Investment bankers prescribe merger therapy
Nils Pratley
Friday September 12, 2003
The Guardian
The pharmaceuticals business, on the face of it, looks like the epitome of a
modern, mature industry that has found a comfortable way to make profits by
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the billion: it's global, hi-tech, and has the ultimate customer, the
healthcare budgets of the world's richest countries.
It does not look like an industry with a looming crisis, yet that is the
conclusion of a research report by pharmaceutical analysts at investment
bank Dresdner Kleinwort Wasserstein. They think the world's major drugs
companies are operating a business model that is unsustainable and "rapidly
running out of steam".
The solution, they argue, is more consolidation. That may sound like more of
the same, given that most of the drug corporations - including Britain's
GlaxoSmithKline and AstraZeneca - were created by mergers, but it is
consolidation with a difference.
This time, DKW says, the prime purpose of the deals should be to create
dominance in just a few areas of therapy, such as oncology, cardiovascular
or CNS, as the industry refers to the central nervous system. Parts of the
combined operations that fall outside the core areas could be sold off,
maximising the efficiencies in research and development and sales and
marketing and making these huge corporations more manageable.
The crisis predicted by DKW is the result of the industry's failure to
maintain the trick that it had performed since the late 1960s - namely to
push up prices.
In the old days, a large drugs company would count on annual sales increases
of 12-15% and would reckon to plough back 15% of its sales into research to
develop the next generation of drugs.
Those ratios worked well, but they relied on half the sales increases coming
in the form of increased prices. Globalisation seems to have put an end to
that. Drugs now cross borders with ease, and it is harder to keep prices
artificially high in some territories.
Nor are politicians as accommodating: most governments' healthcare budgets
are under pressure and in the United States, the Democrats are calling for
drug prices, which are among the world's highest, to be linked to a global
average price.
In the wings are the generic suppliers, who have become skilled in
challenging patents on prescription drugs and so get their copycat products
to market much faster. The startling fact is that nine of the top 10 fastest
growing pharmaceutical companies last year were manufacturers of generic
drugs. It would not be such a problem if the companies could cut their costs
of production - in other words, increase the efficiency of their research.
But the evidence shows that the labs are in fact becoming less efficient; a
meeting of research heads at major drug companies this year concluded that
it now costs $1.4bn to develop a drug, or new molecular entity (NME),
compared to $800m three years ago.
There seem to be fewer new drugs around. Pharmaceutical companies give very
early indications to investors of their research programmes and DKW
calculates that over the next six years there will be 0.3 NMEs per company
per annum, with sales potential of over $400m at peak. "That is a tenfold
shortfall from the two to three NMEs promised by the industry only three
years ago," it comments.
Adding up the bad news, the report concludes that the world's top 17
pharmaceutical companies will deliver growth in sales of prescription drugs
of just 5.9% over the next six years.
One of the prime drivers of its proposed solution - mergers and takeovers -
is clearly cost savings, and the table below indicates the scale of those.
In some cases, the figure is huge - $4.9bn if Pfizer were to buy Novartis.
The 13 possible deals in DKW's table are not just about cost savings. It has
excluded possible deals where sales growth would be diluted for the
acquirer, and the other chief criterion is the "fit" between companies'
therapy areas.
It will read as good news for Glaxo's professional advisers, since Britain's
biggest drug company has four potential targets. Johnson & Johnson would
boost Glaxo's dominance in anti-infectives and CNS; Aventis offers diabetes
and anti-infectives; Schering Plough would bring anti-virals expertise; Novo
Nordisk is strong in diabetes, where Glaxo's major product is Avandia.
For AstraZeneca, there are two major possibilities - Wyeth, which is
complementary in CNS and thrombosis, and Novartis, whose strength in
hypertension and heart drugs fits well with the British company's drive in
the cholesterol market.
The latter would rank as a mega-deal, with cost
savings of $3.1bn and a combined global market share of 8.7%.
That share of the market might seem high, but consider how pharmaceuticals
compares to the automotive business, another industry that is global and
mature. In automotives, just five companies account for 60% of the market;
in the drugs game it is 20. Within a few years, it will almost certainly be
fewer.
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