Why Pfizer's Huge Offer for AstraZeneca Actually Makes Sense

On the surface, offering $106 billion to take over a rival seems like nothing short of desperation. That's exactly what pharmaceutical giant Pfizer (NYSE: PFE  ) is doing, though, trying to acquire European competitor AstraZeneca (NYSE: AZN  ) . Pfizer has been through well-publicized trials and tribulations in its attempts to replace lost sales after its cholesterol drug Lipitor went off patent a few years ago.

That has proven to be harder than management ever thought possible. Pfizer has plowed billions of dollars into research and development but hasn't been able to come even close to repeating Lipitor's level of success. Despite the hefty price tag, taking over AstraZeneca actually makes strategic sense and appears to be the right course of action for Pfizer. That would explain the sense of urgency Pfizer management is signaling in its takeover attempts, and why the company would be wise to offer an even higher bid if necessary.

Deadline approaching fast
AstraZeneca is headquartered in the United Kingdom, and according to U.K. law, Pfizer has until May 26 to present a hostile bid to AstraZeneca's shareholders if it intends to go that route. If reports throughout the financial media are any indication, it seems that Pfizer's management is completely willing to take the hostile approach. They would actually be open to raising its bid if necessary.

The fact that the company would even consider offering more than $106 billion for AstraZeneca reveals the bind it's in to replace Lipitor, the best-selling drug of all time. Consider that Pfizer's offer represents more than a 50% premium to AstraZeneca's valuation just one year ago. There's a good reason for this, considering the lack of return Pfizer is getting from its own research and development investments.

Pfizer reported first-quarter earnings that were thoroughly unimpressive. Revenue fell 9% and the company's reported earnings per share dropped 5%. Not surprisingly, the primary culprit for its disappointing performance was its pharmaceutical segment. Specifically, management cited continued erosion of branded Lipitor in the United States, as well as patent expiration for other products such as Enbrel and Spiriva.

The loss of Lipitor has been truly damaging on Pfizer. Lipitor is now Pfizer's fifth-best drug by total quarterly sales and produced just $457 million in sales in the first quarter, down 27% year over year. In the United States, the collapse of Lipitor is even more staggering. Lipitor generated just $50 million in the U.S. in the last three months, compared to $171 million in the same period last year. That's a 71% collapse. Consider what a steep decline this has been for a drug that produced $10.7 billion in annual sales by itself as recently as 2010.

AstraZeneca can provide some growth
 
AstraZeneca is performing decently on its own, but it's not without its own set of challenges. Revenue increased 3% in constant currencies in the first quarter, after a disappointing 2013 in which revenue fell 6%. With such tepid growth in mind, you might think Pfizer would be crazy to offer such a huge sum for AstraZeneca.

What Pfizer is really going after is AstraZeneca's pipeline, though, which is fairly robust. AstraZeneca has 11 new molecular entities in Phase III or registration, which is twice as many as it had a year ago. Moreover, AstraZeneca holds 19 candidates for potential new Phase III starts this year and next year. In all, AstraZeneca's pipeline now includes 104 projects, 90 of which are in clinical trials.

The bottom line is that while Pfizer is prepared to shell out an enormous amount of cash for AstraZeneca, it needs to do something big to move the needle. Growth has been hard to come by for Pfizer since Lipitor's patent expiration, and it only stands to get worse with other drugs set to lose patent protection soon.

AstraZeneca has a plentiful product pipeline with multiple opportunities to bring growth to Pfizer that it hasn't been able to find through its own research and development. Pfizer management clearly has decided that even at $106 billion, acquiring AstraZeneca is the easiest and most cost-effective way of restoring its pipeline in the post-Lipitor era. That's why the deal, while large, makes strategic sense.

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  • Report this Comment On May 15, 2014, at 9:32 AM, beyon0hero wrote:

    Pfizer bought Warner-Lambert to take control of Lipitor. In so doing they discovered WL also was selling Neurontin and WL was developing Lyrica. Pfizer could never execute business decisions rationally. These are fiascoes committed:a Cipro-like product in the late 1990s, torcetrapib (developed at the Pfizer Groton site, failed in 2005 and the WL folks in Ann Arbor paid for that with job losses) and inhaled insulin.

    Neurontin gave Pfizer breathing room to delay large scale job cuts until Neurontin lost its patent exclusivity. The attempt to take over AstraZeneca makes sense because Pfizer is not an innovator but a survivor. Who knows? May be AZ could turn out as good as WL.

  • Report this Comment On May 16, 2014, at 12:50 PM, SteinwayB731 wrote:

    This deal makes sense if AZN management gets a say in the future company. Optimally, they would keep some development and manufacturing in Groton, and get rid of Groton management, or rather, Groton mismanagement. The only thing PFE management seems interested in is what it's workforce looks like with respect to skin color and phenotype. What that has to do with drug discovery and development, I'm not really sure.

    I was long AZN, had about a 60% gain, so I sold it to wait this out. Actually, I think UK regulators are going to nix the deal, at which point AZN falls back to a more reasonable valuation, and I'll pick up where I left off, ie. owning a good, well-managed company like AZN, and laughing every time someone like my broker suggests buying PFE.

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