Source: GlaxoSmithKline.

Shares of GlaxoSmithKline (GSK 1.02%) were up sharply last week on rumors of a possible takeover by Pfizer (PFE 1.36%) -- the latest speculative deal in a potentially record-setting year for merger and acquisition activity in the healthcare sector.

Introducing PfizerKline? A rumored takeover of Glaxo by Pfizer is nothing new. Reports of such a linkup have been swirling for months. Earlier this year, Deutsche Bank biotech analyst Gregg Gilbert released a report titled "Introducing PfizerKline," wherein he said that "a combination with GlaxoSmithKline would diversify Pfizer's vaccine and consumer portfolios while doubling and quadrupling the revenue base for these businesses respectively."

Source: Pfizer.

Pfizer has been in the market for major acquisition for some time now. Last year, the drugmaker known for such blockbuster drugs as cholesterol-lowering Lipitor, neuropathic pain medication Lyrica, antibiotic Zithromax, erectile-dysfunction treatment Viagra, and anti-inflammatory drug Celebrex, failed in its attempt to acquire AstraZeneca (AZN 0.30%) with a massive $119 billion offer. Had this purchase been completed, it would have been one of the richest buyouts in the pharmaceutical industry. As was the case with AstraZeneca, an acquisition of Glaxo by cash-rich Pfizer appears logical -- Pfizer should ideally be looking to acquire a company with products already in the market, best of all one with a foreign address for tax purposes.

Bloomberg analyst Andrew Baum, however, doesn't believe a Pfizer-Glaxo union will materialize, suggesting "that [British] government resistance to preserve GSK as an independent listed company is materially higher than it was with [London-based] AstraZeneca." Regardless, Pfizer appears focused on a quick fix to improve sales.

Combining these two pharmaceutical giants would likely result in substantial savings for Pfizer, both in drug development and administratively, as the two drugmakers have a few overlapping development programs. GSK would bring its solid line-up of COPD/asthma products including, Breo, Anoro, Incruse, and Arnuity, along with the company's leading product, maintenance drug, Advair which would nicely augment Pfizer's respiratory drug portfolio. Despite worries over declining revenue, Glaxo still has the largest share of the global respiratory market.

In addition, the vaccine portfolio which Glaxo acquired from Novartis would complement Pfizer's highly-successful Prevnar line, making the combined entity a heavy-hitter in vaccines. Glaxo also has 40 drugs in development, 20 of which the company expects to file with regulators over the next five years. If Pfizer is unable to close a deal with Glaxo, I wouldn't be surprised to see Pfizer attempt to secure another major pharmaceutical company to augment its development slate.

M&A is the new R&D
Innovation has primarily been the driving force in the pharmaceutical industry, but Mergers & Acquisitions (M&A) may be replacing spending on Research and Development (R&D), as larger pharmaceutical companies are using their considerable free cash to gobble up smaller companies, allowing them to gain access to additional products that are either already in market or are well along the pipeline to market.

Domestically, there have been 631 deals in the healthcare sector this year to date totaling $364.5 billion, already surpassing the $326.4 billion spent on such transactions in all of 2014. Worldwide healthcare M&A stands at $422.8 billion thus far this year -- a 42% year-over-year increase. It seems almost a foregone conclusion that 2015 will eclipse the all-time annual record of $429.3 billion spent on M&A set last year.

While growth through M&A isn't new, it seems to make more sense now than ever before, as costs to bring new drugs to market have skyrocketed. Drugmakers can expect to spend $2.5 billion over a 10-year period before winning approval to sell a new drug; that's roughly 150% more than pharma companies were spending just 12 years ago. The increase in costs can be partially explained by the push to create drugs to treat and manage more complex diseases, which has resulted in a higher failure rate.

Given these rising development costs, it makes sense that pharmaceutical giants are looking to get their hands on new drugs via acquisition rather than through internal development. If a company feels it doesn't have enough potential blockbuster drugs in its queue, buying smaller companies can help smooth out potential lost revenue streams as patent cliffs approach.

Glaxo may have several suitors
Pfizer may not be the only would-be suitor for Glaxo. Swiss-based Novartis (NVS 1.38%) has been thought to be a potential acquirer as well. These two pharmaceutical giants are well acquainted through a deal last year in which Glaxo swapped out its oncology drugs in exchange for Novartis' vaccines. The two pharma giants also entered into a joint venture to market consumer healthcare products.

A Glaxo-Novartis deal might be contingent on bringing in a third party, fellow Swiss pharmaceutical company Roche Holding AG (RHHBY 1.03%), with Roche taking on several of Glaxo's assets.

Not to be left out of the conversation, Johnson & Johnson (JNJ 0.38%), the New Jersey-based pharmaceutical giant known for such well-known consumer products as Band-aid, Tylenol, and Listerine, has also been mentioned as a potential buyer of Glaxo. As with potential suitor Pfizer, whose presumed rationale for such a transaction would be to diversify its vaccine and consumer portfolios, J&J's interest would be in expanding its own large over-the-counter drug and consumer healthcare unit. Since J&J isn't in the vaccine business, it would either look to divest that portion of Glaxo's business or take the opposite approach and establish a foothold in that space. Regardless of any interest from J&J, Roche, or Novartis, Pfizer appears to have the inside track, with rumored bid talks continuing through the week.

Rumors can move stock prices as much as, if not more than, actual news stories. It could certainly be the case that a takeover by Pfizer, or any other pharmaceutical giant, may be the best possible financial outcome for Glaxo shareholders. But, regardless of a potential deal, Glaxo has been moving in the right direction. The company recently announced that it has 40 new drugs in the pipeline, several of which are the first of their kind to be developed, and the company expects to file about 20 of these with regulators in the next five years. Further, second-quarter results were positive and better than expected. However, CEO Andrew Witty remains firmly in the cross-hairs as a result of the low-margin businesses Glaxo acquired from Novartis, the need to live up to Witty's projection of double-digit earnings gains as early as next year, and the frozen, albeit considerable, dividend yield. These issues probably leave shareholders with an uneasy feeling.

While some traders seek out companies that they believe might be acquisition targets hoping for a quick pop in stock price, this is not my modus operandi. I am a long-term investor looking to invest in high-quality companies with predictable earnings and steady, growing dividend payouts. GlaxoSmithKline's inconsistent earnings, less-than-clear future, and frozen and tenuous dividend payout all leave too much uncertainty for my comfort. Acquisition rumors or otherwise, at this time, I'll pass on Glaxo.