The high-risk, high-reward world of biopharma and medtech has generated a great deal of optimism on Wall Street—and behind-the-scenes financial engineering in the C suite. Shareholders have been rewarded handsomely with strong returns in the sector, but it is unclear how long such high valuations can last. Stock prices may be rising, but the businesses themselves have slowed in terms of growth.
Consider the top 15 biopharma companies. Between 2010 and 2015, they collectively generated a TSR of 19% per year—more than doubling their investors’ money in four years. (See Exhibit 1.) This creation of wealth took place despite negative growth (the growth rate of these 15 companies actually declined by 1.5%). There are several explanations for the sector’s strong market performance. Companies were able to mitigate the impact of patent cliffs better than expected, to rationalize their cost base in order to address eroding operating margins, and to redistribute cash through predictable and growing dividends and massive common-stock repurchases. In addition, many management teams consolidated smaller players or acquired products to cut costs and offset revenue lost to generics.
At the same time, eroding revenue and lack of profitability had a slightly negative impact on shareholder value between 2010 and 2015, resulting in a decrease of 1.7% per year, while cash redistribution added 6.8% per year. The major bump, however, came from rising valuation multiples, which added 13.9% in value per year. Not all of this multiple expansion can be accounted for by projected future growth and concrete pipeline projects.
Analysis of the top medtech companies during this period reveals a similar, though slightly less stark pattern, with 16.1% TSR and revenue growth of 4.7%. Other industry sectors also showed tremendous value creation, but it was typically driven by revenue growth. For example, revenue growth contributed 14% per year in TSR across the S&P 500 during this five-year period.
Generating TSR through cash distributions and positive market sentiment cannot work forever. Sustainable growth and value creation ultimately require top-line growth. It is an inescapable empirical truth, as illustrated by the fact that 72 cents per dollar of value creation by the S&P 500 over a ten-year period can be attributed to growth. (See Exhibit 2.)
If top-line growth continues to stagnate, investors will increasingly question management teams about their growth plans and require solid answers. This is just one of the many reasons that growth should now be a central concern for boards and executive management teams alike.
Companies need different sets of priorities in planning their growth agenda for different time horizons. In the short term, they should focus on maximizing their core business. In the medium term, they should focus on accelerating growth in core platforms. In the long term, they should map out how to reshape the company for future growth opportunities.