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.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies 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.