Pharmaceutical Mergers: Whats the Rush?

Villanova University College of Commerce and Finance MBA 8439 Contemporary Topics in Finance Darren Snellgrove

Spring, 2001 Dr. W.L. Dellva

Pharmaceutical Mergers: Whats the Rush?

Drivers of Recent and Future M&A Activity

Darren Snellgrove

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TABLE OF CONTENTS

i)

Executive Summary

ii) iii) iv) v)

Introduction Industry Structure Reasons for Recent M&A Activity Analysis of Two Recent Mega-Mergers

Glaxo Wellcome / SmithKline Beecham Pfizer / Warner Lambert

vi) vii) viii) ix) x) xi)

Do Drug Mergers Really Work Possible Future Mergers Implications of Biotechnology & Genetic Mapping Conclusions Bibliography Appendix

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i) Executive Summary
OBJECTIVE: Explain what social-political-economic factors are driving the recent step-up in pharmaceutical merger activity, and determine whether or it makes sense. METHOD: Analyze industry data, focusing on the recent pressures that explain recent merger activity. Consider general research and two recent mergers to see whether they are likely to succeed. Assess whether this trend will continue. Industry Stage / Structure Relatively mature, and yet constantly changing industry. Complex financial challenges. Reasons for Recent M&A Activity Major drug reimbursement issues, political pressure and concerns over pricing. Patent expirations / generic competition. Profitable industry, but growth slowing. Sales growth issues / global expansion. R&D pipeline gaps / R&D synergies. DTC campaigns / sales rep. coverage / channel access. Biotechnology / Gene Mapping. Management greed / agency factors. Changing M&A accounting regulations. Analysis of Two Recent Mergers Overall, results are mixed. Portfolio balance and strategic fit are the key success factors. Glaxo / SmithKline - likely to achieve some success through pipeline synergies and cost savings. Pfizer / Warner-Lambert - the most likely to succeed due to strategic fit, operating efficiencies, pipeline synergies, and the fact that this was a hostile purchase. Size may be good up to a point, but some of these mergers may be going too far: Advantages of size: Clinical trial economies of scale Sales rep. Coverage Regulatory / filing power with the FDA Lobbying power (political and with wholesalers etc.) Balance risk in pipeline / product portfolio Disadvantages of being too big: Diseconomies of scale / control issues Lack of focus R&D / commercial disconnects Loss of entrepreneurial environment May not deal with emerging areas (biotech and genomics)

Conclusions Size and growth are being used to defend against increasing industry pressures, i.e. Reimbursement, political pressure, patent expirations, growth issues, R&D pipelines, ad. economies. It is not clear that merging is the answer. Evidence to date suggests only minimal success, & a temporary solution. Cant guarantee discovery. Size issues e.g. R&D/commercial disconnect. Biotechnology and genomics pose both an opportunity and a potential threat these areas may provide better solutions to industry issues than the mega-merger solution. There is a multiplier effect as firms seek to retain/regain industry status.

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Although not necessarily the best solution, big consolidations in the pharmaceutical industry look set to continue.

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ii) Introduction Mergers in the pharmaceutical industry are not new, however, in recent years we have seen increases in the level of pharmaceutical merger activity and more firms are using strategic partnerships and joint ventures to develop and market new products. In this paper I will explore a variety of social-political-economic issues in an effort to understand why pharmaceutical firms are increasingly convinced that bigger is better. Specifically, I will seek to explain what factors are driving the recent step-up in pharmaceutical merger activity. During the course of the paper I will consider two recent mergers to see whether or not they are likely to succeed. The mergers I will consider are Glaxo Wellcomes merger with SmithKline Beecham, and Pfizers hostile takeover of Warner-Lambert. I will assess the financial implications of these mergers, and will also assess the driving forces behind recent mergers, the existence of synergies, and whether value was created, destroyed, or simply transferred. My goal with this analysis is to see whether big mergers really are the solution to some of the challenges pharmaceutical companies currently face. Finally, I will take a brief look ahead to try and understand how recent developments in biotechnology and genetics are likely to impact the pharmaceutical industry, and whether merger activity looks set to continue. In this paper I will explore the notion that a need for size is the overwhelming reason for recent mergers and acquisitions in the pharmaceutical industry, but that this may not necessarily be the best solution to the current financial and economic challenges.

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iii) Industry Structure The pharmaceutical industry is a fascinating industry, filled with mergers, acquisitions, strategic partnerships, join ventures, and licensing. The industry is highly regulated, extremely complex, and filled with financial and economic challenges and points of interest. Finance managers in the industry are faced with many issues including; managed care, insurance, reimbursement, patents and generic competition, licensing, royalties, co-promotions, joint ventures, co-marketing rights, high risk and high cost research and development, parallel import issues, and international regulations. These issues will be explored in an effort to understand the reasons for the industrys current structure and how that structure is driving increased consolidation through mergers and acquisitions. The pharmaceutical industry is by most standards a mature industry. It is also highly profitable (profit margins are about 16% versus 12% for the S&P 500) for those companies lucky enough to develop blockbuster medical treatments which are patent protected for lengthy periods to help companies recoup their research and development investments. Despite the fact that we hear so much about the rising cost of drugs, sales in the industry have actually been growing at a much slower rate in recent years. The 5-year sales growth rate for the industry is currently only about 12% versus and S&P 500 growth rate of close to 17% (source for all financial data: Market Guide.com). EPS growth rates have also been slowing and the current 5-year average is 16% versus 20% for the S&P 500. When you combine this data with the current forces impacting the industry and the fact that many companies are cash-rich the stage is clearly set for mergers.

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Although the industry is relatively mature, it is also an industry that is in a state of almost constant change. In recent years, it has been faced with increasingly complex financial and economic challenges including; intellectual property issues, patent expirations and generic competition, managed care, insurance, and reimbursement issues, complex co-promotion, joint venture, and licensing agreements, and an increasing array of research and development issues, threats, and challenges. The pharmaceutical industry has been under a great deal of scrutiny over the last few years, and has become one of the top political targets. It is often claimed that prescription drugs cost too much and that prices are spiraling out of control this is not true. While there is no doubt that Americans are spending more on drugs, people often confuse more spending with higher prices. Increased drug spending is almost entirely due to the fact that people are buying more drugs. Ronald Bailey points out in an article written for Reason Magazine that Between 1993 and 1999, overall inflation rose 19 percent while drug prices increased 18.1 percent The vast majority of the spending increase on drugs some 78 percent has occurred because doctors and patients are taking advantage of more and better drugs that are now available. (Bailey, 2001). So why is the industry coming under so much pressure? Third-party payers are the main culprits. As doctors prescribe more drugs to cure and ease the pain for their patients, health insurers and managed-care providers have to spend more on drugs. Despite the fact that spending on drugs does lower health care costs and increases the length and quality of patients lives, insurers from an actuarial perspective - actually prefer it when patients just die (or get cured) because then they dont have to pay for years of life-extending drugs. This is clearly a horrible situation.

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The structure of the pharmaceutical industry is often blamed for high prices. Patents provide brand-name protection for new drugs, and allow pharmaceutical companies to achieve average profit margins of 16 percent and up to 20 percent versus about 12 in most other industries. The reason for patents and the need for high profit margins stem from the extremely high and risky nature of pharmaceutical drug development. Between hundreds of molecules have to be screened in order to make one successful drug and it can take as many as 15 years to bring a drug through from discovery to launch. Many drugs developed never even make enough money to cover their development costs, but pharmaceutical companies keep searching knowing that eventually they will discover a blockbuster. In 2000, legislation was passed allowing the re-importation of drugs manufactured in America from Canada where drug prices are significantly lower mainly due to price controls. The danger of this is that it will actually hurt Canadians as US pharmaceutical companies will raise export prices to Canada in order to prevent profits being undercut in the US by reimportation. Despite foreign price controls, many pharmaceutical companies do sell their products abroad at a discount but the margins are low. This is a problem, for although they cover manufacturing and promotional costs, they do not generate enough profit from abroad to adequately fund research and development. If the US follows the lead set by certain European countries that regulate prices it could significantly hinder and most certainly slow the development of new life-saving treatments. Many European countries have government healthcare systems, hence the strict pricing controls. In the US, the insurance companies rule and can have a big impact by deciding what and how much gets covered. US controls are currently limited to best price for Medicare and Medicaid, although there are a number of proposals currently under consideration such as

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prescription drug coverage for seniors that would more than likely see an increase in government control over prices.

Price Controls in Europe: The following table highlights some of the restrictions that apply in the some of the biggest European markets:

In the next section, I will explore the impact that these factors are having on the pharmaceutical industry specifically I will discuss the fact that uncertainty is increasing the level of merger activity. Size and growth are now a necessity in the pharmaceutical industry.

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iv) Reasons for Recent M&A Activity Although consolidation in the pharmaceutical industry is nothing new, the recent increases in merger activity reflect an increasing number of financial and strategic challenges now facing the industry. These often-unique financial challenges have made size a desirable objective. There are seven main reasons why the pharmaceutical industry has been consolidating in recent years: 1) drug reimbursement issues, 2) political pressures and growing concerns over drug prices, 3) patent expirations / generic competition, 4) sales growth issues, 5) R&D pipeline gaps / synergies, and 6) the increasing use of direct-to-consumer (DTC) campaigns, and 7) recent developments in biotechnology and the mapping of the human genome. The last reason will be explored later in a separate section. There are also two other reasons that may help to explain merger activity, namely agency affects and recently proposed changes to merger accounting regulations. In this section I will explore these issues in more detail. Before doing so, it is interesting to compare 1995 industry rankings based on revenue to the ranking list in 1999.

SOURCE: Evaluate Pharma Database of pharmaceutical company information

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The previous table highlights how mergers and different product blockbusters have changed the pharmaceutical rankings in recent years although the issues identified above are the underlying drivers of growth through acquisition, the importance of status within the industry as a driving force should not be ignored. It is also interesting to note the change in size of these companies. In 1995, the number one company was Glaxo with revenue of $10.5 billion. In 1999, Pfizer topped the list with double the revenue at $20.9 billion. Clearly, there is a drive for size. Throughout much of 2000, the pharmaceutical sector was filled with concern. During the election there was a great deal of discussion about rising drug prices. Many thought the federal government would pass new laws aimed at slashing prices. However, the arrival of a Republican White House and an evenly split congress put an end to many of these fears. IMS Health (a firm which tracks pharmaceutical sales and usage) now expects global sales to grow 8.8% to $385 billion in 2001 (Business Week, Jan 8, 2001). Despite these projections, there may still be demands to pass a Medicare prescription-drug benefit. Currently, the government plan provides reimbursement for pharmaceuticals taken in hospital but not for the large number of drugs seniors now take at home on a regular basis. How this will affect the industry remains to be seen, but undoubtedly bigger will be better in an era of price-cutting. One of the biggest threats to pharmaceutical firms over the next few years will come from generic competitors. SG Cowen Securities predicts that between now and 2005 patents will expire on products with annual sales of $34.6 billion (Business Week, Jan 8, 2001). In 2001, drugs like Prozac, which generates annual sales of $2.5 billion for Eli Lilly, will come off patent, as will AstraZenecas Prilosec with sales of $6 billion. This is one of the main reasons that drug manufacturers are anxious to merge. Companies in the industry have shown sustained periods of double-digit sales growth, and dont want this to stop.

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Firms are also merging in order to exploit cost savings and benefit from economies of scale and scope in R&D. Research and drug development in the pharmaceutical industry is extremely risk, expensive, and time consuming. Many companies also have significant gaps in their development pipelines. This has profound implications for a pharmaceutical organization in terms of future sales growth. Finance managers in pharmaceutical companies spend a lot of time analyzing the corporations product portfolio and have to make tough decision to make sure that the company has the right balance of risk and return, and early and late stage opportunities. Companies need to invest carefully given the fact that development programs are so expensive and time consuming. It also takes time to recruit and train scientists and it is extremely inefficient if you have to keep hiring and firing because you do not have a balanced pipeline and workload. Although there are economies of scale associated with R&D activity (primarily associated with the development side in terms of trial capabilities and the use of contract research organizations) executives are constantly trying to manage the use of size while at the same time providing an entrepreneurial environment that will encourage drug discovery. Scale is also increasingly important now that direct to consumer advertising has been made more accessible. Pharmaceutical companies are now able to use television advertising to market their products directly to consumers. Many have argued that this is a bad idea, however, pharmaceutical companies counter by arguing that increasing consumer awareness is a good thing because more patients than ever are now recognizing symptoms and actively pursuing treatments with their doctors. Another associated reason for size relates to the intense selling infrastructures that many large pharmaceutical companies like Pfizer now have. Firms have to grow in order to compete against these marketing powerhouses, which are increasingly locking up distribution channels.

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An additional reason that should also be mentioned as a reason for merger activity is management greed. It is almost impossible to eliminate agency affects from a business, and as a result managers will undoubtedly do what is in their own best interests. Clearly mergers can offer significant benefits to management whether it be via increased job security, golden parachutes, poison pills, stock awards, etc. This is not a new phenomenon however and does not explain the recent flurry of merger activity. During the last year, there were also moves by the Financial Accounting Standards Board (FASB) to eliminate the pooling method of accounting for merger transactions. Companies were concerned that they would have to account for all transactions using the purchase method which requires any premium over and above fair market value (known as Goodwill) to be amortized over 30 years. More recently, FASB issued a limited exposure draft stating that although the pooling method would still be eliminated, goodwill would not have to be amortized and would simply remain on the balance sheet. The only time firms would have to expense any costs to the income statement would be if the asset became impaired in any way. Although this recent move appears to have eliminated many of the concerns regarding future mergers, concerns over possible FASB rulings undoubtedly contributed to some of the increased merger activity in the pharmaceutical industry. In some ways it would appear to make sense for pharmaceutical companies to merge. Investors have come to expect that pharmaceutical companies will always deliver double-digit growth, but as patents begin to expire and generic competition increases this is becoming harder to achieve. Recent combinations of giant firms like Pfizer and Warner-Lambert and Glaxo Wellcome and SmithKline Beecham puts pressure on those remaining to do the same in order to stay competitive. Pharmaceutical companies are merging for size in order to maintain growth.

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v) Analysis of Two Recent Mega-Mergers In order to explore the issues identified in this paper further, and to see whether mergers have actually helped corporations, two recent mega-mergers will be considered. The merger between Glaxo Wellcome and SmithKline Beecham, and Pfizers hostile takeover of WarnerLambert following an initial announcement that Warner-Lambert would be merging with American Home Products. Glaxo Wellcome / SmithKline Beecham

The shares of SmithKline and Glaxo declined immediately after the deal was announced. The combined corporation won approval from the FTC in December. In 2000, the company recorded 702 million pounds in one-time items related to the merger and restructuring costs as well as gains from disposals. Key products include: Paxil, Wellbutrin, Augmentin, Seroxat/Paxil. Avandia, a diabetes drug, recorded $702 million, and Seretide, an asthma drug, posted $316 million. Consumer healthcare division only grew 3% and will more than likely be divested in order to create a more pure-play pharmaceutical company (GSK press release Feb 22, 2001).

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The following analysis seeks to explore the Glaxo Wellcome / SmithKline Beecham merger from a theoretical perspective in order to try and understand the transfer of value that took place

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in the merger based upon the per-merger negotiating area. The framework used was developed by Larson and Gonedes and is a popular technique for assessing corporate mergers (Clark, 1996). Their framework requires the following assumptions:
1) 2) 3)

The objective of the combination is to maintain or enhance stockholder wealth. The price / earnings ratio captures the risk-return characteristics of the merging firms. No synergism from increased earnings or efficiency gains will occur in the first year.

I gathered data from SEC documents (10-Q filings) for the periods prior to the merger to complete this analysis. What we see is that the model expects the post-acquisition value of the combination to be about $61 per share. Because $61 is greater than the acquiring companys current value of $53 per share, the acquiring company shareholders (Glaxo Wellcome) will accept the merger proposal. The target company shareholders (SmithKline) will accept the merger proposal assuming that their post acquisition wealth position is also greater. The calculation is shown above Wb (1 / exchange ratio) = $53. Because $61 (the post-acquisition value) exceeds $53 the target shareholders will also accept. From the analysis we can see that the bargaining area for the deal was 0.95 (the minimum acceptable level for the target shareholders) and 1.81 (the maximum acceptable range for the acquirer). Generally the shareholders of the target firm extract more relative value from the deal than the shareholders of the acquiring firm. This was true for this merger - although the absolute value was lower, relative to the pre-acquisition wealth position SmithKline Beecham shareholders extracted a higher percentage of synergism (16% versus 7%). Although this analysis provides some insight into the merger, the real key to understanding the success / failure of a deal comes from looking at the post-combination announcements, and the real driving forces behind the deal.

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In the first earnings report since the merger, Glaxo Wellcome and SmithKline Beecham reported a 13% rise in 2000 pre-tax profit, boosted by a 10% increase in pharmaceutical sales and double-digit growth in key therapeutic areas. Pharmaceutical sales were $23.4 billion, contributing 85% of total sales. Perhaps more impressive was the fact that new product sales represented $4 billion or 17% of pharmaceutical sales, and grew at 60%. Its pre-tax profit after one-time items rose to 5.33 billion pounds ($7.71 billion) one a pro-forma basis from 4.71 billion pounds a year earlier. Total sales rose 12% to 18.08 billion pounds from 16.16 billion (WSJ, Feb 21, 2001). The prospects for this merger are not fully clear. It seems likely to add some value to shareholders but mostly through cost cutting as well as some pipeline synergies. However, the strategic value is less clear. Dr. Jean-Pierre Garnier, CEO has high expectations for the newly combined firm. In February the company unveiled its strategy for growth, claiming that 2002 EPS would accelerate dramatically, and that over a hundred new chemical entities (NMEs) were currently in development, 117 of which are already in clinical studies. There are new plans to increase R&D productivity, and planned cost savings of at least 1.6 billion pounds sterling were confirmed. Dr. Tachi Yamada, Chairman R&D pointed out the complementary nature of the R&D portfolios that the merger brought together. The plan is to take advantage of economies of scale, while at the same time promoting an entrepreneurial environment no easy task. The benefits of the merger and the performance of the business have led the company to forecast EPS growth of 13%+, despite the fact that the combined corporation will dispose of certain assets. Such divestments are commonplace in pharmaceutical mergers due to regulatory and FTC issues as well as the obvious overlaps that occur with such mergers.

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Pfizer / Warner Lambert

Pfizer purchased Warner-Lambert for $70 billion in June of 2000. Unlike the merger between Glaxo Wellcome and SmithKline Beecham, this was a hostile takeover. Warner-Lambert had announced a friendly merger with American Home Products, however shareholders seemed wary of the motives for this merger as the press reported that the merger was less about real value and more about retiring executives trying to make a name for themselves.

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Despite some initial publicity issues, Pfizers takeover has been very well received. Most industry analysts and many people within the pharmaceutical industry expect this to be one of the few mergers that will really work. The merger represents a superb strategic fit, and provides Pfizers incredible sales and marketing infrastructure with a great R&D pipeline. Analysts currently project earnings growth of about 24% for the quarter, as the company continues to squeeze out better than expected cost savings from the merger. The company currently has strong prescription growth on products such as Lipitor, Neurontin, and Viagra. One of the biggest drivers of the Pfizer merger with Warner-Lambert was Lipitor, Warner-Lamberts blockbuster cholesterol-lowering drug. Alone, Pfizer booked nearly half the revenues as a result of a comarketing arrangement. The drug is set to be the worlds best-selling medicine, surpassing Mercks Zocor and AstraZenecas Prilosec. With the deal complete Pfizer sales of Lipitor would exceed $7 billion by 2002 according to a large number of analysts. Pfizer appears to be serious about cutting jobs and costs as part of the consolidation and the fact that this is a hostile takeover makes it all the more probable. Warner-Lamberts New Jersey headquarters will be combine into Pfizers in New York. Current estimates project 10% workforce reductions. Pfizer hopes to save $1.6 billion in operating costs in as little as 18 months (corp. PR, 2000/01). Pfizer told analysts that overall savings will be $2.5 billion within 3 years. Many actually believe that Pfizer is being conservative. There are a number of reasons why these companies can save so much. Pfizer makes Norvasc, a pill for high blood pressure thats expected to generate $3.5 billion in revenues this year, and Warner-Lambert makes Accupril, a $600 million blood-pressure drug with a different mechanism of action. After the merger, a slightly larger Pfizer sales force can sell the two drugs at once, since doctors may prescribe both to patients with hypertension. Integration on the research side will also work well as any overlaps are minimal. The combined firm will have a

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presence in almost double the number of disease categories. Pfizer has long been known as a sales and marketing powerhouse so the fact that it will now have Warner-Lamberts R&D will improve Pfizers performance as it currently sells a lot of other companys drugs. There are other strategic reasons for the merger for example the combined firm will have more than 10% of sales in the domestic prescription-drug market. The Pfizer / Warner-Lambert merger is truly a strategic merger. Pfizers large market share will give it more influence over contracts with wholesale drug buyers - just the influence a drug company needs in an increasingly hostile environment.

iv) Do Drug Mergers Really Work?

With regards to the mergers analyzed in this paper. The newly formed GlaxoSmithKline is likely to achieve some success through pipeline synergies and cost savings, but whether or not this merger will truly add value for shareholders remains to be seen. Given the industry challenges ahead, size alone should add at least some value. Pfizers acquisition of WarnerLambert seems highly likely to succeed due to strategic fit, operating efficiencies, & pipeline synergies. All of the issues discussed in this paper as reasons to merge are addressed by this merger. Pfizer now has Warner-Lamberts pipeline and will be a tough competitor to beat In general, the evidence as to whether a merger adds value or not has been, at best, mixed. Merger premiums are typically in excess of 40% according to data from the Merrill Lynch Mergerstat Review, and it takes a lot of strategic benefit to recoup these premiums (Clark, 1996). If mergers were to succeed anywhere it would seem that the pharmaceutical industry offers the greatest chances for success. Operating economies, including the elimination of

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overlap in R&D, production and marketing, can produce meaningful cost savings, however a number studies have shown that merged firms have not performed better over the long-term than drug makers opting to go it alone such as Merck. Many combined firms have also lost market share in key therapeutic categories. The shares of SmithKline and Glaxo declined immediately after their deals was announced. SmithKline and Glaxo investors were apparently disappointed by less than expected projected cost savings, questions over revenue growth and likely initial dilution of EPS. Although size may be good up to a certain point, some of these mergers may be going too far. The main advantages of size for pharmaceutical companies include:

Clinical trial economies of scale Enhanced and more utilized sales rep. coverage Additional regulatory and filing power with the FDA Increased lobbying power (both political and with wholesalers) Balanced risk in terms of the companys pipeline and product portfolio

However, many of these benefits are only temporary, particularly given the current rate of consolidation within the industry. Furthermore, there are potential significant disadvantages associated with being too big. These include:

Diseconomies of scale and control issues A lack of focus The potential for disconnects between R&D and commercial (leading to investment in sub-optimal projects from a commercial perspective)

The loss of an entrepreneurial environment that encourages and rewards discovery

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Finally, and perhaps most importantly, these mergers may not deal with some of the most important emerging areas in pharmaceutical development, namely biotechnology and genomics. Although, many of these mega-mergers do seek to address the industry issues outlined earlier, merging may not be the best long run solution. Biotechnology and genomics, which will be discussed in the next section look set to be the future of drug development, and investments and development in these areas, would probably be a better solution. In spite of these factors and the mixed success of mergers, pharmaceutical firms continue to merge in an effort to provide some level of security in an increasingly uncertain industry.

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vii) Possible Future Mergers The following chart depicts the current state of the pharmaceutical industry, but more importantly it highlights a series of possible future mergers:

SOURCE: SEC 10-Ks / Annual reports.

As you can see from the chart above, Pfizer and GlaxoSmithKline are now clearly the largest pharmaceutical companies in the world, with revenues of over $21 billion. Behind these giants, we can see a group of about six large companies, many of which were former giants prior to recent mergers followed by a midsize group of firms all of which are likely to be acquisition targets as the large firms seek to regain their super-size status.

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viii) Implications of Biotechnology & Genetic Mapping Almost all the big pharmaceutical companies have strategic / financial partnerships with biotechnology companies. In the past these partnerships have been a good fit. Biotechnology firms frequently lacked the cash to fully develop their products independently, and even if they had cash for R&D they lacked the resources to compete with the big pharmaceutical companies sales and marketing efforts. On the flip side, pharmaceutical companies are continuously looking to fill gaps in their product pipelines and leverage their existing sales force structures. Partnerships with biotechnology firms are very attractive to pharmaceutical firms. Increasingly, however, biotechnology firms are making it on their own. Capital has been much more accessible in recent years, and some firms such as Amgen, Biogen, and Genentech have been able to fulfill the dream and go from biotech start-up to fully-fledged biopharmaceutical firm. Pharmaceutical firms are finding significant problems associated with licensing agreements, co-marketing arrangements, joint ventures and other strategic partnerships. Although such arrangements reduce costs as firms share the burden of development, they also limit revenue if and when the drug becomes successful. As a result, a number of pharmaceutical firms have launched their own biotech efforts, or are buying or attempting to buy out the biotech partners. However, it is not just partnership issues that are driving pharmaceutical interest in biotechnology. There are significant benefits associated with biotechnology related drug development. In general, biotechnology products can be brought to market quicker due to higher specificity versus their small molecule counter-parts. In addition, biotech products frequently less immuno-genecic effects due to the fact that they are derived from human cell-lines.

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On the surface, it would appear that no force is changing the pharmaceutical landscape more than biotechnology and the mega-mergers discussed earlier, except perhaps genomics. Pharmaceutical firms are desperately trying to understand the implications of a scientific revolution known as genomics, which has the potential to change a companys entire business model. The term genomics refers to the effort to exploit the all the scientific information now available in gene databases around the world. Although most big pharmaceutical company have some genomics expertise, some companies like GlaxoSmithKline are now trying to make it central to their discovery and development efforts. Others are developing external partnerships with new companies like Millennium Pharmaceuticals and the Celera Genomics Group. The opportunities in the area of genomics are immense. Scientists have huge opportunities to find new ways to attack disease. Merck & Co. has already used genomics to identify a gene linked to common form blindness. BMS has a number of compounds derived via genomic research to treat cardiovascular ailments and rheumatoid arthritis, and SmithKline Beecham as uncovered new targets to help treat osteoporosis (Business Week, Jan 8, 2001). How does genomics fit with big pharma? Drug makers have massive libraries of compounds. Matching their database of compounds with the genomic database of disease targets should dramatically improve the speed and efficiency of drug development so dont be surprised to see a significant increase in partnerships and merger activity between drug makers and genome specialists. In fact, this is in my opinion a better solution to the current industry pressures than the more traditional pharmaceutical mergers that we have seen of late.

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ix) Conclusions In spite of mixed evidence, pharmaceutical firms continue to merge in the hope that size will help them to deal with uncertainty and ever increasing industry pressure. Size and growth are being used to defend against increasing industry pressures including reimbursement issues, political pressure, patent expirations, growth issues, R&D pipeline gaps, and advertising economies of scale. It is not clear that merging is the answer. With regards to the mergers analyzed in this paper, GlaxoSmithKline looks likely to achieve some success through pipeline synergies and cost savings, but the strategic benefits are less certain and the announcement was not well received by the market. Pfizers acquisition of Warner-Lambert is more likely to succeed given the fact that it was a hostile takeover, and that there was a good strategic fit. However, Pfizer had to pay a significant premium in order to make the merger happen due to the planned friendly merger between AHP and Warner-Lambert. In general, evidence to date suggests only minimal success and given the current rate of consolidation any benefits gained through increased size are only likely to be temporary. Operating economies, including the elimination of overlap in R&D, production and marketing, can produce meaningful cost savings, however a number studies have shown that merged firms have not performed better over the long-term than drug makers opting to go it alone such as Merck. Many combined firms have also lost market share in key therapeutic categories. Further, you cannot guarantee drug discovery, and there are size issues associated with big mergers. These include diseconomies of scale and control issues, a lack of focus, the potential for disconnects between R&D and commercial (leading to investment in sub-optimal

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projects from a commercial perspective), and the loss of an entrepreneurial environment that encourages and rewards discovery. Finally, and perhaps most importantly, these mergers may not deal with some of the most important emerging areas in pharmaceutical development, namely biotechnology and genomics. These areas are improving target identification and will ultimately help to reduce costs. They have the potential to revolutionize the drug discovery process, if drug companies can match their databases of compounds with the genomic database of disease targets we should see some dramatic improvements in the speed and efficiency of drug development. Biotechnology and genomics would appear to offer potential better ways to deal with current industry pressures than simply merging traditional companies in order to gain some synergies and perhaps some additional lobbying power. They offer the potential to redefine the industry, to actually deal with some of the pricing issues, sales growth, patent, and pipeline issues without consolidating already large companies which simply makes your base for growth even bigger. Even with the mounting financial evidence and growing number of arguments against these mega-mergers the current industry trend looks set to continue. Although not necessarily the best solution, big consolidations in the pharmaceutical industry look set to continue.

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x) Bibliography

Bailey, R. (April, 2001). Reason Magazine: Damn the Pusher Man Why does Everyone Seem to Hate the Pharmaceutical Industry? Besanko, D., et. al. (Ed.). (2000). Economics of Strategy (2nd Ed.). New York, John Wiley & Sons, Inc. Business Week (Jan 8, 2000). Industry Outlook 2000 Life Science. [On-Line]. Available: Businessweek.com Business Week (Jan 21, 2000). Are Mergers the Right Prescription for Drug Stocks?. [On-Line]. Available: Businessweek.com Business Week (May 8, 2000). Looks Like Drugmakers are Popping Growth Pills. [On-Line]. Available: Businessweek.com Business Week (May 17, 2000). Pfizer-Warner: One Drug Merger That Might Just Deliver. [On-Line]. Available: Businessweek.com Business Week (June 12, 2000). The Pharma Frenzy. [On-Line]. Available: Businessweek.com Business Week (Jan 8, 2001). Industry Outlook 2001 Life Science. [On-Line]. Available: Businessweek.com Business Week (Jan 9, 2001). Biotech Horizons, Near and Far. [On-Line]. Available: Businessweek.com Clark, Gerlach, Olson (1996). Restructuring Corporate America. The Dryden Press. Dickson, T. (Ed.). (1997). The Complete MBA Companion. Maryland, Pitman Publishing. Elazar Berkovitch, M. P. Narayanan. (1993). "Motives for Takeovers: An Empirical Investigation." Journal of Financial and Quantitative Analysis. Elazar Berkovitch, M. P. Narayanan. (1990). "Competition and the Medium of Exchange in Takeovers." Review of Financial Studies. Fabozzi, F., & Modigliani, F. (Ed.). (1996). Capital Markets: Institutions and Instruments (2nd Ed.). New Jersey, Simon and Schuster Co..

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Journal of Finance (1995) "Initial Shareholdings and Overbidding in Takeover Contests. PR Newswire (Feb 22, 2001). GlaxoSmithKline Unveils Strategy for Growth. [OnLine]. Available: biz.yahoo.com/prnews Review of Financial Studies (1991) A Theory of Acquisition Markets: Mergers versus Tender Offers, and Golden Parachutes. Robert H. Jennings, Michael A. Mazzeo. (1993). Competing Bids, Target Management Resistance, and the Structure of Takeover Bids." Review of Financial Studies. Wall Street Journal (Feb 21, 2001). GlaxoSmithKlines Pretax Profit Climbs 13% on Rise in Drug Sales. [On-Line]. Available: wsj.com

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