Money for Nothing

By Marie Shields, Editor

Where is this new round of mergers and acquisitions coming from? Is the pharmaceutical industry in danger of consuming itself in its endless quest for profit?

“Most major drug companies are facing challenges from patent expiries, and the magic money fountains of blockbusters are running dry.”
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You'd have to have been living on another planet not to have heard about Pfizer's planned takeover of Wyeth. As far as news goes in pharmaceutical circles, this is about as big as it gets - equaled only by the ongoing saga of Roche's bid to buy the remaining shares in Genentech.

Pfizer's $68 billion dollar bid for Wyeth will give it access to its rival's vaccines, consumer health and animal products. The move was widely seen as an attempt to boost Pfizer's pipeline in advance of Lipitor - the cholesterol drug that the company nearly $12 billion last year - losing patent protection in the US in 2011. In all, 38 percent of Pfizer's current sales will face competition from generics by 2013.

The merger will create a massive player in the industry, with more than 15 products with $1 billion each in annual revenue, allowing the company to move away from its dependence on a single blockbuster.

The Roche/Genentech affair is a little more complicated. The two companies have been linked since the 1980s, when Genentech licensed one of its first drugs to Roche. In 1990, Roche and Genentech merged, with Roche acquiring 60 percent of its smaller rival's shares. At the time, it purchased an option to buy the remaining shares at a pre-set price - an option it exercised nine years later. Roche then brought Genentech back into the market twice in the next year, keeping a 58 percent stake in the company.

In July, Roche offered to buy back the remaining shares not under its control. But the deal stalled when Genentech shareholders rejected Roche's offer as too low. The matter remained unresolved as NGP went to press.

Old news

Mergers and acquisitions in the pharmaceutical industry are not new. Pfizer itself has been down this route before, buying out Warner-Lambert in 2000 and Pharmacia in 2003. In both cases, sweeping job cuts followed, and this time round seems to be no exception. Despite Pfizer CEO Jeffrey Kindler's assertion that the new deal is not about "a single product or cost-cutting, but about creating a broad, diversified portfolio," the company has announced that $4 billion in cost savings will result from the merger, including the shedding of 20,000 jobs.

What if this is only the beginning? Most major drug companies are facing similar challenges from patent expiries, and the magic money fountains of blockbusters are running dry. Between 2007 to 2012, the top 50 pharmaceutical companies are facing patent expiries on $115 billion worth of drugs.

In the opinion of Shabeer Hussain, Program Leader in Pharmaceuticals for Frost & Sullivan, "Though plagued with R&D challenges, patent expiries, generic competition and high drug attrition rates, pharmaceutical companies have resorted to various crisis management strategies to stay afloat during trying times. One of these strategies is M&A activities. With Pfizer taking a strong and bold step in this direction, there may be other companies to follow."

Companies with patents set to run out on major drugs between 2007 and 2012 include Ratiopharm, Sandoz, Merck KgaA, Actavis, Apotex, Barr, GSK and Watson. Wyeth, so eagerly snapped up by Pfizer, faces a tricky situation of its own. Its two biggest selling drugs, Effexor for depression and Protonix for heartburn, will lose patent protection in 2010 and 2011.

The latest report from PricewaterhouseCoopers, Pharma 2020: Virtual R&D, Which path will you take?, points out that: "Pharma's traditional strategy of placing big bets on a few molecules, promoting them heavily and turning them into blockbusters worked well for shareholders for many years.

"However, its productivity in the lab is now plummeting, as it switches its attention from diseases that are relatively common and easy to treat to those that are much more complex or unusual. In 2007, the FDA approved only 19 new molecular entities and biologics - a smaller number than at any time since 1983."

The report quotes estimates that generic erosion will knock between two percent and 40 percent off the revenues of the top 10 companies between now and 2015.

One strategy for coping with this massive loss of income is that exemplified by the Pfizer/Wyeth deal: swallow up your rivals, slim them down by radically cutting staff, and take over their pipelines in the hope that, even if they don't produce the next blockbuster, you will at least add some diversity to your portfolio and gain enough to prop up your bottom line in the short term.

Quick fix

The crucial phrase is 'bottom line'. Such mergers are often nothing more than a quick fix, aimed at making companies look good for shareholders and investors. But how well does this work? When news of the merger broke, many analysts and industry leaders were skeptical. Michael Rainey of Accenture commented that nine out of ten of such big deals created no value or negative value. Bain's Charles Farkas called the deal a half step forward: "Wyeth's assets will be Pfizer some time but will not be enough to replenish its research pipeline or replace Lipitor."

Jeremy Batstone-Carr, head of research at Charles Stanley, was quoted as saying: "By deciding that big is best, Pfixer is only delaying current problems and buying a portfolio of products that are approaching the end of their patent lives." And David Brennan, CEO of UK-based AstraZeneca, weighed in with the view that if big improvements in efficiency were really possible, good managers would make them anyway without having to rely on mega mergers.

As Shabeer Hussain points out: "As blockbusters fall off patent, organic growth has witnessed major hits. Pharma companies have resorted to inorganic growth through M&A. However, this growth cannot form a sustainable business model for long. This is a stop-gap arrangement, to satisfy investors.

"Though Wyeth's Prevnar and Enbrel are expected to benefit Pfizer by softening the loss incurred due to the Lipitor patent expiry, the deal may not add the expected value as imagined by Pfizer. This expensive acquisition is unlikely to bring in great dividends. In fact, expanding the business will make it even more difficult for Pfizer to handle its enormous empire. Growing a huge business of that size is a tall order."

Get creative

This brings us to the question of what such corporate cannibalism will do to the engine that has driven the industry for decades - innovation in research. Despite the layoffs, bigger companies usually have more layers of management, something that tends to stifle research, rather than encourage it.

Shabeer Hussain: "Innovation is not the primary focus for these companies and these activities are just crisis management measures. Such short-term arrangements enhance their stock prices and are purely business-oriented, not innovation-oriented."

According to the PwC report, This 'innovation deficit' has enormous strategic implications for the industry as a whole: "Pharmaceutical companies need to decide what they want to concentrate on doing and identify the core competencies they will require, a process which may involve exiting from some parts of research and development.

"But even those that regard research and development as a core element of their business will have to make fundamental alterations in the way they work. They may, for example, have to focus more heavily on specialty therapies, since most of the diseases for which there are currently no effective medications or cures are not amenable to mass-market treatments, as well as reducing the time and costs involved in researching and developing such medicines to ensure that society can afford them."

To add to the industry's woes, President Obama's plan for healthcare aims to lower drug costs by allowing the importation of safe medicines from other developed countries, increasing the use of generic drugs in public programs and taking on drug companies that block cheaper generic medicines from the market. Obama has also hinted that he will allow Medicare to negotiate directly with drug groups, as opposed to the current arrangement of companies dealing with smaller organizations. Obama's team claims this could drive down prices by up to 40 percent.

While such pronouncements may make consumer groups happy, they do nothing to remedy the situation pharmaceutical companies are facing - in fact, they make it worse. Championing the rights of patients to have access to cheaper medicine may seem like common sense, but pharmaceutical companies, like any commercial enterprise, are driven by profit, and patents ensure there is one to be made. Shrinking profits from fewer blockbusters and the loss of patents mean less money going into research, which dries up pipelines even further, and the whole thing becomes a vicious circle.

Is it really necessary to give generics the upper hand? Shabeer Hussain doesn't think so: "The main agenda is to reduce healthcare costs. People are paying more on healthcare than on mortgage loans. Bringing generic drugs in to the market will lower the value of the original drugs; however, the government should also bring in legislation to reduce the price of branded drugs and make them affordable."

High need

The truth is, no matter how much the public loves to hate big pharma - much as we love to hate any powerful industry with a major impact on our lives - the world needs the pharmaceutical industry. Without the innovative research and development it funds and carries out, many serious diseases would remain untreated.

So what's the answer? It could be what some observers were expecting Jeffrey Kindler to do when he took over the top job at Pfizer in 2006: instead of gorging yourself on your rivals, then going on a ruthless job-cutting purge, try slimming down from within, focusing on your core areas, finding yourself a niche. Accept that the days of big blockbusters are over. Build yourself a portfolio of mid-performers - then if you lose one drug to generic competition, it won't smash a meteor-sized hole in your profits.

Smart companies, the lucky ones with strong enough cash flows to ride out the recession, will target emerging markets or focus on core competencies or rare conditions with high unmet need.

None of this can happen in a vacuum. It will require the support of regulators and vendors in making the strategic changes necessary to carry the industry forward. As the PwC report puts it, "If pharma is to remain at the forefront of medical research and continue helping patients to live longer, healthier lives, it must become much more innovative, as well as reducing the time and money it spends developing new therapies.

"Incremental improvements are no longer enough; the industry will need to make a seismic shift to facilitate further progress in the treatment of disease. It will have to learn much more about how the human body functions at the molecular level and the pathophysiological changes disease causes.

"Only then will it be able to develop a better understanding of how to modify or reverse these changes. This is a huge undertaking - and one that pharma cannot complete alone. It will require the support of academia, governments, technology vendors, healthcare providers and the regulators."

Easier said than done, perhaps. But in these ruthless times, there may be no other choice.

Possible future mergers and acquisitions

sanofi-aventis/Crucell: sanofi could make a bid for Crucell to strengthen its position in vaccines.

saonfi-aventis/Bristol Myers Squibb: If sanofi and BMS merged, the new company would be number two behind Pfizer/Wyeth.

Eli Lilly/Takeda: The two companies have an existing collaboration in the diabetes arena.

Johnson & Johnson/Vertex: J&J has a history of deals with Vertex and may want to acquire its pipeline of candidates for cystic fibrosis and rheumatoid arthritis.

Bristol Myers Squibb/Amgen: Amgen's biotech pipeline would boost BMS's position in the industry.

Companies with the biggest cash reserves

Novartis $15 billion
Roche $13.5 billion
Johnson & Johnson $13 billion
Merck & Co. $10 billion
GlaxoSmithKline $9.5 billion