Source: Wikimedia.
Nearly all big pharma these days have been undergoing wholesale changes due to the patent cliff, the emergence of game-changing new classes of drugs, and payers leveraging their formularies to induce pricing wars.
A direct consequence of these pressures has been a merger and acquisition bonanza, resulting in several deals generating eye-popping premiums. Some of these deals, though, appear to be springboards for even more drastic changes -- namely the dismantling of household names.
Source: Wikimedia.
Pfizer (PFE 1.04%), for instance, has already signaled its intent to explore a possible break-up, stemming from the loss of exclusivity on top selling drugs like Celebrex, Lipitor, and Viagra. Indeed, a deep dive into the drugmaker shows a stark contrast between products like its new breast cancer drug Ibrance that should quickly become a megablockbuster, and its flagging legacy product segment that is expected to post double-digit sales declines throughout this year.
Are these the end times for Pfizer?
In its recent investor presentation, Pfizer's management prepped investors for a major shakeup, stating that they are "establishing the groundwork required to operationalize a potential split of the company". Soon thereafter, Pfizer announced the $17 billion buyout of Hospira, a leader in the fields of injectable drugs and biosimilars.
Source: Wikipedia.
So what does this all mean? To understand the issues at hand and what's likely to follow, we first need to consider Pfizer's recent past. Specifically, the pharma giant jettisoned its animal health unit in 2013 via the Zoetis IPO, allowing the company to restructure its business into three operational units: Global Innovative Pharmaceuticals (GIP), Global Vaccines, Oncology, and Consumer Healthcare (VOC), and Global Established Pharmaceuticals (GEP).
Digging deeper, the year-over-year financial metrics (2013 vs. 2014 fourth-quarter numbers) of each unit provide some significant insight in the company's game plan going forward.
Firstly, we learned in the fourth quarter that Pfizer has been drastically cutting marketing and sales force expenses for its GEP business (down 20%), and shifting these resources to GIP (up 22%) and VOC (up 10%) over the last year. This move makes sense because it helps to improve margins for legacy products that are both already well-known and no longer have patent protection.
At the same time, Pfizer also increased its R&D efforts by 4% annually in the GEP segment, resulting from a deeper dive into the arena of generic biologics (biosimilars). And that's where things get interesting.
Biosimilars are expected to have a watershed year in 2015, as they begin to finally hit the U.S. market. Viewed this way, Pfizer's merger with Hospira appears to be a good way to leverage their combined biosimilar assets to gain a greater competitive advantage in this potentially massive commercial opportunity. All told, Pfizer's GEP unit looks set to be partnered with Hospira via a spin-off to form a generic drug business, with a good chunk of this new entity focusing on biosimilars.
A break-up of the pharma giant therefore looks inevitable.
More moves to come?
A spin-off of the Hospira and GEP businesses would presumably leave the GIP and VOC segments as the heirs to the Pfizer name. However, these two segments only accounted for about 49% of the company's total revenues in the fourth-quarter, which should translate into a revised market cap of approximately $101 billion at current levels, compared to today's $207 billion.
Source: Wikimedia.
That creates a unique problem for Pfizer. With the recent approval of breast cancer drug Ibrance and a highly prized immuno-oncology collaboration with Merck KGaA under way, Pfizer could quickly become the hunted, instead of the hunter. In fact, this new high growth business comes off as a perfect match for Merck & Co., given all the potential synergies in oncology and vaccines.
To solve this problem, Pfizer may chose to execute another merger or acquisition. Such a move would accomplish two goals: increasing its market cap to stave off any takeover attempts, and, perhaps more importantly, lower its effective tax rate from 25% to the low teens.
A quick peak across the pharma landscape suggests that only three names would meet Pfizer's needs, i.e., the merged entity of Allergan/Actavis (NYSE: AGN), AstraZeneca, and GlaxoSmithKline. We already know that Pfizer is interested in AstraZeneca, but the feelings don't appear to be mutual. And because Glaxo is experiencing its own patent problems with Advair, this pairing doesn't look advantageous, leaving Allergan as the logical choice.
Given that Actavis' management (now the top executives in the new company taking the Allergan name) has demonstrated a clear penchant for 'growth by acquisitions', we may end up seeing the largest merger in pharma history in the not-so-distant future.
Key takeaways
Pfizer's buyout of Hospira may turn out to be the linchpin leading to a host of additional changes, and even its eventual split. The good news for investors is that a split should unlock tremendous value by allowing one company to build out a top biosimilar business, and the other to generate double-digit top-line growth. For these reasons Pfizer may be a great long-term pick-up ahead of any forthcoming break-up.
