Mondays are commonly referred to as "Merger Mondays" for a reason: the weekend gives companies time to hash out deals without the overbearing scrutiny of Wall Street analysts and investors who are also off for the weekend. Although no such deal was struck over the weekend, pharmaceutical behemoth Pfizer (NYSE:PFE) did apparently consider a mammoth $101 billion offer to acquire U.K.-based AstraZeneca (NYSE:AZN) which AstraZeneca promptly resisted.
Even though the deal didn't go through, it brings to the forefront the urgency of the pharmaceutical sector to address the patent cliff. Patented drugs only have a finite period where they're protected from generic competition, and, worst of all, that patent protection begins when an investigational new drug is finally allowed to begin clinical studies. In other words, by the time a therapy reaches commercialization it may have only a decade or less of exclusivity remaining. This is why innovation is so paramount in the pharmaceutical sector and why Pfizer may be seeking out new avenues of growth.
However, the big question is whether or not the deal would make sense. Would it be wise for Pfizer to offer what is essentially a 27% premium to AstraZeneca's closing price on Friday?
Let's take a closer look.
Would this deal make sense?
From the perspective of their current strategies (i.e., enhancing shareholder value and reducing expenses), the combination of these two pharmaceutical giants would make sense. Both Pfizer and AstraZeneca are staring down low single-digit declines in revenue this year and next. Much of that has to do with the ongoing expiration of patents to key pipeline products.
Pfizer, for example, saw sales of its cholesterol-fighting drug Lipitor plummet 41% in 2013, with Xalatan and Detrol sales also suffering 27% and 26%, respectively, because of patent losses. Similarly, AstraZeneca saw revenue for its blockbuster schizophrenia drug Seroquel nosedive 39% to just $1.68 billion from $2.8 billion in 2012.
A combination of the two companies would result in demonstrable cost synergies which would further help the two survive their patent cliff downturn. Combined they would be capable of just north of $75 billion in annual revenue and somewhere in the neighborhood of $20 billion to $25 billion in free cash flow. I would make an assumption that the combination of the two companies would result in savings equal to $750 million to $1.5 billion annually, or what is essentially 5%-10% of their combined cost of sales.
But would the melding of their pipelines make sense?
Although AstraZeneca has a global focus (cardiovascular, oncology, neuroscience, infection, and so on), its primary growth driver is its cardiovascular product portfolio. AstraZeneca made this clear as day when it announced the acquisition of the unowned portion of its shared diabetes product pipeline from Bristol-Myers Squibb (NYSE:BMY) in December, encompassing such therapies as revolutionary type 2 diabetes drug Farxiga/Forxiga, Onglyza, and Bydureon. The deal totaled $2.7 billion with an additional $1.4 billion to be paid in various milestone and regulatory achievements.
Pfizer doesn't quite have an existing focus because its portfolio is so diverse, but it clearly has been positioning itself for future success in treating cancer-related illnesses. I'd point to the excitement surrounding ER-positive, HER2-negative advanced breast cancer therapy palbociclib which is given in combination with Novartis' Femara. An early April study release showed that the combo improved progression-free survival a full 10 months to 20.2 months compared to 10.2 months for those receiving Femara by itself. Furthermore, initial data for overall survival indicate a 4.2 month improvement to Femara by itself (37.5 months versus 33.3 months). This has a genuine chance to be a blockbuster for Pfizer and to fuel its top-line growth for years.
In reality, AstraZeneca's oncology product pipeline isn't very exciting. Arimidex has long since lost its patent protection while prostate and breast cancer drug Zoladex saw sales stall right at $1 billion last year, aided only by 10% sales growth in emerging markets.
Likewise, Pfizer's cardiovascular product portfolio has taken a beating with the loss of Lipitor, the all-time best-selling drug. It's turned to cost-cutting to offset weaker sales of the drug, but that's obviously not a long-term solution.
With each company having what the other one seems to lack – AstraZeneca the cardiovascular plug to Pfizer's leak, and Pfizer the oncology potential that AstraZeneca severely lacks – a combination would make sense.
I also believe it would help emphasize their greatest long-term strength: emerging market growth. Emerging markets account for approximately 20% of sales for both companies, so a combination could potentially allow this figure, which grew by 8% for AstraZeneca, and 3% (including currency effects) for Pfizer, to possibly hit double-digits.
Is the price right?
The question or whether or not a $101 billion offer price would be a fair deal to buy AstraZeneca is, by far, the most difficult question to answer.
Based on reports suggesting that AstraZeneca wasn't even willing to come to the table with an offer that represented a 27% premium over Friday's closing price would suggest that it expects a monstrous deal. But, is AstraZeneca worthy of that kind of premium?
Were AstraZeneca to accept a $101 billion buyout it would be valued at 13.6 times operating cash flow, a premium to Pfizer and GlaxoSmithKline which are valued closer to 12 and 11 times operating cash flow, right on par with Roche at 14 times operating cash flow, and notably lower than Novartis at 16 times operating cash flow. Being smack dab in the middle might make the buyout offer seem reasonable – but I don't agree.
First, consider that GlaxoSmithKline has a rapidly growing COPD pipeline and just reported an absolutely phenomenal week of data highlighted by three approvals. Even Novartis, which is priced the highest, respectively, has a number of breakthrough therapies in the works which could drastically pump up its top-line over the long run. And, of course, we have Roche will more than 100 ongoing clinical studies.
AstraZeneca, by comparison, has a number of currently approved drugs that it's attempting to expand the indications of, but the majority of its pipeline revolves around a number of early and mid-stage studies which may not make an impact for years to come. In other words, AstraZeneca might be a bit foolish turning down an offer in the ballpark of $101 billion.
It remains to be seen if these rumors actually go anywhere now that they've been exposed, but it's clear that big pharma needs to find new and creative ways to drive shareholder growth and cut costs. A merger of this magnitude just might be that answer.