Prescription For Success

Dec. 21, 2004
The pharmaceutical industry continues to reinvent itself, with a little help from its friends.

In January of this year Glaxo Wellcome PLC and SmithKline Beecham PLC announced a merger that will create the largest pharmaceutical company in the world, a $25 billion behemoth. That would be news enough in most industries, but then in February Pfizer Inc. acquired Warner-Lambert Co. in a $93.4 billion hostile takeover, yielding a company with $28 billion in sales, $22 billion of which is in pharmaceutical products. Then in March shareholders approved the merger of Monsanto Co. (and its G.D. Searle pharmaceutical division) with Pharmacia & Upjohn Inc. to form Pharmacia Corp., a new company with $17 billion in drug sales. This latest run of mergers brings to 29 the number of major unions in the industry over the last decade, with more likely to come. To this whirlwind of consolidation add the specter of proposed Medicare reform that could result in drug price controls and the blockbuster impact on drug discovery of the Human Genome Project, and you have an industry fraught with both challenge and opportunity. Why all the consolidation? Building enough wealth to fund drug research is a primary reason. Drug development averages 10 years and $500 million in R&D expenses, says the industry trade group Pharmaceutical Research and Manufacturers of America (PHRMA), Washington. Only about three in 10 of drugs that make it to the marketplace actually show a profit, says the group. "The only way to grow revenue is with new products that treat diseases that aren't treated now," says Richard Evans, senior analyst, U.S. pharmaceutical industry, at Sanford C. Bernstein & Co. Inc., a New York investment firm. The company resulting from Pfizer's Warner-Lambert takeover, for example, will spend a mind-boggling $4.7 billion on R&D this year. The R&D expenditures at the new Glaxo SmithKline will fall just short of $4 billion. Once a pharmaceutical company has a marketable drug, it needs a strong sales force and marketing effort to capitalize on its discovery on a worldwide basis. "You need size to get above the noise," says Steve Sands, managing director, life sciences, Lazard Freres & Co. LLC, New York-based investment and financial services firm. The Glaxo SmithKline sales force will be huge -- 40,000 strong, servicing the world, but focusing on the three largest markets for drugs: the U.S., Japan, and Europe. In addition, with more individuals participating in their own health care (some even asking a doctor to prescribe a particular brand of medicine) direct-to-consumer advertising is adding more costs. Since 1996 industry-wide direct-to-consumer advertising expenses for prescription drugs have increased by an average of 31% per year, says IMS Health Inc., a health-care-information company in Plymouth Meeting, Pa. In the past pharmaceutical-company mergers have emphasized cost cutting directed at bottom-line growth. "In today's versions, the sales force and R&D functions of merged companies are not rationalized, so they can maintain the shear power of numbers associated with an emphasis on top-line growth," suggests Sands. Yet there still will be cost savings in consolidation: Both Glaxo SmithKline and the new Pfizer are projecting in the neighborhood of $1.65 billion in savings over the next three years with shareholders deriving benefits from increased earnings. In the case of Pfizer these savings are projected to accelerate earnings growth from a premerger 20% to 25% per year over the next three years, excluding extraordinary merger-related charges. One of those charges, however, is a $1.8 billion breakup fee -- reported as the largest ever on record -- to American Home Products Corp. for the termination of AHP's agreement to acquire Warner-Lambert. The Pfizer/Warner-Lambert union links two of the industry's strongest and fastest-growing companies. Together they will have seven different products selling more than $1 billion each, including Viagra for erectile dysfunction and impotence, Norvasc for hypertension and angina, Zithromax, an antibiotic, and the real deal maker, Lipitor. This product is the fastest-growing cholesterol-lowering agent, expected to reach $5 billion in sales this year and forecast to exceed $10 billion by 2005. Pfizer had been comarketing Warner-Lambert's Lipitor since 1996, sharing in the skyrocketing sales and profits of the product. When AHP made its bid for Warner-Lambert in November, executives at Pfizer got nervous about its comarketing agreement. Pfizer felt it had to protect its position, and began its hostile takeover bid. For AHP it was the third time a merger had fallen through; deals with SmithKline Beecham PLC and Monsanto also had failed over the last two years. Changes At The Top Consolidation in the pharmaceutical industry has resulted in a number of management changes. Two years ago Glaxo Chairman Richard Sykes and SmithKline CEO Jan Leschly both sought executive office as they tried and failed to come up with a merger of the two companies. In the present merger Sykes will become nonexecutive chairman and SmithKline CEO-elect Jean-Pierre Garnier will become CEO of the new Glaxo SmithKline as Leschly retires. At the new Pfizer, William Steere will remain chairman and CEO, three of the four divisions of the reorganized company will be run by Pfizer executives, and Warner-Lambert CEO, Chairman, and President Lodewijk J.R. de Vink, "has made a personal decision not to be an executive with the company after closing," says a company news release. In the third megamerger, Pharmacia & Upjohn CEO Fred Hassan will become president and CEO of the new company, with Monsanto CEO Robert Shapiro serving the company as nonexecutive chairman for 18 months until he is succeeded by Hassan. The new Pharmacia Corp. entity will spin off part of Monsanto's agriculture business as an IPO in a move to increase focus on pharmaceuticals. "In Monsanto you had a company essentially using its pharmaceutical operations to fund its investments in agricultural biotechnology," says Stephen Tang, vice president and national director, health care industry practice, A.T. Kearney Inc., New York. "It was essentially servicing debt on its recent acquisitions on the agricultural side -- seed companies and ag/biotech companies -- rather than reinvesting those earnings in the pharmaceutical franchise." A day after announcing the merger with Pharmacia & Upjohn, Monsanto broke off its 19-month talks on a $1.9 billion acquisition of Delta & Pine Land Co., a Scott, Miss.-based seed company. Monsanto will pay D&P an $81 million withdrawal fee as a result. Pill Politics While consolidation is the big news in the pharmaceutical industry, lurking in the background is the issue of Medicare reform. With elections just a few months away, it is bound to be a political issue, if not a platform plank. Currently there are 15 to 20 bills in Congress that could affect price control and access to drugs, according to PHRMA's Truitt. Medicare presently covers only prescription drugs administered in hospitals. Senior citizens complain that drugs are simply too expensive. "Seniors consume about 38% of the retail prescription market, per person consume about five times as much as an average worker, and are eight times more likely to spend more than $1,000 for prescription drugs," says Sanford C. Bernstein's Evans. At one extreme prescription-drug coverage for seniors under a reformed Medicare could result in significant price pressure, if not price control, putting the squeeze on industry innovation. "Already the government buys about 16% of the market for the poor," continues Evans. "If it were to buy all drugs for seniors, it would control over half the retail market, enough to make it a price-maker by the shear power of its purchases. With that kind of pressure, the industry risk on R&D goes up and the potential return on R&D falls. In a macro sense, politics is the biggest risk to the industry right now." Pharmaceutical companies believe that a free market approach is best not only for the industry, but for patients as well. "We are opposed to price controls because they are artificial and do not address the improved quality and enhanced safety that could be provided by marketplace competition," says Greg Reaves, director of corporate communication and primary media spokesman, Merck & Co. Inc., Whitehouse Station N.J. "We would like to see a marketplace approach, where private-sector entities must compete on efficacy, quality, cost, and safety of their medicines, and thus the value their products bring to the patients in the marketplace." How will it shake out? "If we have a Democratic president, House, and Senate, I think you will have some very negative legislation [for pharmaceutical manufacturers] that reaches the floor in spring of next year," says Evans. "But I feel it plays out in a neutral sense, because the only way for government to become a monopsony [the only buyer for a commodity] is if it provides coverage for all seniors. If you do the math, it can't afford to do that. If [the President and Congress are] Republican, I believe coverage will be limited to low-income seniors and there will be a sigh of relief from [the industry]." The Book Of Life On Mar. 14 U.S. President Bill Clinton and British Prime Minister Tony Blair released a joint statement announcing that data from the publicly funded International Human Genome Project -- an effort to create a genetic blueprint of human life -- will be freely available worldwide. The announcement stunned the stock markets, sending biotechnology stocks into a downward spiral. The American Stock Exchange biotech index fell more than 20% and some of the leading genomic firms lost up to 30% of their value, dragging down the technology-laden Nasdaq. While today's medicines interact with a total of about 500 different therapy-sensitive "targets" in the human body, knowledge of the genetic basis of disease is predicted to expand the number of potential targets to 10,000; some predict that number to reach 30,000. Today about one-third of the 1,000 new drugs in clinical testing are biotechnology-based, new-generation medicines, according PHRMA. Genomic-information-based companies are busy filing patents on genes and selling gene-sequencing information to companies such as Pfizer that use new target information in drug research for ailments from cancer to AIDS to diabetes. The biotech companies have been handsomely rewarded for their progress, none more than Celera Genomics Corp., Rockville, Md. However, after the Clinton/Blair statement, Celera shares plummeted 47 points to 142, and were trading at about 80 in mid-May, down from a 52-week high of 276. Celera is using highly advanced computer technology to sequence the human genome, and is on schedule to complete its assembly later this year. On the other hand, the 10-year-old publicly funded Human Genome Project is targeting 2003 for a finished "book of life," with a "rough draft" available some time this year. In the controversial sequencing effort the two factions, public and private, are competing to accomplish the same task. "It's an interesting combination of politics and business, mixed in with science, which can make for a pretty sticky mess," says David Galas, vice president and chief academic officer, Keck Graduate Institute, Claremont, Calif. "The principle is that the human genome is going to be the fundamental database for biological developments in future. The human genome will be to biology what the periodic table of elements is to chemistry, and the worldwide medical community needs to have widespread access to it. Whether or not you can make a business of acquiring and distributing such information, as Celera has done, is an open question." Regardless, the gene-discovery efforts of Celera and others, including Incyte Pharmaceuticals Inc., Millennium Pharmaceuticals Inc., and Human Genome Sciences Inc., have spurred the federally funded program to advance its deadlines for project completion. To date there has been little cooperation between the factions, yet there is hope that some union will occur that allows objectives of both parties to be served. "The Celera business model is partly one of protecting intellectual property, but also of providing value-added information to subscribers who want early access to additional variation in the human population," says Galas. "In some ways I think they would like to become the Lexis Nexis of the genomics world. Even if the information is public, as much if not all of the Lexis Nexis information is, they have a fine business by packaging it and giving easy access to it. In that way compatibility between the public and private objectives is likely, and there are certainly areas for cooperation." Top Companies in Pharmaceuticals

Leaders by Revenues
IW 1000 Rank Company Revenue (US$ Millions)
39 Merck & Co. Ltd. $32,714
51 Johnson & Johnson $27,471
73 Novartis AG $20,391
76 Bristol-Myers Squibb Co. $20,222
91 AstraZeneca PLC $17,688
Leaders by Profit Margin
IW 1000 Rank Company Profit Margin
556 Amgen Inc. 33.3%
190 Eli Lilly & Co. 25.7%
206 Schering-Plough Corp. 23.0%
128 Glaxo Wellcome PLC 21.3%
92 Roche Holding Ltd. 20.9%
Leaders by Return on Equity
IW 1000 Rank Company ROE
131 SmithKline Beecham PLC 77.0%
128 Glaxo Wellcome PLC 67.3%
190 Eli Lilly & Co. 57.5%
76 Bristol-Myers Squibb Co. 55.0%
206 Schering-Plough Corp. 52.7%
Leaders by Revenue Growth (1996 to 1999)
IW 1000 Rank Company 3-Year Growth
388 Fresenius AG 166.4%
821 Welfide Corp. 108.0%
91 AstraZeneca PLC 104.2%
143 Warner-Lambert Co. 78.8%
92 Roche Holding Ltd. 72.7%
Industry Hightlights
Average revenue growth of companies: 12.7%
Company with highest revenue growth (1998 to 1999): AstraZeneca PLC, 98.7%
Company debuting highest on list: Sanofi-Synthelabo, No. 360
Company with highest profit growth (1998 to 1999): Yamanouchi Pharmaceutical Co. Ltd., 688.0%

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