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Quite a few pharmaceutical industry mergers – including some large deals - may be in the cards in 2018 now that the tax reforms are in place. The tax bill was signed into law by U.S. President Donald Trump in December last year

The tax rate for corporates will now go down from 35% to 21%, which can boost profits of large drug/biotech companies. Meanwhile, the change in tax code will also allow companies to bring back huge cash held overseas at a one-time tax rate of 10%. Also the tax cuts are expected to prevent inversions, which were rampant in the drug industry.

These changes should definitely leave more cash in the hands of drug/biotech companies. The cash can be invested for mergers/acquisitions, which have been few in 2017 compared to 2016.

Gilead’s (GILD - Free Report) nearly $12 billion acquisition of Kite Pharma and Johnson & Johnson’s (JNJ - Free Report) $30 billion acquisition of Swiss biotech Actelion were the only two noteworthy deals of 2017.

This week, senior executives from some of the largest pharmaceutical/biotech companies discussed the impact of tax reform on mergers and acquisition and their plans to use the excess cash at the JP Morgan HealthCare conference.

What the CEOs Said?

Brent Saunders, chief executive officer (CEO) of Allergan (AGN - Free Report) said that the first half of the year is likely to see smaller deals such as the one by Celgene (CELG - Free Report) while the bigger high profile mergers of large pharmaceuticals/biotech companies would probably happen in the latter half of the year or next year.

Last week, Celgene announced that it has offered to buy a small cancer drug developer, Impact Biomedicines. (Read More: Celgene to Acquire Impact Biomedicines to Boost Pipeline).

Lilly (LLY - Free Report) CEO Dave Ricks and J&J’s Chief Financial Officer, Dominic Caruso said that with the tax cuts, American companies can compete better with their foreign counterparts, which operate in better tax environments. Caruso said the new tax law provides “more flexibility and ease of analysis in terms of getting a transaction done”.

Along the same lines, Merck’s (MRK - Free Report) CEO, Meg Tirrell, said that having access to overseas cash will give it more financial flexibility to “think about different ways to go about the M&A transactions”. Tirrell, however, confidently said that even before the new tax law was implemented, the company had “enough power in their balance sheet” to make the bolt-on acquisitions it wanted to do.

Michel Vounatsos, Biogen's (BIIB - Free Report) CEO, smartly argued that though the tax overhaul may spur some M&A activity, the rationale behind any M&A activity should not be the cash available. He went on to say that they are looking at “all sets of potential targets”.

Gilead CEO, John Milligan, said that the tax reform is good for the company as it “allows to plan for the long term” since the FDA approval process is quite lengthy. Meanwhile, it maintained its goal of investing in M&A to replenish the pipeline. He also said that the excess cash will allow it to clean up its balance sheet by repaying debt.

Conclusion

Overall, it is quite clear that the drug industry is optimistic that the tax reform will fuel greater M&A activity in 2018.

As it is, major drug/biotech players struggling with organic growth need an infusion of new growth drivers in their pipeline/product portfolios — either from internal development or from buyouts. Strategic M&A and licensing deals are therefore inevitable for innovation starved drug/biotech companies looking for growth in a highly competitive and global marketplace.

Given that it takes several years and millions of dollars to develop new therapeutics from scratch, large pharmaceutical companies sitting on huge piles of cash may prefer to buy innovative small/mid cap biotech companies to build out their pipelines. What matters for companies looking to buy a drug/biotech stock is the current sales performance of the latter’s drugs/products, prospects of sales growth, and the quality of the pipeline.

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