The pharmaceutical industry is perhaps one of the most competitive businesses in existence. Companies spend literally billions of dollars developing drugs and bringing them to market. For their troubles, they often have to fight lengthy court battles to defend the intellectual property rights of key products and black market knock-offs that invariably pop up for top-selling drugs.
So, it shouldn't be entirely shocking when pharmas try to skirt the rules to gain a competitive advantage in this unforgiving landscape.
The U.K. pharma giant GlaxoSmithKline PLC (NYSE:GSK), for example, has repeatedly run afoul of regulators to boost drug sales. In 2012, for instance, the company was smacked with a record $3 billion fine from the Justice Department for unlawfully promoting the off-label use of Paxil, Wellbutrin, and Avandia -- marking the fourth time the company has been fined in the U.S. over the past decade.
Glaxo sets another record in China
Last Friday, Glaxo announced that the Chinese government fined the company $491.5 million for bribing doctors to increase drug sales -- the largest fine ever doled out to a multinational company by the Communist regime. Five Glaxo employees convicted in the case also received multiyear prison sentences, albeit suspended, meaning that they won't actually go to jail unless they commit another offense in the meantime.
Can Glaxo shares finally head higher now?
Glaxo shares have drastically underperformed the broader markets this year, partly because of this Chinese bribery scandal. Despite losing nearly half a billion last Friday, the market appears to have already baked in this huge loss, as shares actually ended the day in positive territory.
My take is that the markets were expecting an even steeper fine, and were relieved upon learning that the fine was well below the billion dollar mark. But investors shouldn't celebrate just yet.
Glaxo is still facing ongoing bribery investigations in a host of other countries that have caught the eye of the authorities in the U.K. and the U.S. And given the widespread nature of these allegations, Western authorities may come down hard on the British pharma to set a precedent. In short, this record fine in China is only the first step toward resolving Glaxo's broader legal problems and the global outcome is far from certain .
Chinese pharma growth is a lingering concern
In the second quarter, Glaxo saw a 25% drop in overall sales in China, which management attributed to the bribery case. The net effect was that emerging market sales were adversely affected by roughly 4% during the quarter.
Going forward, I think it'll be key to keep a close watch on how Glaxo performs in this burgeoning market. Tighter regulations and marketing restrictions, arising from this bribery case, could hurt the company's ability to tap the Chinese pharma market over the long term. Then again, this might have been only a temporary dip and business could very well pick up again, now that the case has been resolved. Time will tell.
Mr. Market abhors uncertainty. With the largest and most vital of the bribery cases now in the rear-view mirror, I think Glaxo's stock could start to tick higher.
That said, the company will more than likely face further legal problems down the line, as the investigations in other countries continue to unfold -- so I wouldn't exactly expect the stock to come roaring back.
By the same token, management is planning on paying this fine from existing cash reserves, which may result in a dividend reduction . With top-line growth fading due to declining Advair sales and payer issues for drugs like Breo Ellipta, I think management is going to have to at least consider reducing the dividend to conserve cash. So, I plan on remaining on the sidelines with this top healthcare name for the time being.
George Budwell has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.