Glaxo Smithkline: Birth Of A Champion Or A Bureaucratic Blob?

Making the mammoth merger work wouldn't be easy

Talk about a drug reaction. The news that Glaxo Wellcome PLC and SmithKline Beecham PLC were in merger talks has sent shock waves through the pharmaceutical industry. It's not just the prospect of a new giant in the market--a global behemoth that would have combined revenues of about $26 billion a year. The combination of the No.1 and No.10 drugmakers would produce a company that could pump more than $3 billion a year into developing new drugs--$1 billion more thanwhat Novartis, the closest rival in research spending, is shelling out.

While it is far from certain that the talks, begun in late January, will result in a deal, they reflect a major shift in the global drug business. The advent of technologies such as genomic sequencing and advances in the development and testing of new chemical compounds are giving companies countless leads for new drugs. But capitalizing on those leads requires massive spending. And sales and marketing expenses are ratcheting upward as companies battle for share.

The result: Companies with big research budgets and marketing muscle stand to dominate today. "Anyone who is going to remain competitive is going to need an enormous amount of resources," says Alan M. Sebulsky, executive vice-president at Lincoln Capital Management.

"FEED THE BEAST." Still, just to achieve respectable growth, the new company would need exceptionally solid management--and a slew of new products. "It takes a huge quantity of meat to feed the beast," says Samuel D. Isaly, a partner at pharmaceutical research firm OrbiMed Advisors. "And this would be one enormous beast."

Indeed, analysis of past deals suggests bigger hasn't always been better. A recent study by consulting firm A.T. Kearney Inc. tracked the economic return--a formula that factors in cash flow and adjusts for the cost of capital--of drugmakers such as American Home Products, Bristol-Myers Squibb, and Glaxo, all of which have done major deals in the past decade. Kearney found that the return for most declined in the first few years after a merger or acquisition.

Kearney's findings are not unique. A study by Barrie G. James, a consultant at Basel-based Pharma Strategy Consulting, showed that virtually every drug company formed by a major merger in the past 30 years ended up with less market share than the two companies combined had before the deal.

Moreover, the most successful drug mergers have not been driven by growth plans. Deals such as American Home Products Corp.'s acquisition of American Cyanamid Co. have been cost-cutting plays that led to quick savings.

Still, Sir Richard Sykes, chairman of Glaxo, and SmithKline Chairman Jan Leschly believe their deal could succeed given the new capital requirements of drug development. In a joint statement disclosing their merger talks, they described the possible deal as a "compelling strategic opportunity."

Major cost savings are possible: Salomon Smith Barney analyst Kevin Wilson figures that axing up to 15,000 positions and consolidating operations could save nearly $2 billion over three years. The biggest potential payoff, however, stems from the companies' complementary research. Glaxo has invested heavily in technology to automate the chemistry of developing drugs. SmithKline is a leader in genomics: Through more than 150 biotech alliances, including its $125 million investment in Human Genome Sciences Inc., the company has amassed massive data on the role of genes in disease.

MORE COMBOS? The discussions between Sykes and Leschly are forcing rivals to reassess their positions. "It does change things for competitors," Monsanto Chairman Robert Shapiro said at a conference in Switzerland on Feb. 3. Cowen & Co. analyst Stephen Scala figures midsize companies such as Schering-Plough, Warner-Lambert, and Zeneca may end up seeking partners.

Even if rivals don't combine, they will be looking for ways to fill their pipelines. With new technologies accelerating drug discovery, pharmaceutical companies need to churn out more hits than ever. So while size is hardly the sole determinant of success, it is becoming more important than ever.

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