Pfizer's and Merck's Loss Is These Companies' Gain

Pfizer (NYSE:PFE) closed its acquisition of Wyeth earlier this month and the EU signed off on Merck's (NYSE:MRK) acquisition of Schering-Plough (NYSE:SGP) last week. The monster acquisitions will give Pfizer and Merck some serious heft.

It's the opportunity cost of acquiring the companies that I'm worried about.

For those who don't remember from their high school economics class, opportunity cost is the thing that a buyer gives up in exchange for a purchase. In this case, it's other acquisitions or partnerships that were passed up as the companies focused on their large integrations.

Names, please
I'm hesitant to play the who-will-be-acquired-next game simply because I don't think being an acquisition target is reason enough to be an investment thesis. There are plenty of examples where that strategy has failed.

While we might not know who will be picked up next, it is clear that pharma has had a healthy appetite for smaller acquisitions and partnerships since Pfizer and Merck announced their engagements in the first half of the year. I imagine there'll be plenty more.

Sure, Pfizer and Merck might not have been interested in any of those deals even if they hadn't made the large acquisitions. However, excluding its venture capital arm, Pfizer hasn't done any drug deals since announcing the Wyeth acquisition, compared with four deals over the same timeframe in 2008. It seems that the depleted cash reserves and diverted focus have slowed things down a bit.

The biggest war chest wins
So if Pfizer and Merck aren't going to scoop up the promising smaller drugmakers, who will? There are still plenty of drug companies with lots of cash on their books.

Source: Capital IQ, a division of Standard & Poor's, and Google Finance.

A tale of three drugmakers
Johnson & Johnson, the company with the most cash of those listed, is taking on a new strategy to build its pipeline. As an alternative to the conglomerate's usual strategy of acquiring companies and bolting them on, CEO William Weldon says the company will continue to use its new tactic of sharing risk through partnerships, like the recent deals with Elan and Crucell. With that kind of cash, it should be able to make a lot of them.

Novartis also has a lot of cash, but it's set aside for a rainy day. As part of its acquisition of a 25% stake in Alcon from Swiss conglomerate Nestle, Novartis agreed to a put option and got a call option for the rest of Nestle's stake in Alcon.

The call option gives Novartis the right to acquire the shares for $181 each between January 2010 and July 2011. The put option gives Nestle the right to force Novartis to buy the shares for a premium of 20.5% over Alcon's share price, but not to exceed $181 per share. Essentially, Novartis needs to have $28 billion available to make the purchase during those 18 months.

Bristol-Myers doesn't have the most cash available of the group, but its stash could have the biggest impact. The company is facing the loss of Plavix, which made up more than 28% of Bristol-Myers' revenue in the first three quarters of the year. The loss is already priced in; the company trades at ridiculous multiples -- near a multiyear low P/E and a dividend yield of 5.6% -- so any late-stage pipeline-stacking could have a major impact on its future.

At least it'll have a lot less competition.