Drugmakers Diversify -- Again

Can you imagine what Bristol-Myers Squibb (NYSE: BMY  ) would look like today if it had kept Clairol hair care and over-the-counter (OTC) medicines, or hadn't spun off Zimmer, with its orthopedic products, and Mead Johnson, with its infant nutrition?

Instead, Bristol-Myers steadily pursued a strategy of turning itself into a prescription drug-focused developer and marketer. Peers Pfizer (NYSE: PFE  ) and Merck (NYSE: MRK  ) have done the same. But while Bristol-Myers is sticking to its plan, Pfizer and Merck have changed their minds.

Pfizer, which is buying Wyeth (NYSE: WYE  ) , and Merck, which is buying Schering-Plough (NYSE: SGP  ) , will take on some products and businesses -- including OTC medicines -- which they had previously snubbed. Welcome to the new conglomerates of the drug industry.

Class is in session
Maybe these two have decided to go to the same school Johnson & Johnson (NYSE: JNJ  ) and Abbott attended. The latter two companies have managed diverse portfolios that include prescription drugs, medical devices, nonprescription medications, diagnostics, nutritional products, and animal health-care products. Possibly as a result, over the past five years, J&J and Abbott each consistently outperformed Merck and Pfizer.

Jeffrey Kindler, Pfizer's chairman and CEO, recently said he admired the business models of Johnson & Johnson and Abbott, and that he wants Pfizer to have smaller business units to better operate an increasingly diverse group of products. Coincidentally, he was appointed CEO just after Pfizer sold its health-care division (including the Listerine and Sudafed brands ) to Johnson & Johnson.

Merck has usually avoided big transactions -- its last large deal was buying Medco in 1993, and spinning it off a decade later as Medco Health Solutions. The company instead prefers to expand its licensing and collaboration deals. But with Schering-Plough in its pocket, Merck now says it will offer more diverse products in more locations.

Steady, but not spectacular
If the Schering-Plough deal goes through, the new Merck would be marketing Coppertone sunscreen and Dr. Scholl's foot-care products, among others. "I would recommend that you include the OTC business in our financials going forward and not assume it's being sold," Richard Clark, Merck's chairman and CEO, said early this month.

Over-the-counter products would give the new Merck some steady revenue, but the question remains how much OTC products would actually affect business.

Looking at the numbers, Schering-Plough sold $1.3 billion in consumer health-care products last year, up 1% from 2007, but accounting for just 7% of total revenue. As part of Merck, that would represent less than 3% of $47 billion in revenue. Pfizer faces the same issue. Wyeth's OTC business was 12% percent of revenue, but would make up less than 4% for the combined company. And even when Pfizer had an OTC division prior to mid-2006, it was only contributing about 8% of revenue.

At levels like those, it's going to take a while to match the star student, Johnson & Johnson.

Biting the generic bullet
But selling OTC products is not all there is. There's money to be made in generics, too. However, most large drugmakers have disdained generic drugs as a commodity-like business with low profit margins, and one that doesn't require the research and development and marketing models that have dominated big pharma. However, this attitude is clearly changing.

For example, look at Novartis (NYSE: NVS  ) . Its Sandoz division sold $7.56 billion in generic drugs last year, nearly 18% of total revenue. In addition, Novartis is well-positioned to capitalize on hard-to-make generic copies of biotech drugs, known as biosimilars or follow-on biologics, though U.S. lawmakers still need to provide a way for these to be handled here in the States.

Both Pfizer and Merck want a big piece of the action, and acquiring the capabilities of Wyeth and Schering-Plough would help them achieve part of the goal. "Follow-on biologics represent a significant market opportunity," Clark said in a speech in December 2008.

Who makes the next move?
For investors looking at big pharma, pay attention to several signs to determine if Pfizer-Wyeth and Merck-Schering-Plough represent a coincidence or a trend.

One indicator will be if -- or how -- other companies like AstraZeneca or Eli Lilly diversify from their narrower focus. sanofi-aventis, for instance, is already making a move into generics by acquiring the Dutch company Zentiva.

If Pfizer or Merck decide that some newly acquired ventures in diversity aren't big enough in the context of the marketplace or their corporate structure, they may make additional bolt-on acquisitions.

Whatever happens next, the pharmaceutical industry is in flux right now, with uncertainty in the air. And where there is uncertainty, there is often opportunity.

We prescribe further Foolishness:

Novartis is a Global Gains recommendation and Johnson & Johnson is an Income Investor selection. Pfizer is an Inside Value pick and MedcoHealth Solutions is a Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days

Fool contributor Robert Steyer doesn't invest in any companies cited in this article. The Fool has a disclosure policy.


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