High cost of drug development drives mergers

OUTLOOK

Cost savings will help to enhance earnings

January 23, 2000|By Mara H. Gottfried

LAST WEEK, Glaxo Wellcome PLC and SmithKline Beecham PLC agreed to create the world's biggest drug company in a stock swap worth $75.8 billion, after a wave of mergers among rivals heated up competition.

The pharmaceutical industry is being reshaped by a spate of multibillion-dollar combinations. The world's top two drugmakers, Aventis and AstraZeneca, were created by European mergers last year. And currently, Pfizer and American Home are battling for control of Warner-Lambert to gain control of Lipitor, Warner- Lambert's top-selling cholesterol treatment, and other drugs.

What is driving this wave of mergers? How large a factor is the enormous cost of finding, developing and marketing new drugs? Did SmithKline's prowess in genomics make it attractive to Glaxo?

Mike Krensavage

Analyst, Brown Brothers

Harriman & Co., New York

I think a lot has to do with the fact that the drug market is fragmented. To say it more bluntly, desperation drives mergers. Glaxo has been having difficulty replacing the ulcer drug Zantac after it lost patent protection. That's really what you're looking for: Do these companies face problems that force them into a merger?

It remains to be proven that any company in the industry lacks the resources to develop new drugs. Some companies make the argument that you have to be large to bring a new drug into the market. I believe that theory remains unproven.

One other thing I would like to point out is that these mergers were greeted with less enthusiasm by investors than they historically received. The threat of government intervention has cast a pall over the entire industry.

Jeff Chaffkin

Analyst, PaineWebber,

New York

There's several factors driving the mergers. Most importantly, the cost of doing research and development is going up. When you merge these large pharmaceutical companies, the cost savings will help to enhance earnings growth. Also, you develop a global infrastructure for sales and marketing which allows the companies to launch products faster.

There is a general trend toward continued consolidation in the pharmaceutical industry. I think you can expect to see more deals going forward this year.

The cost of research and development is definitely a factor. There's a real advantage to having a large research and development base because bringing a drug through the process is in the hundreds of millions of dollars.

This merger is absolutely about research and science. SmithKline has obviously been in the lead in this area, and that's obviously attractive to Glaxo as they look ahead in the research pipeline.

Neil B. Sweig

Analyst, Ryan, Beck & Co., New York

The ongoing consolidation within the global pharmaceutical industry is both fact and fiction. Some companies believe that behemoth research and development and sales forces are necessary, and other companies believe that they can get along quite well without it. So there's definitely a split within the industry.

Research and development, without a doubt, is the lifeblood of the industry. Companies need to be cautious in striking the right balance. How much to spend annually is the true question. Some burn the money more than others and still don't produce enough new drug success.

Genomics is one of the reasons that SmithKline was attractive to Glaxo. Genetics research is but one of many pieces in this ongoing merger, which failed in February 1998. This is a continuation of those conversations with a different cast of characters.

Bob Kirby

Analyst, Edward Jones, St. Louis

The mergers are being driven because I think bigger is better, given the cost of bringing a new drug to the market. You need a lot of resources and deep pockets. Once you make that kind of investment, you have to make a concerted effort on the marketing side to make it pay off.

Research and development is key, with $500 million being the price tag of developing a drug on average. They're fairly risky projects.

I like the merger, all in all, even though the Street hasn't reacted favorably. In the long term, I think they'll be able to take advantage of marketing opportunities, and the merger will be a plus.

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