Online Extra: GlaxoSmithKline: Who Says Bigger Isn't Better?

The huge British drugmaker's initial post-merger results reveal a safe haven for investors, one analyst says

After a millennium year tainted by merger delays and product setbacks, Britain's Glaxo SmithKline, the world's largest drugmaker, with $22.7 billion in global sales, is back on track. Just six months after the $195 billion merger that formed it, GSK is proving that when it comes to drug discovery, bigger is better.

The new company's debut results on Apr. 24 were impressive. GSK's first-quarter pretax profits rose 19%, to $2 billion, on sales of $7 billion, an increase of 16% from the previous year. The company has emerged a world leader in five important therapeutic areas, which account for 84% of revenues. New-product sales, led by diabetes treatment Avandia and asthma drug Seretide, were up 34% in the first quarter. Moreover, sales in the U.S., the world's fastest-growing market for prescription drugs, surged 14%, thanks in large part to GSK's 8,000-strong American salesforce.

The most exciting news for GSK investors, however, is that the company's aggressive CEO, Jean-Pierre Garnier, is on the prowl. With some $6 billion in free cash flow, GSK is looking to bolster its arsenal of new medicines. GSK has been rumored to be interested in U.S. rival American Home Products, but Garnier has denied that such a deal is in the works. Instead, he's particularly interested in expanding his cardiovascular division and has recently reasserted that intention with further investment in biotech companies. Indeed, analysts expect the British drug giant to make a series of smaller deals before tackling another big merger.


  Even without an imminent acquisition, however, GSK's stock offers good value. That's because despite outperforming its European rivals year-to-date, GSK is trading at an 8% discount to them based on estimated 2002 earnings. The global pharmaceutical sector is expected to take a bit longer to get out of the doldrums than high-growth areas such as telecom and banking. But within the drug sector, Glaxo is likely to continue to shine.

Goldman Sachs rates the company an outperformer and has set a target share price of around $30, above its current trading level of $27.50 on the London exchange. "GSK represents a safe haven for investors," says London-based HSBC pharmaceutical analyst Martin Hall. "It has tremendous flexibility over the next three to five years over what they [management] can do with the bottom line."

For starters, Garnier is moving fast to integrate the various elements of the new company. GSK is thus on track to achieve merger-related savings of $580 million this year and a total of $2.4 billion by 2004, analysts say. The 53-year-old French native has restructured the company's massive research-and-development division into competiting teams to encourage innovation. And thanks to its $4 billion annual R&D budget, among the industry's largest, GSK has 161 new chemical compounds, vaccines, and product extensions in development and an additional 117 in clincial testing.


  As a result, GSK is expected to launch up to 15 new drugs between now and 2005. The British giant is also emerging as a leader in vaccines, with 23 in development. For instance, GSK plans to start human trials of an AIDS vaccine later this year.

The drug to watch, though, is Advair a new combination treatment for asthma launched in the U.S. in April. It combines two existing GSK drugs, Serevent and Flovent, in a single, more powerful treatment. It was designed to switch patients from the two existing drugs, which are set to come off patent relatively soon. But sales of Advair in Europe and the U.S. are well ahead of expectations. So "there has been a strategy change," says HSBC's Hall. "Now, Advair is being heavily marketed as a product in its own right." Goldman Sachs forecasts that global sales of Advair will hit $2.4 billion by 2005.

Garnier says the reception Advair has gotten in its first seven weeks on the U.S. market exceeds that for other blockbuster drugs, such as Pfizer's cholestorol lowering treatment Lipitor. "Clearly, the start of the product is ahead of our own expectations," he bragged at the company's annual meeting on May 21.


  It's a good thing. Advair and diabetes drug Avandia are viewed as the company's main growth drivers over the next two years. These products will be supported by continued strong sales of antiobiotic Augmentin and antidepressant Paxil, as well as by product extensions on a handful of older drugs. But some analysts say GSK could face a sharp slowdown in growth unless it comes up with a broader range of potential big sellers. "The weakness of the company is that the R&D pipeline for the next three years is really quite unexciting, says one London-based drug analyst.

The good news for investors is that GSK has the financial firepower to make acquistions and license promising new compounds from rival drugmakers. The company recently acquired an antidepressant from Merck that's expected to offset lost revenues from GSK's own antidepressant, Seroxat, which will go off patent in 2005. The Merck drug is currently in phase two testing and is expected to launch in the U.S. in 2005. Analysts expect its first-year sales to reach $188 million.

The deal investors hope GSK will clinch is rights to an impotence drug called Vardenafil, which is currently being developed by German drugmaker Bayer. Vardenafil is expected to come to market by the end of next year, and its sales could eventually exceed those of Pfizer's blockbuster, Viagra, which raked in $1.6 billion last year. Vardenafil has fewer side effects than Viagra, and in clinical trials it has been shown to start working within 20 minutes, compared with an hour for Viagra. Analysts say that GSK could strike a licensing agreement with Bayer as early as July.

With tons of cash and the market clout to negotiate favorable deals, GSK will no doubt move quickly to fill the holes in its product pipeline. Which means that the world's biggest drugmaker is likely to get bigger still.

By Kerry Capell in London

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