Smithkline's New World Order

SmithKline Beecham PLC Chief Executive Jan Leschly is a former tennis pro with a good sense for when to charge the net. On Aug. 29, he made his move, announcing SmithKline's second multibillion-dollar acquisition in four months--the $2.9 billion purchase of Eastman Kodak Co.'s Sterling-Winthrop.

Advantage, Leschly. While allowing Kodak CEO George Fisher to pay down debt and focus on the photo business, the deal overnight will make SmithKline Beecham the global leader in the $30 billion market for over-the-counter medicines, adding to its core brands such stalwarts as Phillips' Milk of Magnesia, Mi-dol, and Stridex (table). Sterling's Panadol pain reliever alone produces $250 million in sales in 64 countries.

More important than bulk, though, is geography. The U.S. OTC market, where SmithKline is strongest, has slowed to 3% annual growth or less. Overseas, where Sterling gets two-thirds of its revenue, growth is at least twice that. Sterling will build SmithKline's OTC presence in Western Europe but more dramatically in rapidly growing Eastern Europe and Asia. It "looks strategically like a good fit," says Lehman Brothers Inc. analyst Stewart Adkins.

PRESCRIPTION SWITCH? Smith-Kline's bet is twofold. First, Leschly hopes to use the combined companies' expanded distribution network to lift sales across the product line. More intriguing, though, is his gamble that the OTC category will grow ever more important as European governments, hard-pressed to pay prescription-medicine bills for their citizens, switch more prescription drugs to OTC status.

Britain's government, for example, is currently pondering OTC approval of nine popular prescription drugs, which would shift the bulk of the purchase cost to consumers. Such switches are expected to increase, making distribution such as Sterling's crucial. SmithKline could use the Sterling network, for instance, to boost slow sales of its Tagamet 100 heartburn remedy, which began selling in Britain in May.

Leschly has grander designs for his global network: He wants to sell the OTC medicines of rival drugmakers that have weaker presences in markets where SmithKline is strong. "There are plenty of major players [with which] we can develop relations," he says. Merck & Co. arranged a successful joint venture in 1989 with Johnson & Johnson. SmithKline already distributes certain products for Marion Merrell Dow Inc.

Before he attempts such ventures, though, Leschly has to get costs down. Sterling's price tag, at three times sales and 18 times earnings, is modest compared with other recent drug deals. But it will leave SmithKline with $5 billion in debt, about half its annual sales. The company is setting aside some $750 million for a restructuring that could threaten thousands of jobs over the coming three years. "We don't need all the overhead we have," Leschly says. Executives want to boost the operation's pretax profit margin to 20% in that time--quite a stretch, since SmithKline's margins are now as low as 12% and Sterling's are little better.

ASSET SALE? But analysts say SmithKline should be able to make the deal pay in less than a year. Earnings may be only slightly diluted this year and start showing gains in 1995. Just how big the gains will be depends on what so-called nonstrategic assets Leschly sells. Among the potential candidates: Aqua-fresh toothpaste and a Beecham line of nutritional drinks sold in Britain.

Another, more likely, cut: Sterling's Bayer aspirin. Although Leschly won't say, some SmithKline insiders and analysts think he may sell North American rights to Bayer, a low-growth item, to Germany's Bayer, which was forced to give up the product after World War I. Bayer bid unsuccessfully for the entire Sterling business and now says it will approach SmithKline to bid on Bayer. The product could be worth $500 million to $1 billion, say analysts.

The downside for Smith-Kline: By tying up capital in Sterling and its $2.3 billion acquisition of Diversified Pharmaceutical Services Inc. in May, the company limits its ability to buy into prescription-drug operations, where margins are far higher. Leschly won't rule out more deals. "We are not panicking," Leschly told analysts on Aug. 30. "We think we do have a healthy pharmaceutical business....If the perfect opportunity comes up, and we see it can be done, we will look at it." With his OTC score, though, Leschly risks leaving SmithKline a pharmaceutical also-ran.

                                 SMITHKLINE      STERLING
                                  BEECHAM         WINTHROP
      1993 SALES              $2.0 billion        $1.01 billion
      OPERATING PROFITS       $245 million        $162 million
        -- GASTROINTESTINAL      Tums, Tagamet 100   Milk of Magnesia
        -- COUGH/COLD            Contac              Valda, Neo-Synephrine
        -- ANALGESICS            Ecotrin             Panadol, Bayer, Midol
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