Pharmaceuticals: For Drugmakers, There's No Panacea

>>Blockbusters are in store, but the cost of R&D, ads, and factory fixes will eat profits
>>Pressure from insurers and government on prices will be a drag on revenues

At first glance, it seems that GlaxoSmithKline (GSK ) should be living large come the new year. Levitra, its impotence pill launched in the U.S. five months ago, could hit $280 million in sales in 2004. Advair Diskus, an asthma treatment released two years ago, is on track to reach more than $4 billion in sales. GSK also plans to roll out Ariflo in 2004, a tablet for so-called smoker's disease, and Vesicare for urinary incontinence.

But instead of celebrating, Glaxo will likely be wrestling with a host of negatives. Since mid-2003, generic drugs have torpedoed two of its megasellers in the U.S. -- antidepressant Paxil and antibiotic Augmentin -- and Glaxo could soon lose patent protection on a third, Wellbutrin SR, another antidepressant. As a result, the company's 2004 earnings will inch up only 1%, to $16.2 billion, excluding one-time items, say industry analysts. "It's a very brutal business," laments Chief Executive Jean-Pierre Garnier. "When a drug is pretty much at its peak, it just goes away instantly, like switching off a light."

So it goes for Big Pharma. Overall, the industry has a broad stream of new products expected to reach at least $1 billion each in annual sales. Eli Lilly & Co. (LLY ) alone plans to introduce four promising drugs in 2004, after launching three in 2003. Pfizer Inc. (PFE ) could be right behind, with three.

New drugs, however, don't always mean new profits. Many of the new compounds will take away sales of existing drugs. Moreover, new drugs typically lose money in their first year or two while the cost of advertising blitzes overwhelm initial sales. There isn't likely to be much relief on the pricing front, either, given that governments and insurers are rebelling against price hikes as they struggle with double-digit increases in health-care costs. Finally, regulators are forcing drugmakers to spend more to bring their manufacturing plants up to snuff.

All of these factors will take their toll on industry profits in 2004. SG Cowen analyst Stephen M. Scala forecasts that industry earnings will grow only 9%, to $41.8 billion, vs. 10% in 2003. Sales are expected to climb 6%, to $170.1 billion. Scala's forecasts could have been worse. He decided to exclude Schering-Plough Corp. (SGP ), which he says will have a "nightmarish" year following the end of patent protection for the allergy drug Claritin and will lose $220 million. "For the next handful of years, this industry will not be what it had been," Scala cautions.

The pharmaceutical business has always been a high-stakes gamble. Lately, though, the odds have lengthened. Over the past several months, Merck & Co. (MRK ) gave up on four potentially big drugs, including two in late-stage testing, because of poor results or safety concerns. CEO Raymond V. Gilmartin promises that Merck will still raise profits by 7% in 2004, thanks to double-digit sales increases of blockbusters such as Fosamax for osteoporosis. But he concedes that Merck, the No. 3 drug company after Pfizer and Glaxo, will be lucky to come out with two new drugs this year.

To increase profits, drugmakers are turning to other tricks. More and more, they are licensing products from biotech startups or foreign firms. Some are also resorting to workforce reductions: Abbott Laboratories (ABT ) cut 2,000 jobs in 2003, for instance, while Merck is eliminating 4,400 positions.

One thing they're not doing is big acquisitions. Mergers among giants were all the rage in this industry in the 1990s, but no more. Gilmartin foreswears any dealmaking, despite investor pressure. "A large-scale merger would provide, at best, a short-term boost with an expensive long-term cost," he argues. "That's not an appropriate trade-off."

Not that long ago, drugmakers defied the business cycle, selling more and more drugs in good times and bad. They still boast outsize margins. But in 2004, Big Pharma will look a lot more like any other subset of manufacturing companies.

By Michael Arndt in Chicago

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