OREANDA-NEWS. A race to find the next blockbuster drug, combined with the availability of cheap financing, is leading to riskier M&A activity that in the long-run could weaken credit profiles in the pharmaceutical sector, Fitch Ratings says. The acceleration in deal activity in the first few months of 2015 reinforces our negative rating outlook on the sector despite its positive fundamentals.

As large pharma companies have struggled with R&D costs and productivity, the biotech sector has become an increasingly important source of new drug discoveries, making them a top M&A target. But such specialist deals tend to be strategically riskier than more traditional pharma M&A, as biotech start-ups have much narrower R&D focuses and smaller pipelines.

We believe biotech valuations are potentially highly volatile because of the difficulty in estimating future cash flows in a market facing increased competition in core treatment areas. This uncertainty will be exacerbated by cost sensitivity over specialty drug prices in developed healthcare systems, which will intensify as the next round of drugs comes to market. Valuations have probably been boosted by pharma companies' low borrowing costs and deep market liquidity, as equity investors bet the biggest players will be willing to stock up on cheap debt to fund acquisitions.

These trends reinforce our decision to change the sector's rating outlook to negative from stable in December, when we highlighted M&A, pressure for higher shareholder returns, and increased exposure to interest-rate rises due to higher leverage across the sector as key ratings' risks.