Pfizer Inc. (NYSE:PFE) and other big drugmakers have a problem on their hands. Facing a steady stream of patent expirations on top-selling medicines, they're caught in a tug-of-war between developing next-generation therapies and cutting costs to offset declining revenue. Pfizer's decision to slash its research and development budget indicates it hopes it can walk a very thin line in this dilemma.
The big problem
Pfizer has been hard hit by patent expirations. Following the loss of patent protection on its $12 billion-per-year cholesterol-fighting drug Lipitor in 2011, generic competition has caused the company's revenue to tumble.
Over the past five years, Pfizer's trailing 12-month revenue has slid from about $65 billion to less than $50 billion in 2014.
That drop-off in revenue has created anxiety for investors -- particularly dividend investors who are attracted to the company's solid 3.3% yield, but who worry that slumping sales could threaten future payouts.
Turning the freighter
Pfizer has a cash war chest that has sparked considerable M&A speculation. Following its failed $118 billion bid to acquire AstraZeneca last year, the company announced in February that it would hand over $17 billion to pick-up biosimilars drugmaker Hospira (UNKNOWN:HSP.DL).
The move positions Pfizer nicely to capture a big share of the emerging biosimilars market, while also adding $4.4 billion in trailing 12-month sales and $0.10 to $0.12 in EPS during the first year. Pfizer estimates the growing biosimilars market opportunity will be worth $20 billion by 2020, but that could be conservative given that roughly $70 billion in biologics will lose patent protection by 2018.
However, since the biosimilars market is still emerging, the top-line benefit might not come fast enough to convince investors to hold on to their shares. As a result, the company is also cutting spending deeply.
Short-term gain, long-term pain?
Ahead of Lipitor's patent expiration, Pfizer set a goal to reduce annual research and development spending from $9.4 billion in 2010 to between $6.5 billion to $7 billion. That target has resulted in a steady decline in R&D spending.
The company delivered on that target in 2013, but R&D spending surged 26% last year to $8.4 billion. If you adjust that spending to remove the impact of a collaboration deal with Merck KGaA (not to be confused with Merck & Co.), spending grew a bit less, to $7.15 billion.
Given that spending spike, it probably isn't too surprising that Pfizer is doing some shifting in its R&D team to reallocate its resources.
According to Fierce Biotech, those shifts include cutbacks at Pfizer's Cambridge, Mass., research team. Pfizer's layoffs indicate the company remains focused on managing costs. That's a good thing, but only if Pfizer can still develop next-generation blockbuster therapies.
Pfizer's guidance for 2015 includes a projection for R&D spending of between $6.9 billion and $7.4 billion. At the midpoint, that suggests adjusted R&D spending will remain about the same this year as it was in 2014. Whether Pfizer can maintain this level of spending; however, remains uncertain. Last year, the company's sales fell to a new five-year low of $49.6 billion; this year, Pfizer thinks revenue will drop again to between $44.5 billion and $46.5 billion. As a result, the percentage of sales spent on R&D is set to increase this year. That could mean that additional cuts in 2016 if the company doesn't commercialize a few new blockbuster drugs.