Acquisitions of Small-Medium Pharma Companies in EU

Many Pharma companies in EU suffer a size problem. When revenues are below 100 M€ is extremely difficult to survive in a market where to renew the portfolio is increasingly costly, as well as to pay the regulatory demands, which grow year by year (environmental regulations, verification, wastes processing, plastics control, etc...). Additionally, the easy solution of playing in the Generics Market does not work anymore, mostly due to the devastating price erosion in major markets (France, Germany, Italy and Spain). These companies use to be a family property and their operations do not exceed the regional scope, say, Spain plus Portugal, France plus Benelux, Germany plus Austria …). They do not generate own resources (cash flow) for financing the growth or at least for keeping the position.

The immediate solution might be to look for an external financial tool. Banks are discarded, due to interest rates. Investment Funds are not an option, because the EBITDAs are low and in general the private equity do not trust in small companies too much. And the management in these companies is very personalized (a family member) with poor understanding on multinational financial environments.

We could say: the “middle class” is disappearing. In one side we have Big Ones (> 1.000 M€) and on the other side micro companies (< 100 M€). Due to this fact, there are a lot of small companies for sale, and they prefer a buyer belonging to the Pharma operational world, being very reluctant to pure investors. These small companies are attractive for larger companies for some reasons: they are in an interesting niche; they own an efficient specialized sales team or simply they own a high market share in a given small territory.

Then, the selling out process starts and the troubles too. There are several specific issues to be considered by the bidders; we try to offer some advising:

• The seller is a family and not always the buyer can talk to an individual with sufficient decision power, even when a sole administrator exists. Buyer must be patient and talkative, listening to several family members.
• The companies normally have a large financial debt with banks and/or with partners. The Net Enterprise Value must be decreased with that debt, as well as with Net Working Capital. It is extremely difficult for sellers to understand this. Sometimes the Net Company Value (Equity Value) is negative. The bidders must negotiate the price in a friendly way, but with high degree of clarity.
• The buyer usually will find family members in the payroll and their dismissals without indemnity must be previously negotiated. The same for the benefits they enjoy, like company cars, medical insurance, or free credit card.
• The level of compliance in Regulatory Issues is acceptable in Pharmaceutical Rules (Good Manufacturing/Distribution Practices), but in terms of governance the situation uses to be not too acceptable. A lot of Management Procedures will not be available. We recommend the buyers to avoid a Due Diligence Process carried out by analysts without sufficient flexibility, the compliance standards may be implemented later.
• The GAAP (General Accounting Accepted Principles) does not follow an international format. They will follow the National Plan; subsequently the financial audit must be done understanding this.
• A very classic issue is the management continuity, not only the sole administrator or CEO but also the management team. After an acquisition, the buyer wants to integrate as soon as possible the acquired company in the bigger group. We must accept this is not an easy process. The cultural crash is unavoidable. We recommend not to leave the integration in not experienced persons. On the contrary, it is a mission for experienced managers in the buyer party. Let´s not forget the personnel in acquired company is afraid about losing the job and they are extremely sensitive.
• To set an “escrow” agreement is almost mandatory. It means to retain at least a 10 % of payable price for the company in order to cover future contingencies: labor claims, tax inspections, claims from 3^rd parties, not disclosed liabilities, etc… Again, this will not be well understood by sellers, and however it is necessary.
• To clarify from the very beginning that the income tax in the transaction year must be proportionally shared amongst seller and buyer. It uses to be a source of discussions.
• It is a normal practice to demand a Business Plan to sellers, projecting P & L for N years after transaction. The buyer should take those plans as “informative”, and not as a binding compromise. The plans are done with a high dose of optimism.
• The buyer must insist a lot in defining a CAPEX (Capital Expenditure) for next N years. The acquired company has been some years in a cash crisis and likely many necessary investments in equipment renewal for factory or IT systems have been postponed up to critical limits.

A high % of acquisitions fail. This is a sad reality. And the investment is lost. The reasons are not always the market volatility or the regulations. The causes for the failure are the “human factor”. The buyer tends to underestimate the value of human resources in the acquired company. Step by step the motivation falls, dismissals take place and the company, or the business, loses momentum. To avoid this undesirable effect the recommendation is to accept that the acquired company can also teaches a lot to the acquirer one. Modesty is an asset in these cases.

Another key issue when a company is acquiring a smaller one is therisk. Many buyers want to acquire at zero risk, what does not exist. But the “controlled risk” exists, and it is what the buyer must implement. ¿How to control the risks?

• In the first year the large investments must be avoided. First, understand the bought company and after to develop it.
• The same for new recruitments. Be prudent before expanding operational expenses.
• To inject cash in the company could be necessary, but only for working capital.
• A thorough scrutiny in new products projects must be carried out before proceeding. Some will be quite clear. Others just a dream to be discarded.
• Special care in returned goods from clients (wholesalers and pharmacies) is completely necessary. Small companies like to overload the channel and the goods expire, and returns come. Therefore, a clause in purchasing contract protecting the buyer should be included.

And the last and not the least, we must calculate the price (Enterprise Value, EV) to be paid. Traditionally is used a multiple of EBITDA, that ranks from 8X up to 12X. Rarely the EV exceeds 12X. And the most frequent case is 10X. This is the “gross price”, before deducting debt and adjusting with working capital.

But what happens when the EBITDA is zero or negative? Then, there is no other way than to negotiate a price, maybe a multiple of net sales, 1X or 2X as maximum.

In any case, the price is what the seller wants to get, and the buyer wants to pay. Negotiation again. The seller is in a difficult situation (debt, cash shortage, declining sales….) and the buyer enjoy a healthy position. Therefore, the buyer plays in superiority, and the seller might feel under an abusive position. We recommend not to humiliate too much the seller.

A large number of small companies there will be for sale, and the acquisition method should be standardized as much as possible.