May 16, 2017

Expanded license

by Breakingviews

Thermo Fisher Scientific has started a new experiment with a pricey deal. The maker of electron microscopes, DNA-sequencing machines and other lab supplies is paying about $5.2 billion to buy Patheon, which produces drugs and the chemicals used in them. Cost savings don’t come close to covering the premium being paid. While the industry may be ready for consolidation, Thermo Fisher also has a lot to learn.

The $68 billion company has done more than a dozen deals over the past five years, as it expanded into providing more equipment and services to customers. Thermo Fisher’s investors have benefited from the resulting growth, with the shares tripling and strongly outperforming the S&P 500 Index over the span. All this merger activity, however, means there are now fewer suitable targets, especially at reasonable valuations.Drug production, on the other hand, offers both solid growth and a vast array of takeover targets. New biological therapies, which are far harder to produce efficiently than traditional chemically derived pills, are becoming more popular. Furthermore, regulators are getting tougher. The resulting headaches have encouraged pharmaceutical companies to outsource a growing chunk of their supplies. Contract manufacturing is expanding more than 5 percent annually, analysts reckon.It’s not a complete foray into the wild for Thermo Fisher. There are overlapping customers. And one of its units packages and distributes drugs used in clinical trials, a service that should fit well with Patheon’s business.

That limited amount of convergence, however, means cost-cutting opportunities are few. Thermo Fisher estimates some $90 million of savings a year. The capitalized value of about $900 million, even at the buyer’s tax rate of zero last year, falls short of the $1.3 billion Thermo Fisher is shelling out over Patheon’s undisturbed stock price. Potential tax benefits might help a bit more. And there may be more expenses to chop if this turns out to be a rollup strategy. The 10 biggest companies in the industry account for only about 35 percent of the market.

The muted reaction from shareholders at least suggests some optimism. Even so, when companies move into tangential businesses, it’s often a worrying sign of sprawl. In this case, Thermo Fisher may be headed into a troubling M&A drug trial.

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