There’s an article this morning on Bloomberg insinuating that the Pfizer/Wyeth, Genentech/Roche and now Merck/Schering-Plough mergers have placed pressure on the remaining members of big pharma to get into the game. I implore them not too; megamergers are rarely, if ever, good for business. Recent history suggests acquiring small companies with one major, late-stage pipeline drug is the way to go. I’d argue that Lilly and Takeda with their slightly overpriced purchases of ImClone and Millennium respectively will come out much further ahead in the long run than Pfizer and Merck.
Hypothetically, let’s say major Pharma X has $10B in cash and is looking for strategic alternatives in this high cost of capital environment. There are (simplistically) three options:
The most pressing issue facing Pharma X is the loss of revenue due to patent expiration and lack of a late-stage pipeline to replace the revenue. Addressing these issues should be the #1 priority in evaluating strategic alternatives. Period. I don’t care about cost-savings or share price or margin. In the long run, those things just don’t matter. Unless Pharma X is aching to collapse under its own bloat, they have to become more productive. Unfortunately for them, R&D productivity doesn’t scale with revenue or employee number. Larger companies simply just not as productive as smaller ones at bringing drugs to market and this fact alone should rule out a mega-merger.
So what are the strategic alternatives? I Looked at small-cap companies with a market cap greater than $250 million, and assuming a 30 percent premium to current market values, instead of blowing $10 billion on bankers and lawyer fees (and paying a ridiculous cost of capital to take out massive debt in a credit crunch), Pharma X could potentially acquire a staggering 22 companies with mid to late stage products and the platform technology to boot.
I realize this is a simple hypothetical and evaluating each alternative is vastly more complicated… but it does make you think; how is taking out billions of dollars of debt in order to not solve the major R&D productivity issue even an option? I could be just as brainless and suggest a preferred alternative; simply just admit you can’t beat the patent cliff, take a deep breath, and sell off key assets followed by the return of a substantial cash reserves to the shareholders.
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Eben is a highly caffeinated business development associate at a small, cash sensitive pharmaceutical company somewhere in Massachusetts. He enjoys cliche-less banter, compartmentalization, non-equilibrium thermodynamics and NPV analysis. Agree or disagree with what he's posted? He encourages comments.
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