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2007 was the year that pharma fell in love with biologics, but as the saying goes, you can't love someone else before you love yourself. 2009 was the year pharma fell in love with itself.
There were still some marriages with biotech. Roche closed the deal for Genentech in 2009, but the courtship started in 2008. Besides, they were already married once before, and Genentech already had a ring on its finger, considering Roche owned 66% of the company.
What consolidation offers
Mergers in and of themselves aren't necessarily a bad thing. For instance, you only have to pay one CEO. Drug reps can be more efficient by pushing drugs from both companies to doctors. Adding up the spare manufacturing capacity between the two companies could result in the need for one less plant. In all, the potential to increase efficiency is certainly there.
That's been the strategy with Johnson & Johnson (NYSE: JNJ ) and Abbott Labs' (NYSE: ABT ) bolt-on acquisitions. Each company has increased earnings faster than revenue by increasing its own efficiency.
Five-year annualized revenue growth rate
Five-year annualized growth rate of net income
Johnson & Johnson
Source: Capital IQ, a division of Standard & Poor's.
But those acquisitions took place on a much smaller scale. Johnson & Johnson's largest was its $16.6 billion acquisition of Pfizer's consumer health-care division in 2006. For Abbott, it was a $7 billion acquisition of BASF's pharmaceutical business. When you get really big mergers -- Wyeth's price tag was $68 billion -- it can be harder to make the integrations work.
What consolidation doesn't offer
My biggest problem with large drug mergers is that research and development -- the very thing drug companies need to overcome lost revenue from drugs going off-patent -- doesn't seem to scale very well.
Part of the problem is just a size thing. Getting a new drug approved at a midsized drug company like Gilead Sciences or Celgene (Nasdaq: CELG ) can add a lot of value, but for companies like Merck and Pfizer, it takes a lot to move the revenue needle.
The bigger problem I see is a cultural difference between a small struggling development-stage drugmaker and a large pharmaceutical giant. Researchers at the former have a lot more incentive to discover new drugs -- individual contributions have a larger effect on the company's value, and therefore on stock options.
What to look for in 2010 and beyond
While anything is possible, I wouldn't expect much more consolidation of major drugmakers. Eli Lilly (NYSE: LLY ) and sanofi-aventis have both said they'd rather focus on small acquisitions and partnerships than a large acquisition. Besides, there aren't that many left to acquire. At a $50 billion market cap, Bristol-Myers Squibb (NYSE: BMY ) is about the right size for a large acquisition, but it seems to be more of an acquirer than a target.
For Merck and Pfizer to make the ever-larger-pharmaceutical-company model work, they'll going to have to shift away from drug discovery and toward marketing. They can use the cash they generate to license or acquire drugs from smaller drug companies and focus on what they do best: usher drugs through clinical trials and regulatory approvals, and get them into the hands of patients
Unfortunately, with the long lag time in drug development, it may take years to know whether pharma has gotten mergers right this time.
Been in a coma for the last year? Here's a look at some of our coverage of drug mergers from 2009:
- Deja Vu All Over Again
- Just Say No to Drug Company Mergers
- Pfizer: Diversified Dreams, Dubious Decisions
- Merck-Schering Trumps Pfizer-Wyeth
- Drugmakers Diversify -- Again
- Not So Fast, Schering ... er, Merck ... er, Whoever You Are
- Merck, Sanofi, and Schering's Love Triangle
- Merck to Bride: Leave the Jewelry at Home
- Pfizer's and Merck's Loss Is These Companies' Gain
- And finally, we bid adieu in An Ode to Wyeth and one to Schering-Plough.