This year is already shaping up to be a big one for biopharma mergers and acquisitions, with Bristol-Myers Squibb’s planned $74 billion buyout of Celgene well underway. But analysts at Morningstar are predicting the BMS-Celgene deal will mark the beginning of an M&A wave that will continue this year and stretch into 2020.

As for who’s likely to be buying, Pfizer, Merck and J&J are the best positioned to do deals, Morningstar argued in its recently released annual drug pipeline report. And there are plenty of targets to choose from, starting with Biogen and BioMarin "given their undervalued shares and focused portfolios," the analysts said.

M&A, in short, will help the biopharma industry deal with significant new challenges, Morningstar said. Drug companies can no longer produce strong growth by slapping annual price increases on their products like they could in the past. That’s because they’re under pressure from U.S. legislators, who have been vowing to bring down drug prices, and they're facing policy changes from the Centers for Medicare and Medicaid Services (CMS) and private payers. On top of all that, value-based assessments from the Institute for Clinical and Economic Review are becoming more prominent, putting even more pressure on drug companies to justify high prices.

"Given the pricing pressure overhang, firms need higher levels of innovation in their pipelines to justify pricing and prevent pharmacy benefit managers from using competition to drag prices down," the analysts wrote. "Slight dosing advantages and minor improvements in efficacy in crowded therapeutic areas will not support the innovation needed for pricing power as was the case in the 1990s and early 2000s."

Morningstar predicts pharma companies will pursue one of two strategies to maintain growth: Increase diversification by getting into new areas, like vaccines or consumer health, or pour more resources into R&D in therapeutic areas that have strong pricing power. U.S.-based companies are more likely to focus on boosting their high-value pipelines, Morningstar suggests—a strategy that often calls for acquisitions.

Several large-cap companies stand out as key targets, including Gilead and Regeneron, the Morningstar analysts say, but Biogen and BioMarin are particularly attractive. Investors tend to focus on Biogen’s phase 3 Alzheimer’s drug, aducanumab, which is facing an uncertain future. Revenues from the company’s flagship multiple sclerosis franchise were flat at $9.1 billion in 2018, raising pressure on executives to spin value out of the pipeline.

Biogen did add six neurology drugs to its pipeline in the fourth quarter of last year, but investors are still resting their hopes on Alzheimer’s—a mistake, Morningstar argues. Biogen’s neurology pipeline "remains undervalued even ignoring aducanumab," they said in the report.

As for BioMarin, Morningstar pegs its prime attractions as "explosive growth potential in hemophilia and ultra-orphan disease." Morningstar estimates that BioMarin’s sales between 2017 and 2022 will grow at a compound annual growth rate of 19.3%, making it among the most undervalued large-cap biopharma stocks. In fact, BioMarin is so attractive, Morningstar says, it would be a good takeover target not only for the three pharma companies it pegged as likely dealmakers, but for a half-dozen other large biopharma firms, including Roche, AbbVie and Gilead.

Will 2019’s M&A wave be dominated by megamergers? Not likely, the analysts predicted in the report, but there could very well be two Big Pharma marriages in 2020. They suggested Pfizer could pick up Bristol-Myers and Merck could buy Eli Lilly—with both deals being consummated at 30% premiums. Pfizer and BMS (post the Celgene merger) have strong synergies in the oncology and anticoagulant markets, while Lilly and Merck match up well in diabetes and oncology, Morningstar figures.

Pfizer and Merck are no strangers to M&A speculation. Pfizer CEO Albert Bourla addressed the issue head-on in the company’s fourth-quarter earnings call, saying he would pursue small deals that enhance the pipeline, but not a big acquisition that would pull resources away from making its potential new product launches successful. In fact, big M&A could "derail us," Bourla said.

Merck, for its part, has been fielding questions from analysts for years about why it’s not pursuing major acquisitions. Merck has the resources to consummate deals "of all sizes and all types," said CEO Ken Frazier said during a fireside chat at the J.P. Morgan Healthcare Conference in January. But competition and high valuations kept Merck on the sidelines, he said. Then he hinted that might be changing. "Broadly speaking, I think with the valuations coming down, it creates more possibilities," he said.

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