Darren Snellgrove - Pharmaceutical Mergers - Villanova University

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Pharmaceutical Mergers: What’s the Rush?

Darren Snellgrove

Page
1

3/16/2013




Villanova University

College of Commerce and Finance








Spring, 2001

MBA 8439


Contemporary Topics in Finance






Dr. W.L. Dellva





Darren Snellgrove












Pharmaceutical Mergers: What’s the Rush?

Drivers of Recent and Future M&
A Activity





Pharmaceutical Mergers: What’s the Rush?

Darren Snellgrove

Page
2

3/16/2013





TABLE OF CONTENTS




i)

Executive Summary


ii)

Introduction

iii)

Industry Structure

iv)

Reasons for Recent M&A Activity

v)

Analysis of Two Recent Mega
-
Mergers



Glaxo Wellcome / SmithKline Beecham



Pfizer / Warner Lambert


vi)

Do Drug Mergers Really Work

vii)

Possib
le Future Mergers

viii)

Implications of Biotechnology & Genetic Mapping

ix)

Conclusions

x)

Bibliography

xi)

Appendix

Pharmaceutical Mergers: What’s the Rush?

Darren Snellgrove

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i) Executive Summary


OBJECTIVE:

Explain what social
-
political
-
economic factors are driving the recent step
-
up in


pharmaceutical merger activity, and
determine whether or it makes sense.


METHOD:



Analyze industry data, focusing on the recent pressures that explain recent merger activity.



Consider general research and two recent mergers to see whether they are likely to succeed.



Assess whether this tr
end will continue.


Industry Stage / Structure



Relatively mature, and yet constantly changing industry. Complex financial challenges.


Reasons for Recent M&A Activity



Major drug reimbursement issues, political pressure and concerns over pricing.



Patent exp
irations / generic competition.



Profitable industry, but growth slowing.



Sales growth issues / global expansion.



R&D pipeline gaps / R&D synergies.



DTC campaigns / sales rep. coverage / channel access.



Biotechnology / Gene Mapping.



Management greed / agenc
y factors.



Changing M&A accounting regulations.


Analysis of Two Recent Mergers



Overall, results are mixed. Portfolio balance and strategic fit are the key success factors.



Glaxo / SmithKline
-

likely to achieve some success through pipeline synergies and
cost savings.



Pfizer / Warner
-
Lambert
-

the most likely to succeed due to strategic fit, operating efficiencies,
pipeline synergies, and the fact that this was a hostile purchase.



Size may be good up to a point, but some of these mergers may be going too f
ar:


Advantages of size:



Clinical trial economies of scale



Sales rep. Coverage



Regulatory / filing power with the FDA



Lobbying power (political and with
wholesalers etc.)



Balance risk in pipeline / product portfolio

Disadvantages of being too big:



Disecon
omies of scale / control issues



Lack of focus



R&D / commercial disconnects



Loss of entrepreneurial environment



May not deal with emerging areas

(biotech and genomics)


Conclusions



Size and growth are being used to defend against increasing industry press
ures, i.e.

Reimbursement, political pressure, patent expirations, growth issues, R&D pipelines, ad. economies.



It is not clear that merging is the answer. Evidence to date suggests only minimal success, & a
temporary solution. Can’t “guarantee” discovery.
Size issues e.g. R&D/commercial disconnect.



Biotechnology and genomics pose both an opportunity and a potential threat


these areas may
provide better solutions to industry issues than the mega
-
merger solution.



There is a multiplier effect as firms seek t
o retain/regain industry status.



Although not necessarily the best solution, big consolidations in the pharmaceutical industry look set
to continue.

Pharmaceutical Mergers: What’s the Rush?

Darren Snellgrove

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ii) Introduction


Mergers in the pharmaceutical industry are not new, however, in recent years we have
see
n increases in the level of pharmaceutical merger activity and more firms are using strategic
partnerships and joint ventures to develop and market new products. In this paper I will explore a
variety of social
-
political
-
economic issues in an effort to und
erstand why pharmaceutical firms
are increasingly convinced that bigger is better. Specifically, I will seek to explain what factors
are driving the recent step
-
up in pharmaceutical merger activity.

During the course of the paper I will consider two recen
t mergers to see whether or not
they are likely to succeed. The mergers I will consider are Glaxo Wellcome’s merger with
SmithKline Beecham, and Pfizer’s hostile takeover of Warner
-
Lambert. I will assess the
financial implications of these mergers, and wil
l also assess the driving forces behind recent
mergers, the existence of synergies, and whether value was created, destroyed, or simply
transferred. My goal with this analysis is to see whether big mergers really are the solution to
some of the challenges
pharmaceutical companies currently face.

Finally, I will take a brief look ahead to try and understand how recent developments in
biotechnology and genetics are likely to impact the pharmaceutical industry, and whether merger
activity looks set to contin
ue. In this paper I will explore the notion that a need for size is the
overwhelming reason for recent mergers and acquisitions in the pharmaceutical industry, but that
this may not necessarily be the best solution to the current financial and economic cha
llenges.




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iii) Industry Structure


The pharmaceutical industry is a fascinating industry, filled with mergers, acquisitions,
strategic partnerships, join ventures, and licensing. The industry is highly regulated, extremely
complex, and filled with financ
ial and economic challenges and points of interest. Finance
managers in the industry are faced with many issues including; managed care, insurance,
reimbursement, patents and generic competition, licensing, royalties, co
-
promotions, joint
ventures, co
-
mark
eting rights, high risk and high cost research and development, parallel import
issues, and international regulations. These issues will be explored in an effort to understand the
reasons for the industry’s current structure and how that structure is drivi
ng increased
consolidation through mergers and acquisitions.

The pharmaceutical industry is by most standards a mature industry. It is also highly
profitable (profit margins are about 16% versus 12% for the S&P 500) for those companies lucky
enough to dev
elop blockbuster medical treatments which are patent protected for lengthy periods
to help companies recoup their research and development investments. Despite the fact that we
hear so much about the rising cost of drugs, sales in the industry have actuall
y been growing at a
much slower rate in recent years. The 5
-
year sales growth rate for the industry is currently only
about 12% versus and S&P 500 growth rate of close to 17% (source for all financial data: Market
Guide.com). EPS growth rates have also bee
n slowing and the current 5
-
year average is 16%
versus 20% for the S&P 500. When you combine this data with the current forces impacting the
industry and the fact that many companies are cash
-
rich the stage is clearly set for mergers.

Although the industry

is relatively mature, it is also an industry that is in a state of almost
constant change. In recent years, it has been faced with increasingly complex financial and
Pharmaceutical Mergers: What’s the Rush?

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economic challenges including; intellectual property issues, patent expirations and gener
ic
competition, managed care, insurance, and reimbursement issues, complex co
-
promotion, joint
venture, and licensing agreements, and an increasing array of research and development issues,
threats, and challenges.

The pharmaceutical industry has been unde
r a great deal of scrutiny over the last few
years, and has become one of the top political targets. It is often claimed that prescription drugs
cost too much and that price’s are spiraling out of control


this is not true. While there is no
doubt that Am
ericans are spending more on drugs, people often confuse more spending with
higher prices. Increased drug spending is almost entirely due to the fact that people are buying
more drugs. Ronald Bailey points out in an article written for Reason Magazine that

“Between
1993 and 1999, overall inflation rose 19 percent while drug prices increased 18.1 percent… The
vast majority of the spending increase on drugs


some 78 percent


has occurred because
doctors and patients are taking advantage of more and better d
rugs that are now available.”
(Bailey, 2001).

So why is the industry coming under so much pressure? Third
-
party payers are the main
culprits. As doctors prescribe more drugs to cure and ease the pain for their patients, health
insurers and managed
-
care pr
oviders have to spend more on drugs. Despite the fact that spending
on drugs does lower health care costs and increases the length and quality of patient’s lives,
insurers


from an actuarial perspective
-

actually prefer it when patients just die (or get
cured)
because then they don’t have to pay for years of life
-
extending drugs. This is clearly a horrible
situation.


The structure of the pharmaceutical industry is often blamed for high prices. Patents
provide brand
-
name protection for new drugs, and all
ow pharmaceutical companies to achieve
Pharmaceutical Mergers: What’s the Rush?

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average profit margins of 16 percent and up to 20 percent versus about 12 in most other
industries. The reason for patents and the need for high profit margins stem from the extremely
high and risky nature of pharmace
utical drug development. Between hundreds of molecules have
to be screened in order to make one successful drug and it can take as many as 15 years to bring
a drug through from discovery to launch. Many drugs developed never even make enough
money to cover

their development costs, but pharmaceutical companies keep searching knowing
that eventually they will discover a blockbuster.


In 2000, legislation was passed allowing the re
-
importation of drugs manufactured in
America from Canada where drug prices are
significantly lower mainly due to price controls.
The danger of this is that it will actually hurt Canadian’s as US pharmaceutical companies will
raise export prices to Canada in order to prevent profits being undercut in the US by re
-
importation. Despite
foreign price controls, many pharmaceutical companies do sell their
products abroad at a discount but the margins are low. This is a problem, for although they cover
manufacturing and promotional costs, they do not generate enough profit from abroad to
ade
quately fund research and development. If the US follows the lead set by certain European
countries that regulate prices it could significantly hinder and most certainly slow the
development of new life
-
saving treatments.

Many European countries have gover
nment healthcare systems, hence the strict pricing
controls. In the US, the insurance companies rule and can have a big impact by deciding what
and how much gets covered. US controls are currently limited to “best price” for Medicare and
Medicaid, although

there are a number of proposals currently under consideration such as
prescription drug coverage for seniors that would more than likely see an increase in government
control over prices.

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Price Controls in Europe:

The following table highlights some of
the restrictions that apply in the some of the biggest
European markets:


In the next section, I will explore the impact that these factors are having on the
pharmaceutical industry


specifically I will discuss the fact that uncertainty is increasing the
level of merger activity. Size and growth are now a necessity in the pharmaceutical industry.


France
Germany
Italy
Spain
UK
Cross Country Comparison
Internal Reference
Negative List
Positive List
Price Cuts
Price Freezes
Profit Control
Rebates
Reference Prices
Applied price control system
Source: Managed Care in Europe, 1995
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iv) Reasons for Recent M&A Activity


Although consolidation in the pharmaceutical industry is nothing new, the recent
increases in merger activity reflect an

increasing number of financial and strategic challenges
now facing the industry. These often
-
unique financial challenges have made size a desirable
objective. There are seven main reasons why the pharmaceutical industry has been consolidating
in recent ye
ars: 1) drug reimbursement issues, 2) political pressures and growing concerns over
drug prices, 3) patent expirations / generic competition, 4) sales growth issues, 5) R&D pipeline
gaps / synergies, and 6) the increasing use of direct
-
to
-
consumer (DTC) ca
mpaigns, and 7) recent
developments in biotechnology and the mapping of the human genome. The last reason will be
explored later in a separate section. There are also two other reasons that may help to explain
merger activity, namely agency affects and rec
ently proposed changes to merger accounting
regulations. In this section I will explore these issues in more detail. Before doing so, it is
interesting to compare 1995 industry rankings based on revenue to the ranking list in 1999.

1.
Glaxo Wellcome
$10.5
2. Merck
$8.4
3. BMS
$7.8
4. HMR
$7.5
5. J&J
$7.1
6. AHP
$7.0
7. Pfizer
$6.8
8.
Roche
$6.8
9. SmithKline
Beecham

$6.0
10.
Sandoz
$5.0
1.

Pfizer
$20.9
2.
Glaxo
SmithKline
$20.7
3.

Merck
$14.2
4.
AstraZeneca
$13.5
5. BMS
$12.1
6.
Novartis
$11.8
7.
Aventis
$11.4
8. J&J
$11.1
9.

AHP
$9.3
10.
Pharmacia
$9.1
1995 Rank and
Pharma
Revenue
$ Billions
1999 Rank and
Pharma
Revenue
$ Billions
SOURCE: Evaluate Pharma


Database of
pharmaceutical company information

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The previous table high
lights how mergers and different product blockbusters have
changed the pharmaceutical rankings in recent years


although the issues identified above are
the underlying drivers of growth through acquisition, the importance of status within the industry
as
a driving force should not be ignored. It is also interesting to note the change in size of these
companies. In 1995, the number one company was Glaxo with revenue of $10.5 billion. In 1999,
Pfizer topped the list with double the revenue at $20.9 billion.

Clearly, there is a drive for size.

Throughout much of 2000, the pharmaceutical sector was filled with concern. During the
election there was a great deal of discussion about rising drug prices. Many thought the federal
government would pass new laws aime
d at slashing prices. However, the arrival of a Republican
White House and an evenly split congress put an end to many of these fears. IMS Health (a firm
which tracks pharmaceutical sales and usage) now expects global sales to grow 8.8% to $385
billion in
2001 (Business Week, Jan 8, 2001). Despite these projections, there may still be
demands to pass a Medicare prescription
-
drug benefit. Currently, the government plan provides
reimbursement for pharmaceuticals taken in hospital but not for the large number
of drugs
seniors now take at home on a regular basis. How this will affect the industry remains to be seen,
but undoubtedly bigger will be better in an era of price
-
cutting. One of the biggest threats to
pharmaceutical firms over the next few years will co
me from generic competitors. “SG Cowen
Securities predicts that between now and 2005 patents will expire on products with annual sales
of $34.6 billion” (Business Week, Jan 8, 2001). In 2001, drugs like Prozac, which generates
annual sales of $2.5 billion
for Eli Lilly, will come off patent, as will AstraZeneca’s Prilosec
with sales of $6 billion. This is one of the main reasons that drug manufacturers are anxious to
merge. Companies in the industry have shown sustained periods of double
-
digit sales growth,

and don’t want this to stop.

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Firms are also merging in order to exploit cost savings and benefit from economies of
scale and scope in R&D. Research and drug development in the pharmaceutical industry is
extremely risk, expensive, and time consuming. Many
companies also have significant gaps in
their development pipelines. This has profound implications for a pharmaceutical organization in
terms of future sales growth. Finance managers in pharmaceutical companies spend a lot of time
analyzing the corporatio
ns product portfolio and have to make tough decision to make sure that
the company has the right balance of risk and return, and early and late stage opportunities.
Companies need to invest carefully given the fact that development programs are so expensiv
e
and time consuming. It also takes time to recruit and train scientists and it is extremely
inefficient if you have to keep hiring and firing because you do not have a balanced pipeline and
workload. Although there are economies of scale associated with R
&D activity (primarily
associated with the development side in terms of trial capabilities and the use of contract
research organizations) executives are constantly trying to manage the use of size while at the
same time providing an entrepreneurial enviro
nment that will encourage drug discovery.

Scale is also increasingly important now that direct to consumer advertising has been
made more accessible. Pharmaceutical companies are now able to use television advertising to
market their products directly to c
onsumers. Many have argued that this is a bad idea, however,
pharmaceutical companies counter by arguing that increasing consumer awareness is a good
thing because more patients than ever are now recognizing symptoms and actively pursuing
treatments with t
heir doctors. Another associated reason for size relates to the intense selling
infrastructures that many large pharmaceutical companies like Pfizer now have. Firms have to
grow in order to compete against these marketing powerhouses, which are increasingl
y locking
up distribution channels.

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An additional reason that should also be mentioned as a reason for merger activity is
management greed. It is almost impossible to eliminate agency affects from a business, and as a
result managers will undoubtedly do wh
at is in their own best interests. Clearly mergers can offer
significant benefits to management whether it be via increased job security, golden parachutes,
poison pills, stock awards, etc. This is not a new phenomenon however and does not explain the
rece
nt flurry of merger activity.

During the last year, there were also moves by the Financial Accounting Standards Board
(FASB) to eliminate the pooling method of accounting for merger transactions. Companies were
concerned that they would have to account fo
r all transactions using the purchase method which
requires any premium over and above fair market value (known as Goodwill) to be amortized
over 30 years. More recently, FASB issued a limited exposure draft stating that although the
pooling method would s
till be eliminated, goodwill would not have to be amortized and would
simply remain on the balance sheet. The only time firms would have to expense any costs to the
income statement would be if the asset became impaired in any way. Although this recent mov
e
appears to have eliminated many of the concerns regarding future mergers, concerns over
possible FASB rulings undoubtedly contributed to some of the increased merger activity in the
pharmaceutical industry.

In some ways it would appear to make sense for
pharmaceutical companies to merge.
Investors have come to expect that pharmaceutical companies will always deliver double
-
digit
growth, but as patents begin to expire and generic competition increases this is becoming harder
to achieve. Recent combinations

of giant firms like Pfizer and Warner
-
Lambert and Glaxo
Wellcome and SmithKline Beecham puts pressure on those remaining to do the same in order to
stay competitive. Pharmaceutical companies are merging for size in order to maintain growth.

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v) Analysis o
f Two Recent Mega
-
Mergers


In order to explore the issues identified in this paper further, and to see whether mergers
have actually helped corporations, two recent mega
-
mergers will be considered. The merger
between Glaxo Wellcome and SmithKline Beecham,
and Pfizer’s hostile takeover of Warner
-
Lambert following an initial announcement that Warner
-
Lambert would be merging with
American Home Products.


Glaxo Wellcome / SmithKline Beecham




The shares of SmithKline and Glaxo declined immediately after the
deal was announced. The
combined corporation won approval from the FTC in December. In 2000, the company recorded
702 million pounds in one
-
time items related to the merger and restructuring costs as well as
gains from disposals. Key products include: Paxi
l, Wellbutrin, Augmentin, Seroxat/Paxil.
Avandia, a diabetes drug, recorded $702 million, and Seretide, an asthma drug, posted $316
million. Consumer healthcare division only grew 3% and will more than likely be divested in
order to create a more pure
-
play

pharmaceutical company (GSK press release Feb 22, 2001).

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The following analysis seeks to explore the Glaxo Wellcome / SmithKline Beecham merger
from a theoretical perspective in order to try and understand the transfer of value that took place
The Bargaining Area and Synergism - USD Millions
Acquiring Firm
Target Firm
Glaxo Wellcome
SmithKline Beecham
EPS (fully diluted)
0.92
$

1.67
$

Annual Dividend
0.55


0.18


Dividend Growth Rate
5%
5%
Book Value per Share
3.80


4.00


Average Market Price per Share (Wa)
53.00
$

62.19
$

Number of Shares (Sa)
3,254


1,179


P/E Ratio
57.54


37.32


Total Earnings
2,997
$

1,965
$

Total Stockholder Wealth (W x S)
172,440
$

73,344
$

Pre-Acquisition Wealth Positions:
172,440
$

73,344
$

Post-Acquistion Value of the Combination:
61.63
$

Wab = O (Ya + Yb) / [Sa + (ER) Sb]
Expected P/E Ratio after the combination (O)
58


Average of current ratios
Total first period earnings (before synergism) Ya + Yb
4,962
$

Assuming no change
No. of shares of the acquiring company (Sa)
3,254


No. of shares of the target company (Sb)
1,179


Tentative Exchange Ratio (ER)
1.2


Acquirer price/ target price
Post-Acquistion Wealth Position of the Shareholders:
Acquiring company shareholders:
Will support the merger, if they expect Wab > Wa
Yes this is the case, therefore accept
Target company shareholders:
Wb (1 / ER)
53.00
$

If the post acquistion price is greater, they will accept
Yes this is the case, therefore accept
Maximum Exchange Ratio Acceptable to the Acquiring Company
ERa = [O (Ya+Yb) - (P/Ea)(Ya)] / [(P/Ea)(Ya)(Sb/Sa)]
1.81


Minimum Exchange Ratio Acceptable to the Shareholders of the Target Company
ERb = [(P/Eb)(Yb/Sb)(Sa)] / [O(Ya+Yb) - (P/Eb)(Yb)]
0.95


Post Combination Synergism
Value of the Enterprise after the Combination
285,795
$

Less:
Value of the Enterprise before the Combination
245,784
$

Total Synergism
40,011
$

Less:
Share of Synergism to Stockholders of A:
28,071
$

Share of Synergism to Stockholders of B:
11,940
$

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in the me
rger based upon the per
-
merger negotiating area. The framework used was developed
by Larson and Gonedes and is a popular technique for assessing corporate mergers (Clark, 1996).
Their framework requires the following assumptions:

1)

The objective of the combi
nation is to maintain or enhance stockholder wealth.

2)

The price / earnings ratio captures the risk
-
return characteristics of the merging firms.

3)

No synergism from increased earnings or efficiency gains will occur in the first year.

I gathered data from SEC d
ocuments (10
-
Q filings) for the periods prior to the merger to
complete this analysis. What we see is that the model expects the post
-
acquisition value of the
combination to be about $61 per share. Because $61 is greater than the acquiring company’s
curren
t value of $53 per share, the acquiring company shareholders (Glaxo Wellcome) will
accept the merger proposal. The target company shareholders (SmithKline) will accept the
merger proposal assuming that their post acquisition wealth position is also greate
r. The
calculation is shown above Wb (1 / exchange ratio) = $53. Because $61 (the post
-
acquisition
value) exceeds $53 the target shareholders will also accept.


From the analysis we can see that the bargaining area for the deal was 0.95 (the minimum
accept
able level for the target shareholders) and 1.81 (the maximum acceptable range for the
acquirer). Generally the shareholders of the target firm extract more relative value from the deal
than the shareholders of the acquiring firm. This was true for this me
rger
-

although the absolute
value was lower, relative to the pre
-
acquisition wealth position SmithKline Beecham
shareholders extracted a higher percentage of synergism (16% versus 7%).


Although this analysis provides some insight into the merger, the rea
l key to
understanding the success / failure of a deal comes from looking at the post
-
combination
announcements, and the real driving forces behind the deal.

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In the first earnings report since the merger, Glaxo Wellcome and SmithKline Beecham
reported a 1
3% rise in 2000 pre
-
tax profit, boosted by a 10% increase in pharmaceutical sales
and double
-
digit growth in key therapeutic areas. Pharmaceutical sales were $23.4 billion,
contributing 85% of total sales. Perhaps more impressive was the fact that new prod
uct sales
represented $4 billion or 17% of pharmaceutical sales, and grew at 60%. It’s pre
-
tax profit after
one
-
time items rose to 5.33 billion pounds ($7.71 billion) one a pro
-
forma basis from 4.71 billion
pounds a year earlier. Total sales rose 12% to 18
.08 billion pounds from 16.16 billion (WSJ, Feb
21, 2001).

The prospects for this merger are not fully clear. It seems likely to add some value to
shareholders but mostly through cost cutting as well as some pipeline synergies. However, the
strategic value

is less clear. Dr. Jean
-
Pierre Garnier, CEO has high expectations for the newly
combined firm. In February the company unveiled it’s strategy for growth, claiming that 2002
EPS would accelerate dramatically, and that over a hundred new chemical entities (
NME’s) were
currently in development, 117 of which are already in clinical studies. There are new plans to
increase R&D productivity, and planned cost savings of at least 1.6 billion pounds sterling were
confirmed. Dr. Tachi Yamada, Chairman R&D pointed ou
t the complementary nature of the
R&D portfolios that the merger brought together. The plan is to take advantage of economies of
scale, while at the same time promoting an entrepreneurial environment


no easy task.

The benefits of the merger and the perfo
rmance of the business have led the company to
forecast EPS growth of 13%+, despite the fact that the combined corporation will dispose of
certain assets. Such divestments are commonplace in pharmaceutical mergers due to regulatory
and FTC issues as well a
s the obvious overlaps that occur with such mergers.

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Pfizer / Warner Lambert



Pfizer purchased Warner
-
Lambert for $70 billion in June of 2000. Unlike the merger
between Glaxo Wellcome and SmithKline Beecham, this was a hostile takeover. Warner
-
Lambert ha
d announced a friendly merger with American Home Products, however shareholders
seemed wary of the motives for this merger as the press reported that the merger was less about
real value and more about retiring executives trying to make a name for themselv
es.


Despite some initial publicity issues, Pfizer’s takeover has been very well received. Most
industry analysts and many people within the pharmaceutical industry expect this to be one of
the few mergers that will really work. The merger represents a su
perb strategic fit, and provides
Pfizer’s incredible sales and marketing infrastructure with a great R&D pipeline. Analysts
currently project earnings growth of about 24% for the quarter, as the company continues to
squeeze out better than expected cost sa
vings from the merger. The company currently has
strong prescription growth on products such as Lipitor, Neurontin, and Viagra. One of the
biggest drivers of the Pfizer merger with Warner
-
Lambert was Lipitor, Warner
-
Lambert’s
blockbuster cholesterol
-
loweri
ng drug. Alone, Pfizer booked nearly half the revenues as a result
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of a co
-
marketing arrangement. The drug is set to be the world’s best
-
selling medicine,
surpassing Merck’s Zocor and AstraZeneca’s Prilosec. With the deal complete Pfizer sales of
Lipitor w
ould exceed $7 billion by 2002 according to a large number of analysts. Pfizer appears
to be serious about cutting jobs and costs as part of the consolidation and the fact that this is a
hostile takeover makes it all the more probable. Warner
-
Lambert’s New

Jersey headquarters will
be combine into Pfizer’s in New York. Current estimates project 10% workforce reductions.
Pfizer hopes to save $1.6 billion in operating costs in as little as 18 months (corp. PR, 2000/01).
Pfizer told analyst’s that overall savin
gs will be $2.5 billion within 3 years. Many actually
believe that Pfizer is being conservative. There are a number of reasons why these companies
can save so much. Pfizer makes Norvasc, a pill for high blood pressure that’s expected to
generate $3.5 billi
on in revenues this year, and Warner
-
Lambert makes Accupril, a $600 million
blood
-
pressure drug with a different mechanism of action. After the merger, a slightly larger
Pfizer sales force can sell the two drugs at once, since doctors may prescribe both to

patients
with hypertension. Integration on the research side will also work well as any overlaps are
minimal. The combined firm will have a presence in almost double the number of disease
categories. Pfizer has long been known as a sales and marketing pow
erhouse so the fact that it
will now have Warner
-
Lambert’s R&D will improve Pfizer’s performance as it currently sells a
lot of other company’s drugs. There are other strategic reasons for the merger for example the
combined firm will have more than 10% of

sales in the domestic prescription
-
drug market. The
Pfizer / Warner
-
Lambert merger is truly a strategic merger. Pfizer’s large market share will give
it more influence over contracts with wholesale drug buyers
-

just the influence a drug company
needs in
an increasingly hostile environment.


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iv) Do Drug Mergers Really Work?


With regards to the mergers analyzed in this paper. The newly formed GlaxoSmithKline
is likely to achieve some success through pipeline synergies and cost savings, but whether or not
this merger will truly add value for shareholders remains to be seen. Given the industry
challenges ahead, size alone should add at least some value. Pfizer’s acquisition of Warner
-
Lambert seems highly likely to succeed due to strategic fit, operating effi
ciencies, & pipeline
synergies. All of the issues discussed in this paper as reasons to merge are addressed by this
merger. Pfizer now has Warner
-
Lambert’s pipeline and will be a tough competitor to beat

In general, the evidence as to whether a merger adds

value or not has been, at best,
mixed. Merger premiums are typically in excess of 40% according to data from the Merrill
Lynch Mergerstat Review, and it takes a lot of strategic benefit to recoup these premiums (Clark,
1996).

If mergers were to succeed a
nywhere it would seem that the pharmaceutical industry
offers the greatest chances for success. Operating economies, including the elimination of
overlap in R&D, production and marketing, can produce meaningful cost savings, however a
number studies have s
hown that merged firms have not performed better over the long
-
term than
drug makers opting to go it alone such as Merck. Many combined firms have also lost market
share in key therapeutic categories. The shares of SmithKline and Glaxo declined immediately

after their deals was announced. SmithKline and Glaxo investors were apparently disappointed
by less than expected projected cost savings, questions over revenue growth and likely initial
dilution of EPS.

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Although size may be good up to a certain point,
some of these mergers may be going too
far. The main advantages of size for pharmaceutical companies include:



Clinical trial economies of scale



Enhanced and more utilized sales rep. coverage



Additional regulatory and filing power with the FDA



Increased lob
bying power (both political and with wholesalers)



Balanced risk in terms of the company’s pipeline and product portfolio

However, many of these benefits are only temporary, particularly given the current rate of
consolidation within the industry. Furthermo
re, there are potential significant disadvantages
associated with being too big. These include:



Diseconomies of scale and control issues



A lack of focus



The potential for disconnects between R&D and commercial (leading to investment
in sub
-
optimal projects

from a commercial perspective)



The loss of an entrepreneurial environment that encourages and rewards discovery

Finally, and perhaps most importantly, these mergers may not deal with some of the most
important emerging areas in pharmaceutical development,

namely biotechnology and genomics.
Although, many of these mega
-
mergers do seek to address the industry issues outlined earlier,
merging may not be the best long run solution. Biotechnology and genomics, which will be
discussed in the next section look se
t to be the future of drug development, and investments and
development in these areas, would probably be a better solution. In spite of these factors and the
mixed success of mergers, pharmaceutical firms continue to merge in an effort to provide some
lev
el of security in an increasingly uncertain industry.

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vii) Possible Future Mergers



The following chart depicts the current state of the pharmaceutical industry, but more
importantly it highlights a series of possible future mergers:


SOURCE: SEC 10
-
K’s
/ Annual reports.



As you can see from the chart above, Pfizer and GlaxoSmithKline are now clearly the
largest pharmaceutical companies in the world, with revenues of over $21 billion. Behind these
giants, we can see a group of about six large companies,
many of which were former giants prior
to recent mergers followed by a midsize group of firms all of which are likely to be acquisition
targets as the large firms seek to regain their super
-
size status.



Pfizer

GSK

Merck

AstraZeneca

BMS

Novartis

Aventis

J&J

AHP

Pharmacia

Roche

Lilly

Abbott

Scher
-Plough

Bayer
WW Rx Rev.
1999
$ Billions
Rx Share
1999
$ Billions
Market Cap
12/00 Act.
$ Billions
21
21
7.1
7.0
Giant
Large
Midsize
290
178
14
13
12
12
11
11
14
13
12
12
11
11
9
9
9
9
8
7
6
3.1
3.1
3.0
3.0
2.6
2.5
2.0
83
79
71
102
75
84
38
218
59
146
116
146
68
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viii) Implications of Biotechnology & Genetic Mappi
ng


Almost all the big pharmaceutical companies have strategic / financial partnerships with
biotechnology companies. In the past these partnerships have been a good fit. Biotechnology
firms frequently lacked the cash to fully develop their products indepe
ndently, and even if they
had cash for R&D they lacked the resources to compete with the big pharmaceutical companies’
sales and marketing efforts. On the flip side, pharmaceutical companies are continuously looking
to fill gaps in their product pipelines
and leverage their existing sales force structures.

Partnerships with biotechnology firms are very attractive to pharmaceutical firms.
Increasingly, however, biotechnology firms are making it on their own. Capital has been much
more accessible in recent y
ears, and some firms such as Amgen, Biogen, and Genentech have
been able to fulfill the dream and go from biotech start
-
up to fully
-
fledged biopharmaceutical
firm.

Pharmaceutical firms are finding significant problems associated with licensing
agreements,

co
-
marketing arrangements, joint ventures and other strategic partnerships.
Although such arrangements reduce costs as firms share the burden of development, they also
limit revenue if and when the drug becomes successful. As a result, a number of pharmac
eutical
firms have launched their own biotech efforts, or are buying or attempting to buy out the biotech
partners. However, it is not just partnership issues that are driving pharmaceutical interest in
biotechnology. There are significant benefits associa
ted with biotechnology related drug
development. In general, biotechnology products can be brought to market quicker due to higher
specificity versus their small molecule counter
-
parts. In addition, biotech products frequently
less immuno
-
genecic effects d
ue to the fact that they are derived from human cell
-
lines.

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On the surface, it would appear that no force is changing the pharmaceutical landscape
more than biotechnology and the mega
-
mergers discussed earlier, except perhaps genomics.
Pharmaceutical firm
s are desperately trying to understand the implications of a scientific
revolution known as genomics, which has the potential to change a company’s entire business
model. The term genomics refers to the effort to exploit the all the scientific information
now
available in gene databases around the world. Although most big pharmaceutical company have
some genomics expertise, some companies like GlaxoSmithKline are now trying to make it
central to their discovery and development efforts. Others are developing

external partnerships
with new companies like Millennium Pharmaceuticals and the Celera Genomics Group. The
opportunities in the area of genomics are immense. Scientists have huge opportunities to find
new ways to attack disease. Merck & Co. has already u
sed genomics to identify a gene linked to
common form blindness. BMS has a number of compounds derived via genomic research to treat
cardiovascular ailments and rheumatoid arthritis, and SmithKline Beecham as uncovered new
targets to help treat osteoporosi
s (Business Week, Jan 8, 2001).

How does genomics fit with big pharma? Drug makers have massive libraries of
compounds. Matching their database of compounds with the genomic database of disease targets
should dramatically improve the speed and efficiency o
f drug development


so don’t be
surprised to see a significant increase in partnerships and merger activity between drug makers
and genome specialists. In fact, this is in my opinion a better solution to the current industry
pressures than the more tradit
ional pharmaceutical mergers that we have seen of late.

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ix) Conclusions


In spite of mixed evidence, pharmaceutical firms continue to merge in the hope that size
will help them to deal with uncertainty and ever increasing industry pressure. Size and growt
h
are being used to defend against increasing industry pressures including reimbursement issues,
political pressure, patent expirations, growth issues, R&D pipeline gaps, and advertising
economies of scale.

It is not clear that merging is the answer. With

regards to the mergers analyzed in this
paper, GlaxoSmithKline looks likely to achieve some success through pipeline synergies and
cost savings, but the strategic benefits are less certain and the announcement was not well
received by the market. Pfizer’s

acquisition of Warner
-
Lambert is more likely to succeed given
the fact that it was a hostile takeover, and that there was a good strategic fit. However, Pfizer had
to pay a significant premium in order to make the merger happen due to the planned friendly

merger between AHP and Warner
-
Lambert.

In general, evidence to date suggests only minimal success and given the current rate of
consolidation any benefits gained through increased size are only likely to be temporary.
Operating economies, including the e
limination of overlap in R&D, production and marketing,
can produce meaningful cost savings, however a number studies have shown that merged firms
have not performed better over the long
-
term than drug makers opting to go it alone such as
Merck. Many combi
ned firms have also lost market share in key therapeutic categories.

Further, you cannot guarantee drug discovery, and there are size issues associated with
big mergers. These include diseconomies of scale and control issues, a lack of focus, the
potential

for disconnects between R&D and commercial (leading to investment in sub
-
optimal
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projects from a commercial perspective), and the loss of an entrepreneurial environment that
encourages and rewards discovery.

Finally, and perhaps most importantly, these m
ergers may not deal with some of the most
important emerging areas in pharmaceutical development, namely biotechnology and genomics.
These areas are improving target identification and will ultimately help to reduce costs. They
have the potential to revolu
tionize the drug discovery process, if drug companies can match their
databases of compounds with the genomic database of disease targets we should see some
dramatic improvements in the speed and efficiency of drug development. Biotechnology and
genomics w
ould appear to offer potential better ways to deal with current industry pressures than
simply merging traditional companies in order to gain some synergies and perhaps some
additional lobbying power. They offer the potential to redefine the industry, to a
ctually deal with
some of the pricing issues, sales growth, patent, and pipeline issues without consolidating
already large companies which simply makes your base for growth even bigger. Even with the
mounting financial evidence and growing number of argum
ents against these mega
-
mergers the
current industry trend looks set to continue. Although not necessarily the best solution, big
consolidations in the pharmaceutical industry look set to continue.


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