Pharmaceutical Industry Outlook – 2001 (1)

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Table of Contents



The Merging Reality
-----------------------------------------------------




1



Merger Savings?
----------------------------------------------------------




3



An Analysis of Three Recent Pharmaceutical Mergers
--------------




5



Merger #1: Glaxo Wellcome and SmithKline Beecham
---




5


Merger #2: Pfizer and Warner
-
Lambert
----------------------




7


Merger #3: J&J and Alza
---------------------------------------




9


Pharmaceutical Industry


Outlook for 2001
------
-------------------


14


Endnotes
-------------------------------------------------------------------


17





1

The Merging Reality


The payoff of growth resulting from a merger can be enormous for pharmaceutical
companies. However, some statistics about me
rgers and acquisitions across industries and
in general communicate the inherent risks in choosing to proceed with the integration of
two different companies. Some of the researched statistics, noted in Pharmaceutical
Executive in January 2001, are as fol
lows
1
:



75% of large mergers fail to create shareholder value greater than industry
averages



Productivity drops 50% following the announcement of a merger



Leadership attrition soars to 47% within three years following a merger



Employee satisfaction drops 14
% following mergers



80% of employees feel senior management cares more about economics than
about product quality or people

It is important for the merger or acquisition of two companies to be appealing both prior to
and after the deal. Otherwise, if not
attractive after the deal, the combination will fail to
create long
-
term value, producing frustration for employees, customers, and shareholders.


In addition, it is important for pharmaceutical companies to realize that bigger is
not always better. Many
corporate mergers were the result of a defensive competitive
move or the pressure to consolidate. The complexity in managing people, product
portfolios, research and development projects, facilities, territories, and technology
increases with the company’
s size, resources, and employee population.
1

As a result, it is
critical for merger and acquisition activities to support an underlying business strategy in

2

order for them to create added value and increase long
-
term share
holder value. The
synergy of the merger or acquisition is aided by the presence of a commitment to three key
value
-
creating goals: cost reduction, operational integration, and accelerated growth
1
.


Despite the merger activ
ity in the pharmaceutical industry, it is interesting to note
that the industry as a whole remains rather fragmented.
2

In fact, Pfizer, the leader in
worldwide prescription drug sales, owns only seven percent of the market. In addition, the
top ten drug
makers have forty
-
five percent of the market. As a comparison, in the auto
industry, General Motors alone has twenty
-
nine percent of the United States car sales. The
fragmentation of the industry may impact the future consolidation activity.


3

Merger Savi
ngs?


When considering a merger or an acquisition, pharmaceutical companies must
question whether or not the action will truly deliver the anticipated results and the
economic benefits of consolidation will be achieved
3
. The latest round of mergers in the

industry (Pfizer and Warner
-
Lambert, Monsanto/Searle and Pharmacia, and Glaxo
Wellcome and SmithKline Beecham) involved much complexity and took place in an
environment of significant social, economic, and regulatory change. For example, among
other thin
gs, the industry needs to deal with the following, as noted in Pharmaceutical
Executive in February 2001
3
:



Rapid transformation of research and development that must incorporate
processes for recombinant and

genome/protein based drug development



Need to accommodate remarkable increases in discovery research yield and its
implications for development capacity



Move away from significant reliance on “blockbusters” to greater reliance on
“category killers,” indiv
idual therapies that will deliver more focused
therapeutic impact to narrower segments of the population



Need to justify funding for discovery, development, and commercialization in
an environment of external pricing constraints and shrinking profit margin
s

Based on these issues, will mergers truly be able to result in productivity, savings, and
profit? In general, the industry is currently striving towards process innovations and cost
controls, irregardless of mergers
3
. T
herefore, pharmaceutical companies must question
whether a merger will really be able to provide more cost savings than those savings that

4

each company could have separately. Also, a merger will result in the erosion of product
prices and additional costs

related to post
-
merger integration activities. Therefore, the
savings resulting from a merger need to be substantial in order to offset these merger
results. In defining organizational complexity, Pharmaceutical Executive of February
2001, writes that “
A successful merger has a lot to do with managing “complexity” so that
the benefits of scale are not lost or reversed and the value of the merger is not destroyed.
This requirement must be made manifest in most functional areas and across most
processes o
f the organization.”
3

As a strategy for advancing business goals and addressing
shareholder needs, pharmaceutical companies consider mergers, acquisitions, and
alliances. Pharmaceutical companies need to consider “committ
ing to the unification of
practices and processes, eliminating or outsourcing all functions and processes that are not
of strategic importance, and forging external partnerships that reduce complexity and allow
a focus on strategic initiatives and the buil
ding of organizational competence” as they
compete in an industry that is expected to see more consolidation
3
.


5

An Analysis of Three Recent Pharmaceutical Mergers

Merger #1: Glaxo Wellcome and SmithKline Beecham

The seventy

billion dollar merger of Glaxo Wellcome and SmithKline Beecham
was completed at the end of 2000. The merger created one of the world’s largest drug
companies, with annual sales of more than twenty
-
five billion dollars and key operational
headquarters at
SmithKline Beecham’s offices in Center City, Pennsylvania
4
. The new
company is expected to control about seven percent of the world’s pharmaceutical market,
making it equal with Pfizer for the world’s largest drug company
4
. In the short
-
run, the
company needs to deal with a weak drug pipeline and the challenge of combining one
-
hundred thousand employees into one operation. In the long
-
run, the new company is
going to have to strive to benefit from its new size, rather tha
n falling under its weight
4
.

GlaxoSmithKline, as the new company is called, will be a worldwide sales leader
in four key areas: anti
-
infective drugs and vaccines, treatments for gastrointestinal and
metabolic diseases, drug
s for central nervous system disorders, and drugs for respiratory
disease. Eight
-
four percent of the merged companies prescription sales last year were
composed of these four drug areas
4
.

Currently, the t
wo companies have more than twenty new potential drugs and
seventeen vaccines in clinical development, with approximately half of them in the final
stages
4
. The lack of product overlap made the merger attractive from the b
eginning
5
.
Except for a few areas, mainly neurological products, there is not a lot of overlap between
the two companies by product areas. However, each company has also faced its own
setbacks. In late 2000, a promising Glaxo drug for irritable bowel sy
ndrome was taken off

6

of the market and the trial work of a SmithKline heart and stroke drug was stopped due to
safety issues
4
. Both companies have had poor luck with research and development during
the past few years. How
ever, this poor luck has been the result even though both
companies together spend more than anyone else in the industry in research and
development efforts
4
.

Jean
-
Pierre Garnier, the CEO for SmithKline, will lead the combi
ned company. He
plans to form six research concentrations. Each concentration will focus on a different
therapeutic area. The groups will be required to compete for resources and rewards within
the company, similar to the way small, entrepreneurial busi
nesses do in capital markets.
This plan is an attempt by Garnier to address the complaint that big is bad.
4

The research budget of the new company is four billion dollars.
4

This amount of
money will allow the company to invest in expensive, high
-
tech screening processes,
robots, and new genetic tools. These investments will enable the company to identify
more disease targets and generate new compounds faster. When this early research is
p
romising, the work will be assigned to one of the special groups for further development.

The company will use its size in conducting huge, global clinical trials on new drugs,
attempting to receive regulatory approvals. If approved, the company will have

the
strength of forty thousand sales and marketing employees to assist in the marketing of the
new drug.
4





7

However, even with the size of the new company and its resources, it needs to
produce new products and get them t
o market. The two companies both lacked
momentum, and, as a result, it was critical for them to complete the deal. In the near term,
the combined company lacks new products coming from its pipeline. As a result, it is
predicted that GlaxoSmithKline will

begin to announce product licensing deals with other
companies in order to help with revenue. It is necessary for the company to look outside to
fill this gap in the short
-
term
4
.


Merger #2: Pfizer and Warner
-
Lambert


The previous CEO of Pfizer, Bill Steere, retired from the company at the end of
2000. Although he was a critic of mergers in the industry and saw them as a sign of
weakness, he stated that “he has always believed

that only large
-
scale science and
marketing can drive the pharmaceutical enterprise. The bigger we are, the more
opportunities we have. So, we are convinced that scale is important in this business.” In
fact, the size of the new Pfizer includes approxi
mately twelve thousand researchers in six
different places on all continents and twenty
-
one thousand sales representatives
worldwide
6
.


Pfizer’s hostile bid for Warner
-
Lambert resulted from Warner
-
Lambert’s attempt to
merge with American Home Products.
Actually, Pfizer was not looking at taking over
Warner
-
Lambert and was happy with them as an independent company
6
. However,
Warner
-
Lambert’s actions put the company “at play.” The result of the hostile merger
resulted in
Pfizer as the clear leader of the two companies. The difficult merger included
the trading of stock for stock and the breaking up of the other deal. Warner
-
Lambert was

8

also happy as an independent company. However, even though the merger was hostile,
Wa
rner
-
Lambert did seem to like Pfizer’s products, reputation, and values.
6

In fact, if this
merger is successful, it will have accomplished a critical feat. Prior to this merger,
basically all of the industry mergers of th
e past decade failed to increase, or even maintain,
market share and value.
6


Pharmaceutical research involves large numbers of compounds and the screening of
them against thousands of receptors looking for a “match.” If a

company finds a match, it
tries to turn it into an actual drug product. Pfizer has a huge compound library and,
working with other companies, also has a large library of receptors.
6

With many targets,
the probability of
Pfizer bringing a new drug to market is increased. Although the large
nature of Pfizer works in its favor, Pfizer also acknowledges the critical role that small
science
-
based companies play.
6

In fact, Pfizer has a rotatin
g portfolio of approximately
sixty biotech partners through licensing or equity positions. The results achieved
determine which companies enter, remain, or exit the portfolio.


Pfizer is constantly looking for new information and breakthroughs, whether in

informatics, robotics, or receptors. However, Pfizer sees the greatest promise in
technologies focused on the human genome.
6

Bill Steere, previous CEO of Pfizer, stated
that “an estimate of twenty
-
thousand of the one
-
hun
dred thousand human genes have
relevance to drug discovery; all the medicines invented up to now address only about
seven hundred of those.”
6

Therefore, Pfizer has the possibility for quite an opportunity of
new findings i
n drug research.


9


As a result of the merger, Pfizer estimates that it will achieve approximately $1.2
billion in cost synergies in 2001 and expects to exceed $1.6 billion in savings in 2002.
7

In
addition, Pfizer expects annual earnings per share growth of

twenty
-
five percent or more
during 2000
-
2002.
7

As a result of ongoing productivity initiatives and cost savings from
the Warner
-
Lambert integration, Pfizer’s operating margin has improved more than eight
full percentage p
oints since 1995.
7

This is one of the best performances in the industry.
The margin improvements have come while product support and research and development
efforts have been fully funded to maximize the potential at Pfi
zer. As a result of in
-
line
products, new product launches, the absence of regulatory withdrawals and limitations, and
improved performances in the Consumer and Animal Health businesses, Pfizer anticipates
a return to double
-
digit reported revenue growth
in 2001.
7

Merger #3: J&J (Johnson and Johnson) and Alza


The most recent pharmaceutical merger involved Johnson and Johnson (J&J) and
Alza. In early 2001, J&J agreed to acquire Alza in a stock deal valued at approximately
twelve billion dollars. The deal represents a thirty
-
nine percent premium over Alza’s value
before the news of the deal was public.
8

The Alza deal represents the biggest acquisition
ever for J&J, who has previously avoided the megamergers in the pharmace
utical
industry.
14

Vice President of J&J, William Weldon, described the merger as one that was
“built on strength, not a search for synergies.”
9


J&J offered a fixed exchange ratio of 0.49 share for each of Alza’s 294.7 m
illion
shares outstanding, which includes options and debt that will be converted to equity.
16

In
addition, Alza brings approximately $1.8 billion in cash to the books of J&J. As a result of

10

the transaction, J&J plans to
dilute its earnings this year by fourteen cents and next year by
five cents, after excluding for one
-
time charges. It is expected that the merger will begin to
add to earnings in 2003. J&J has recommended that analysts reduce their earnings’
forecasts fo
r this year by ten cents and to make no changes to their 2002 forecast.
16

After
passing the antitrust review, the deal will most likely be completed in the third quarter of
2001.
16

The fac
t that Alza is much smaller than J&J and that the companies’ operations do
not overlap very much suggest that there will be few, if any, regulatory issues to hold back
the deal.

As part of the merger, Alza will remain as an independent unit of J&J. As a

result,
integration risks and the chance of large layoffs are removed.
9

In addition, Alza will
continue to develop new products and collaborate with rival drug makers, such as Pfizer
and Bayer, which both sell drugs that
use Alza’s drug
-
delivery technology.
10

Alza’s
collaborations are important to the company’s operations. In 2000, sales totaled $199
million, including $36.8 million in contract manufacturing.
10

In addition, Alza generated

$69.3 million in royalties and fees.
10

These joint projects contribute to further advances in
Alza’s technology. A challenge facing J&J will be how it chooses to market Alza’s drug
-
improvement technologies to direct comp
etitors.
15

It will be a challenge for J&J to expand
some parts of certain businesses in which they will be competing with their clients.

In addition, the deal has a $180 million break
-
up fee attached to it.
11

Alza would
be

responsible for the fee if J&J terminates the deal because Alza’s board changes or
withdraws its recommendation of the deal in response to receiving a better proposal and
then enters into the other proposal within twelve months of the termination. Alza w
ould

11

also be responsible for the fee if either of the companies terminates the deal because it has
not been completed by the December 31
st

walkaway date or if Alza’s shareholders do not
approve the deal and Alza then accepts a better proposal within twelve

months.
11


The two individual companies, prior to the merger, are described in the following
table:
14


J&J

Alza

Headquarters

New Brunswick, NJ

Mountain View, CA

CEO

Ralph L. L
arsen

Ernest Mario

Employees

98,500

26,400

2000 Revenue

$29.1 billion

$988.5 million

2000 Net Income

$4.8 billion

$223.3 million

Key Market

Consumer, pharmaceutical and

professional health care products

Urology, oncology, and central

nervous system



During the past several years, Alza has grown to become significantly more than a
manufacturer for other companies of the NicoDerm patch for quitting smoking. In fact, it
has captured part of the pharmaceutical market by designing pills, capsules, implant
able
devices, and patches. It makes time
-
release capsules that allow people to take fewer pills
and systems that use electricity to push drugs through skin.
12

Alza’s products deliver
controlled doses of drugs to patients over a long time period, ranging f
rom several hours to
months. Alza has strived to discover new ways to deliver established drugs that are no
longer protected by patents. The application of innovative technology attracted J&J to
Alza as a takeover target.
13



12

When Alza began to market its

own drugs, Abbott Laboratories announced that it
planned to acquire the company. The 1999 deal would have been a stock deal worth
approximately seven billion dollars, significantly less than the recent deal with J&J.
13

H
owever, the deal did not happen due to the inability for the two companies to face terms
with the Federal Trade Commission. Afterwards, Alza became known in the industry as a
takeover target partly because it had agreed previously to the deal with Abbott.
14

In the past, J&J has looked to targeted acquisitions to capture strategic technology
or to increase product prospects when its own research and development have not been
resulting in successful outcomes.
14

A series of pr
omising products have failed in
development for J&J and several of their blockbusters are soon going to face tough
competition.
15

As a result, in this case, J&J was attracted to the promising new drugs and
the host of techniques for improving old drugs tha
t Alza could bring to the merger. J&J
hopes to use Alza’s technology for slowly releasing drugs into the bloodstream to create
new tablet forms of key J&J drugs. In fact, the acquisition of Alza brings drug
-
enhancing
technology that is protected by appro
ximately three thousand pending or issued patents to
J&J.
14

These patents could be used to bolster its portfolio. The acquisition is expected to
bring one and a half percentage points to the growth rate of J&J’s revenue d
uring the next
five years.
16

The gain will result primarily from the sales of new drugs, especially in J&J’s
pharmaceutical division, which represents about forty percent of the company’s revenues
and sixty percent of its earnings.
17

It is estimated that Alza will bring $1.2 billion in
revenue and that Alza’s sales will grow twenty
-
three percent in 2001.
15

Although the


13

growth rate is small in comparison to that of Pfizer, for example, it i
s better than what J&J
could have achieved for growth without acquiring Alza.
17

Alza provides J&J with notable
new product opportunities and the ability to extend product life
-
cycles.

On the other hand, J&J will also ser
ve Alza in the deal. J&J believes that it can
increase the sales of Alza’s products through the expansion of its distribution. For
example, Alza does not have much presence in Europe. As a result, J&J hopes to expand
its overseas and United State market
ing in order to increase Alza’s sales. The Alza
products are expected to benefit immediately from J&J’s financial resources available for
research and development, its world
-
wide marketing strength, and its global distribution
infrastructure, especially i
n Asia, Latin America, and Europe.
17

More revenue will be
gained for Alza’s drugs than if they were marketed solely by Alza.
16

In addition, the longstanding marketing relationship between J&J and Alza was an
attraction for
both companies to the deal. J&J licensed Duragesic from Alza. Duragesic is
a patch that delivers the painkiller Fentanyl through the skin. The patch could provide
about seven
-
hundred million dollars in sales to J&J this year. The prior marketing
relati
onship between the two companies was predicted to assist with the cultural fit
between them as a result of the acquisition.
14



14

Pharmaceutical Industry
-

Outlook for 2001

During 2000, pharmaceutical revenues were aided by a

number of fast
-
growing
products that helped the worldwide sales of pharmaceuticals grow 11.7%
18
. However, this
same performance is not expected to occur in 2001. The rollout of new products in 2000,
though important and helpful, did not match the blockbu
ster launches that occurred in the
late 1990s. In addition, the Unites States patents on several major drugs are set to expire.
As a result, an expected number of generic versions will hinder the industry’s growth.
During 2001, the pharmaceutical indust
ry, which has already experienced some mega
-
mergers, may face even more consolidation. Despite the challenges facing the industry,
global drug sales are expected to grow 8.8% in 2001 (to $385 billion)
18
. Although the
perc
ent increase of sales is less than that from 2000, Norman Fidel, healthcare portfolio
manager at Alliance Capital Management LP, commented, “It is still a very good outlook.
We’ve had a period of unprecedented prosperity.”
18

Patent expirations will affect the industry significantly in the near future. It is
estimated that between 2000 and 2005, the expiration of United States patents and other
protections will occur on products with annual domestic sales of approximately $
34.6
billion.
18

The impact of generics in the market is evidenced by Merck and Company’s
drug, Vasotec, used to treat hypertension. This drug was worth $1.7 billion in annual
sales.
18

How
ever, in late 2000, annual sales of this drug fell due to the introduction of
generic products. Although many patients and health care companies desire cheaper
generics, which could help to decrease the rising costs at managed
-
care operators, the
lower re
venues from the presence of generics may force drug manufacturers to initiate new

15

deals among themselves. The recent combinations of four big players


Pfizer and
Warner
-
Lambert, Glaxo Wellcome and SmithKline Beecham


may encourage other drug
companies,
small in comparison to these combinations, to consider new deals.

The pressure to merge is increased by patent expirations. Pharmaceutical
companies are attracted to the possibility of post
-
merger savings and the better and larger
research and developme
nt opportunities resulting from their increased scale. Analysts
have noted the benefits that may be noticed from the linking of Merck and Schering
-
Plough.
18

Schering
-
Plough may face generic rivals of its allergy medicine,

Claritin, in a
few years. In addition, during 2000, the companies became closer, announcing that they
would create two new products, combinations of existing drugs or developmental
compounds already in their portfolios. In addition, Bristol
-
Myers may lo
ok to a deal with
one of its competitors in order to not have to survive on its own. In 2000, the company
encountered a major setback with its anticipated hypertension drug, Vanlev. As a result of
the delay, the product is not expected until at least 200
2.

In addition to the pressure to merge, pharmaceutical companies will be challenged
to renew their product lines in 2001. In order to accomplish this, the companies are likely
to look to the biotechnology industry. Pharmaceutical companies are likely to

consider
partnerships, rather than outright takeovers.
18

In the meantime, pharmaceutical companies
will continue to license biotechnology products. These deals are appealing to smaller
biotechnology firms lacking cash fo
r marketing campaigns. Larry Feinberg, managing


16

partner of health
-
care hedge fund Oracle Partners LP said, “One way or another, 2001 will
be a year of pipeline building, and the pipeline is clearly in the genomics and biotech
companies.”
18


The drug industry is relying on genomics, the latest scientific revolution.
Genomics refers to the efforts to exploit all of the scientific information flowing into gene
databases around the world.
18

E
very big pharmaceutical company has genomics expertise,
but some companies, such as SmithKline, have made it central to their discovery and
development efforts. Other companies have been relying on external partnerships with
upstarts, such as Millenium Ph
armaceuticals and Celera Genomics Group. The impact of
genomics is conveyed in a statement made by Pfizer’s CEO, Henry McKinnell. He said,
“We have 10,000 to 15,000 genes that could be relevant targets. The scale of the
opportunity is enormous.”
18

Pharmaceutical companies await the large payoff of
genomics, but they need to be patient because it is not likely to come for several more
years.


17

Endnotes





1

Bogan, Christopher. Pharmaceutical Executi
ve, “Marriages made in heaven?,” January 2001.


2

Krauskopf, Lewis. The Record


Business,
www.bergen.com
, “Pharmaceuticals setting stage for
a merger
-
mad year,” February 4, 2001.


3

Bellaire, David. Pharmaceutical

Executive, “Merging for scale savings?,” February 2001.


4

http://inq.philly.com
, “How to make a drug merger work,” December 24, 2000.


5

http://inq.philly.com
, “SmithKline,

Glaxo workers await new jobs,” December 24, 2000.


6

Koberstein, Wayne. Pharmaceutical Executive, “Standing on Scale: Chairman Bill Steere likes
Pfizer’s new size,” August 2000.


7

http://pfizer.com
, Pfizer Press Rele
ase, December 11, 2000.


8

Roman, Monica. Business Week, “J&J Banks on Alza to Deliver,” April 9, 2001.


9

Bennett, Johanna. Dow Jones Interactive Newstand, “J&J
-
Alza Deal
-
2: Not Based on
Synergies,” March 27, 2001.


10

Wall Street Journal Europe. Dow
Jones Interactive Newsstand, “Johnson and Johnson Seeks Key
Alza Strengths in Deal,” March 28, 2001.


11

Siegel, Ben. Dow Jones Interactive Newsstand, “Johnson and Johnson


Alza Deal has $180M
Breakup Fee,” March 28, 2001.


12

Chicago Tribune, Dow Jones Int
eractive Newsstand, “Johnson and Johnson Sets $123 Billion
Deal for Alza Corp.,” March 28, 2001.


13

www.siliconvalley.com
, Silicon Valley Technology, “Alza patches together a prominent place in
pharmaceuticals.



14

Deogun, Nikhil. Wall Street Journal, “J&J is in Advanced Talks to Acquire Alza


Stock Deal
for $12 Billion Would Aid Drug Lines, Provide Key Technology,” March 26, 2001.


15

Deogun, Nikhil. “Wall Street Journal, “Johnson and Johnson is Finalizing Deal

to Buy
Alza Corp.,” March 27, 2001.


16

Hensley, Scott. Wall Street Journal, “Johnson and Johnson Agrees to Buy Alza in $12
Billion Stock Deal,” March 28, 2001.


17

Mantz, Beth. Dow Jones Interactive Newstand, “J&J
-
Alza Deal: Logical but Adds Little
to Rev
enue Growth,” March 27, 2001.


18

Barrett, Amy. Business Week Online, “Industry Outlook 2001


Life Science,” January 8,
2001.