If You Can't Beat 'Em, Join 'Em: Pharma Goes Generic

In the battle against generic rivals, it seems pharmaceutical companies would rather switch than fight. A pair of deals yesterday heralded Big Pharma's latest moves into the generic-drug world.

And who can blame them? The generic-drug industry has done O.K. for itself in the past, and its future looks pretty bright:

Company

Last 5 Years' Annual EPS Growth

Next 5 Years' Estimated Annual EPS Growth

Teva Pharmaceuticals (Nasdaq: TEVA  )

19%

15%

Mylan

3.4%

19%

Watson Pharmaceuticals

4.3%

9.7%

Perrigo

20%

14%

Source: Yahoo! Finance.

Going all in
The biggest pharmaceutical player in the generic world is Novartis (NYSE: NVS  ) . The company has built out its generic division, Sandoz, into a major player; sales of generic drugs made up 18% of revenue last year. That puts it just behind Teva as the world's second-largest generic-drug maker.

Yesterday, Novartis added to its generic arsenal with the acquisition of EBEWE Pharma's specialty generic injectables business, for about $1.2 billion. The acquisition adds a nice array of injectable cancer drugs -- a growing opportunity, since some $9 billion in annual sales are expected to lose patent protection by 2015.

EBEWE Pharma had operating income of about $77 million last year, so the acquisition of the injectables business doesn't look particularly cheap. But Novartis should be able to use its size to expand margins, and the new drugs -- along with new developments -- should help grow earnings from here.

sanofi-aventis (NYSE: SNY  ) seems to be following Novartis into the generic waters with a series of global bolt-on acquisitions. Earlier this year, it closed on its nearly $2 billion purchase of Czech generics company Zentiva. sanofi-aventis already owned 25% of the company and got in a bidding war with another minority owner. Last month, the French pharmaceutical company moved across the Atlantic with two smaller deals, purchasing Mexican generic-drug maker Laboratorios Kendrick and Brazil's Medley.

Dabbling
Some pharmaceutical companies have just started to get their toes wet with generic drugs.

Pfizer (NYSE: PFE  ) is looking to expand the role of its subsidiary, Greenstone, which has sold generic versions of Pfizer's drugs once they go off-patent. Earlier this year it licensed 70 generic products and 12 antibiotics from India's Aurobindo Pharma to sell in the U.S. and Europe, and yesterday it expanded its agreement with Aurobindo to market 60 drugs in 70 different countries. Yesterday, Pfizer also added 15 generic injectable products from Claris Lifesciences in a separate agreement.

The company now has 128 non-Pfizer drugs to market, but it'll have to add a heck of a lot more to make any meaningful contribution to the $47 billion in annual revenue.

GlaxoSmithKline (NYSE: GSK  ) is taking a different slant, letting other companies do the dirty work, but still profiting from it. Last summer, it signed a deal with South Africa's Aspen to sell its products as generics in developing countries. Then, earlier this month, Glaxo traded a few drugs and a manufacturing plant in exchange for a 16% stake in Aspen.

Go big or go home
Pharmaceutical investors interested in grabbing some of the generic-drug growth should avoid looking for an all-in-one package. In my opinion, it's better to buy the best of each world, rather than buying a pharmaceutical company just because it's moving into generic drugs.

Like Costco (Nasdaq: COST  ) and Wal-Mart Stores (NYSE: WMT  ) , generic-drug companies need to be large to deal with the industry's low margins. Teva and Mylan have the size to make it work, unlike pharmaceutical companies dabbling in generic drugs because the grass looks greener on the other side.

The exception to avoiding an all-in-one drugmaker is Global Gains selection Novartis. It's large and growing generic-drug division is big enough to compete with Teva and Mylan.

Generic drugs are here to stay and pharmaceutical companies aren't going away anytime soon. Take one of each. They're cheap.

Costco is a Stock Advisor selection. Costco, Pfizer, and Wal-Mart are all Inside Value selections. Novartis is a Global Gains choice. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool owns shares of Costco and has a disclosure policy that's anything but generic.


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