by Daniel R. Hoffman, Ph.D.
What does it say about an industry when its leading competitors appear fundamentally at odds about whether they should grow bigger, smaller, more diversified or more focused?
The rosy view is that the abundance of opportunities offers multiple paths to success and the various Big Pharmas are pursuing these divergent paths to profit. That view, however, is delusional, as a glance at the Big Cap pharma sector will show. As of last week, Big Pharma is trading at a 4 percent lower earnings multiple than the S&P 500 and at a 6 percent discount on CIRA estimated earnings. Big Pharmas as a group have performed below the S&P composite by approximately 610 basis points this year, during which time the S&P is up 4.8 percent while the major drug companies are down 1.3 percent.
The grow-or-shrink dilemma is nowhere more acute than at AstraZeneca, the UK-based pharma with U.S. headquarters in Wilmington. In recent weeks, both before and after the announcement that CEO David Brennan will leave in June, some shareholders and analysts felt frustration with the Brennan management team about acting too timidly to make game changing acquisitions. Then a second wave of bright ideas emerged to the effect that AZ would do better by shrinking itself, appreciably cutting back R&D and transforming itself from a Big Pharma into a specialty company.
As far as the benefits of getting bigger, Citigroup analyst John Boris this week showed that the M&A results for Pfizer, Big Pharma's leading grow-big practitioner, have been poor to middling at best. Considering the three major acquisitions Pfizer made since 2000 (Warner Lambert, Pharmacia and Wyeth), Boris' analysis shows that only the first created any incremental shareholder value. While Warner Lambert boosted value by 28 percent, the Pharmacia buy created a 0 percent gain and the 2009 Wyeth deal eroded value by 19 percent.
Among the smaller deals (+/- $4 billion), Boris notes that these "have not yielded long-term accretion." In this class he includes such Pfizer acquisitions as those involving King Pharmaceuticals, Rinat and Esperion.
So if both big and small acquisitions failed to open a royal road for Pfizer, what about late-stage co-development deals as an alternative to equity purchases? Boris finds these have not been much better. He reviewed Pfizer's product development deals with Medivation, Eyetech, Sanofi, Biocon and Ligand and concluded that such "deals have not borne fruit."
A case can be made for downsizing and over the past 18 months Pfizer has been tantalizing analysts with prospects that it may shrink itself beyond divesting the animal health and infant nutritionals businesses. Yet there is something about Big that disdains Small. Mainly that rests on the feeling among CEOs that they're not likely to get paid more for running smaller companies. The decision by Abbott's Miles White to spin off the company's pharma business, while he continues to run its other operations, was likely supported by assurances from the board that his compensation and eventual exit package would not decline.
But the all-consuming avarice of CEOs remains a constant and, as such, it cannot explain the variabilities of corporate success and failure. Big, small, diversified and pure-play can each be a potential winner, but a successful outcome requires the ability to work effectively with a company's situation and its competitive environment. Something else about Big Pharma suggests they cannot do Small effectively.
The point is illustrated by Merck's acquisition last year of the eye care specialty company, Inspire. Some pharma strategists make a case that the best prospects for achieving growth and margins currently lie in smaller drug classes such as dermatology, ophthalmology, dental and podiatric therapeutics and a few others.
Big Pharma has historically given these categories short shrift because the absolute revenue numbers are so much smaller than those for primary care blockbusters that managers feel these niche classes can't justify the high fixed overheads.
Managers at some Big Pharmas such as Novartis, Pfizer and GSK hope to dispel that traditional view by showing they can create synergies across a number of small, niche franchises.
Apparently Merck's purchase of Inspire was also an effort to parallel the other pharmas by increasing its presence in some small categories. Inspire, in particular, was intended to build (or more correctly, revive) an ophthalmology franchise as a high-growth profit center,
To date that hasn't worked especially well. Sales for the ophthalmic anti-inflammatory, Zioptan, have stagnated and Merck has done little to effectively differentiate it from other prostaglandin treatments, aside from touting it as preservative free.
AzaSite is another product that Merck planned to launch with the Insight sales force. To date little in the way of an AzaSite marketing campaign appears visible and the product doesn’t even have a Web site at this point.
Some sources claim that Merck's traditional culture represents the main problem in getting an ophthalmology franchise off the ground. That culture, it is said, regards small categories as "low science" and otherwise scorns them to a point that the company can't or won't make a full-fledged effort in those areas.
If people who make that assessment are correct, it suggests either leadership is too weak and/or inept to compel implementation of its strategy or, alternatively, while a case can be made for going small and smart, pharma just can't bring it off.
In either case, pharma's strategic alternatives may be fewer than what many people imagine.
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