Crunch Time In Pill Land
In the normally genteel world of pharmaceuticals, the din of battle among Pfizer, American Home Products, and Warner-Lambert is growing louder. Warner-Lambert execs had barely received word of Pfizer's hostile bid before Pfizer lawyers were in court charging Warner-Lambert directors with breaching their fiduciary responsibility by accepting an ironclad bid from AHP. Warner-Lambert, which prefers to hook up with AHP, is looking for ways to retaliate, including the possible termination of the two company's co-marketing agreement on the $3.6 billion cholesterol-lowering drug Lipitor.
These skirmishes are only the beginning of what is shaping up to be a frantic, if not chaotic, period of pairing up in the pharmaceutical world--an industry where consolidation has already produced a crop of awkwardly hyphenate corporate families. Why more deals? After years of robust sales and earnings off a string of fast-selling drugs, industry execs fear a slowdown. Even giants like Pfizer Inc. and Merck & Co. don't have any obvious blockbusters in the wings. Investor anxiety over Pfizer's thin pipeline prompted the company to move up a Nov. 22 analysts' meeting to Nov. 16.
At the same time, research budgets are escalating as the search for new drugs moves from hit-or-miss chemical screening to the costlier process of uncovering the genetic riddles of diseases. Worse still, patents on a number of big drugs are set to expire within several years, triggering a flood of cheaper generic versions. To keep earnings growth on track and stock prices up, drug execs are looking at deals--even if history shows that such consolidation doesn't always yield the expected results. "The mergers are inevitable," says independent analyst Hemant K. Shah. "I think you will see half a dozen companies or so left."
REGULATORY SETBACKS. Until recently, few observers would have expected Pfizer, the 800-pound gorilla with $16 billion in sales, to be a player in those deals. But the drugmaker's setbacks over the past year show how quickly a hot product lineup that includes Viagra can cool off. Earlier this year, the Food & Drug Administration put tight restrictions on use of Pfizer's antibiotic Trovan, virtually wiping out sales potential of a drug that was expected to hit $1 billion in revenue in a few years. A schizophrenia drug has been delayed by the FDA, and work on a promising drug for nerve damage from diabetes was recently shelved after testing showed poor effectiveness. The result: CIBC World Markets Corp. analyst Steven B. Gerber figures Pfizer's sales growth will slow from 22.5% in 1998 to 13% in 2001.
Pfizer clearly sees Warner-Lambert's cholesterol drug Lipitor as a way to head off that slowdown. Lipitor should generate $4.4 billion in sales next year, a portion of which goes to marketing partner Pfizer. And analysts figure it may become the top-selling global drug by 2005, with sales as high as $10 billion.
But Pfizer has a problem: Under the marketing contract, Warner-Lambert can cut Pfizer's sales force out of the arrangement in 2001. Pfizer would still get payments based on Lipitor's sales, but the payout would be far lower. That's something Pfizer Chief Executive William C. Steere and his heir apparent, President Henry A. McKinnell, can't afford. So, many on Wall Street expect Pfizer to up its bid for Warner and even accept financially unattractive accounting provisions that could hurt Pfizer's future earnings. "We have every intention of winning," says Steere.
And Lipitor is not the only big drug on Pfizer's radar. Steere says he would also be interested in the drug operation of Monsanto Co., which co-markets the new $1.3 billion arthritis drug Celebrex with Pfizer. Here, too, he is likely to encounter rivals: Sources confirm that Novartis has recently discussed a deal for Monsanto. Schering-Plough Corp. is also said to be interested.
In fact, the success of products like Celebrex and Lipitor underscores why many drug companies are angling to get bigger. Both drugs have achieved blockbuster status in large part because of huge marketing efforts and massive sales forces. The pattern has been established: One giant drugmaker brings out a product, and a copycat formulation follows. The battle then shifts from research to marketing--and everybody spends bigger bucks than ever to gain or even maintain market share. According to market research firm Scott-Levin, the top 40 drug companies now employ more than 62,000 salespeople in the U.S., up from 36,500 in 1995.
At the same time, expensive new technologies are requiring massive investment. With them and insights into the genetic triggers for disease, drugmakers are uncovering thousands of potential targets for drugs. But the new tools are expensive. And turning that information into a safe and effective drug is still slow, costly work. That means midtier players like Pharmacia & Upjohn Inc. and Schering-Plough will face more pressure to strike deals that give them added research firepower.
Behind many merger plans, too, are patent expirations. U.S. patents on 33 drugs representing $14 billion in sales, products like the stomach drug Prilosec with nearly $3 billion in sales in the U.S., and the antihypertension therapy Vasotec, which racks up $870 million in U.S. sales, will expire by the end of 2003, consulting firm A.T. Kearney figures. That's like to be followed by cheap generic versions of those drugs that wipe out much of the sales of the original branded product.
A big deal, of course, can produce hefty cost savings to plug the hole left by those patent expirations. Glaxo Wellcome PLC, for example, is still generating weak growth in the wake of the expiration of its ulcer drug Zantac in 1997, as newer drugs have been disappointing. That's a major reason Glaxo tried to strike a deal with SmithKline Beecham last year--a transaction that analysts expect might be rekindled. Meanwhile, Merck's growth is expected to slump in the next few years as patents on several big drugs like Vasotec expire. And while Merck CEO Raymond V. Gilmartin has maintained Merck hasn't needed a deal, experts think Pfizer's move could change that. "I think every large company that previously stated it could go it alone is in the hunt," says Ronald M. Nordmann, portfolio manager at Deerfield Management Co.
WHO'S THE BOSS? Of course, there are high hurdles to pulling these deals off. Investment bankers say that the biggest stumbling block to drug deals in the past has been disagreement over who would run the combined company. With AHP, for example, Warner Chief Executive Lodewijk J.R. de Vink is in line to succeed American Home CEO John Stafford. If Pfizer wins, de Vink is likely to be out, since the current CEO Steere has a clear heir apparent in McKinnell.
But if striking a deal is tough, making them pay off will be even harder. A study earlier this year by Basel-based Pharma Strategy Consulting found that in virtually every case, drug companies that were formed from mergers saw declines in market share after the deal when compared with the market share of the two companies before the merger. So while cost savings from putting two big companies together may pump up earnings for a few years, it doesn't usually result in strong sales growth. Executives in the current round of mergers are hoping they can find a way to beat that record.