $3.9 billion. In 2017 these two shareholders were joined by branches of the Abu Dhabi Investment Authority and of GIC, Singapore’s sovereign wealth fund. Since 2011, the new leadership has implemented a mainly external growth strategy with acquisitions along with several strategic alliances and joint ventures.
SYNERGIES
Revenue Synergies ($50 million in run-rate expected)
Given the activities of the companies, the merger will likely benefit from cross-selling opportunities. Indeed, the portfolio of clients of each company is a group of potential new customers for the other. It will allow both companies to gain market base. Their positions within the value chain of the pharmaceutical industry makes it easier to design a new offering combining both companies’ activities to help laboratories develop drugs (PPD offering services and Thermo Fisher equipment).
The acquisition would allow Thermo Fisher to benefit more from the development of Covid-19 drugs and vaccines. Thermo Fisher already supplies drug ingredients to many laboratories, but PPD could gain more clients in the drug development process as governments and drug makers invest in newer treatments. PPD has already been hired by Moderna for the development of the vaccine. The CEO of Thermo Fisher confirmed to Reuters it was a growth acquisition. As all the trials that were postponed due to the pandemic are now ongoing and as Covid-19 has boosted demand for clinical research services, PPD would largely benefit from the situation over the next few years.
The acquisition of PPD by Thermo Fisher would allow the company to gain trust from potential new customers that already recognize Thermo Fisher’s value proposition. As customers in the pharma industry need strategic, high-quality and confidence-inspiring relationships with their suppliers, PPD would be able to prove its ability to reduce the time and cost of drug development processes.
Cost Synergies ($75 million in run-rate expected)
Thermo Fisher expects mostly economies of scope as the company will be able to combine the supporting functions for the new range of products. It will be able to cut duplicated costs, such as administrative, IT, marketing, sales, and distribution costs. Thermo Fisher and PPD should also obtain better purchasing terms with suppliers.
However, there could be costs when implementing the synergies between the two companies, as each company develops different solutions for their customers. The expertise within the industry may not be sufficient to overcome the obstacles brought by different company structures.
RISKS AND UNCERTAINTIES
First and foremost, regarding certain financial aspects, the industries in this sector seem to have their hands tied. Dependence on government funding policies or customer capital spending policies increases the financial risk of the merger in the long term. Also, with the Biden presidency, the effect of changes in government regulations weighs heavily and makes the future uncertain for mergers in such large industries. In the Thermo Fisher report, the industry highlights its concerns about currency fluctuations on international transactions.
Eventually, incompatible corporate cultures are responsible for more than 85% of failed M&A deals. Historically, Thermo Fisher and PPD are opposites. Indeed, Thermo Fisher is an American multinational with 75,000 employees, also known for its lobbying activities in the United States or its non-compliance with certain European environmental regulations. Although PPD is a large pharmaceutical company with 24,000 employees, it is still three times smaller than Thermo Fisher. These strong differences between Thermo Fisher and PPD pose a risk regarding the cultures of these companies.
FINANCIAL CONSEQUENCES
Considering the net income resulting from the acquisition and the value of synergies over the next three years, estimated at $125m and $90m after tax, the deal seems to be accretive: Thermo Fisher’s EPS is expected to increase by 16,5%. By looking at the yield of the acquired entity (2,81%) - meaning the price paid by Thermo Fisher relative to the expected net income of PPD one year forward – and comparing it to the foregone interests on cash of the company (1,91%), we can confirm the deal’s profitability since the former is greater than the latter. Therefore, this acquisition is supposed to create value for shareholders. Aside from the reasons mentioned above, another factor in the accretion is that the deal is only paid in cash, without any share issuance. This result is in line with expert’s analysis, expecting an immediate and significant accretion to Thermo Fisher’s adjusted EPS. In the first 12 months, it is supposed to go up by $1,40, which corresponds to a 6,8% increase whereas we found 16,5% since we considered the expected value of synergies over three years.
Our calculations of both companies’ net debt and EBITDA one-year forwards conclude in a multiple of x1.06 for Thermo and x2.63 for the merged entity to be. We are looking at a $33b of net debt for the new entity and an EBITDA of $12.6b. The staggering $17b bid for PPD is a consequential amount coming from a $30b-in revenue company. This sum is to our eyes a fair excuse to expect Thermo’s rating to decrease at least one slope. However, Fitch is confident in Thermo Fisher’s ability to deal with heavy transactions, based on past experience with the company. So the upcoming x3.0 multiple of gross debt to EBITDA will not shake Thermo’s BBB+ ranking according to the rating agency. Fitch says Thermo has a good record of debt repayment and expects the pharmaceutical to maintain the aggressive M&A momentum it is riding right now.
IS THIS DEAL FAIRLY PRICED?
When adding the bid for PPD and its financial debt, then comparing it to EBITDA, we find a transaction multiple that does not seem too outlandish: x19.05, nearing the industry’s median of x24,7 (Bloomberg). Thermo Fisher can pride itself in having found an advantageous acquisition, which indeed seems to be cheaper than the average of its peers.
Based on the latter figure, we expect the stated $125m in synergies to add a little over $3b in value to the new entity. This comes out as surprising considering the premium stated in the press release is significantly higher at over $4b (corresponding to a reported 24% of the $17.4b announced bid).
We can however come to terms with this unevenness given Thermo Fisher got a cheaper-than-average acquisition multiple for PPD. What is more, shareholders may rejoice in the fact there will be no dilution to the share structure, and they can expect to earn 16.52% more in earnings per share.
Overall, we deem the deal to be reasonably priced, and we assess that Thermo Fisher can afford the hefty premium when considering the many advantages we found.
MARKET REACTION AND PROBABILITY OF DEAL COMPLETION
As close of 15th April trading day, one day after the deal was announced, PPD’s share price reached $46.31, a bit more than one dollar below the offer price per share of $47.50. This immediate positive stock move was naturally incentivized by the fact that the deal appears to be friendly, considering CEO’s reactions in front of the press, meaning a strong probability of deal completion at the price agreed. Most analysts were not surprised by this news as this segment is consolidating very much in the United States. Furthermore, Thermo Fischer had already acquired similar companies in the recent years (e.g. Patheon N.V. for $7.4 billion in 2017 and FEI Company for $4.1 billion in 2016) and the market is not worried on the capacity of the firm to manage properly this acquisition, hence a neutral reaction on Thermo Fischer stock