Growing revenue by 20%, 50%, even 100% year over year is easy when a drugmaker is launching its first drug. It's a little harder to move the revenue meter, but certainly not impossible, when the second and third drugs come along. At some point, though, high-growth drugmakers have to slow down.

Increasingly mature large biotechs may be hitting that point. As they bring in cash by the truckload, it might be time to start sharing that lucre with investors.


2010 Free Cash Flow (in billions)

Amgen (Nasdaq: AMGN) $5.21
Biogen Idec (Nasdaq: BIIB) $1.45
Celgene (Nasdaq: CELG) $1.08
Gilead Sciences (Nasdaq: GILD) $2.77

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

Pharma 2.0? No thank you!
Besides the obvious argument that the money rightfully belongs to shareholders, the best case for establishing a dividend is that it keeps management from making stupid mistakes. By giving money back to shareholders, rather than hoarding it for themselves, management can't indulge in bulky, ill-advised acquisitions.

Pfizer's (NYSE: PFE) and Merck's (NYSE: MRK) acquisitions have certainly boosted the top line, but it's not clear whether they'll result in a better long-term benefit than if the companies had just returned the cash to shareholders, or even repurchased shares.

Investors are better off on the other end of the purchase -- a la sanofi-aventis bidding up Genzyme (Nasdaq: GENZ) -- getting a nice one-time gain when a pharmaceutical company decides it needs to bulk up.

Giving up?
By demanding a dividend, investors are saying that they can create better returns on the cash than management can. Even a token 2% dividend yield represents substantial cash that shareholders siphon from the company.


Cash Required for 2% Dividend Yield (in millions)

Amgen $982
Biogen Idec $341
Celgene $511
Gilead Sciences $662

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

Based on the free cash flow numbers above, the companies can certainly afford a dividend at that level. But would a dividend best employ that cash?

Let's do some rough back-of-the-envelope calculations. Assuming you could license a phase 2 drug and develop it through FDA approval for $500 million, if the drug brings in $1 billion annually at a 25% net margin, that's $250 million. At a P/E of 10, that merits a $2.5 billion increase in market cap, or around a 10% increase in share price down the line for giving up 2% now.

Since most investors would gladly take that kind of return, those clamoring for a dividend essentially believe that these companies will find nothing worth licensing.

Dividends' evil stepsister
The debate between dividends and share buybacks has raged on longer than biotechs have been selling products. I won't try to end the conflict here.

However, I would point out that repurchasing shares offers companies more flexibility than offering a dividend; when payouts get cut, investors often revolt. If shares are cheap, the companies can buy back shares, and if development-stage drugmakers are cheap, they can make acquisitions or license drugs.

The caveat, of course, is that you have to trust management to know which deal is better at any given point in time.

First one on its way?
We'll know soon enough. In its investor meeting April 21, Amgen might announce a dividend.

Considering investors' rekindled appetite for dividends, Amgen might want to establish a dividend just to widen the potential investor pool. Whether others might follow suit remains to be seen.

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