Forest Laboratories: Perhaps the Next Consolidator?

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 |  Includes: BMY, ENDP, FRX, LLY, MYL, PFE, SGP, TEVA, WYE
by: Prudent Speculations

The week got off to an improbable start on Monday with the announcement that Pfizer (NYSE:PFE) had entered into a definitive merger agreement with fellow large cap drug maker Wyeth (WYE).

Pfizer, like nearly every large drug company, has come under tremendous pressure in recent years to replace an aging pipeline with innovative new blockbuster products. Despite ambitious attempts by Pfizer’s management team and by all of the other drug makers in a similar position, the results have been dismal. As a result, these broken firms have been left with but one quasi solution, and that is to merge with their rivals in an attempt to diversify and prolong the life of their pipelines.

Such mergers cannot be faulted, as they are often one of the few options that corporate management teams have left open to them when faced with ineffective R&D spending and limited internal growth. Given the recent media speculation on a surge in deal making within the pharmaceutical industry, it is interesting to ponder who will become a consolidator in the industry. While the growth through consolidation model clearly cannot work beyond a certain point it can be tremendously profitable until sheer size prohibits further profitable acquisitions.

Forest Laboratories (NYSE:FRX) has been a tremendously well-run company over its entire history. However, like many of its peers it is facing an especially difficult environment going forward as it struggles to deal with stagnating sales and patent uncertainties. The company’s blockbuster depression and Alzheimer’s drugs have generated tremendous profits that have allowed the firm’s management to create the industry’s strongest balance sheet.

By specializing in two areas, Forest Laboratories has managed to become one of the most profitable drug companies in America. This is a significant competitive advantage and will allow the company to conduct itself in a dignified manner as it races to morph itself into a truly multi-line drug company.

In looking at the company’s balance sheet, it is clear that it is in a position of strength and poised to acquire other drug manufacturers in the next several years. The company currently has no long-term debt, $1.8 billion in cash and a tremendous amount of treasury stock that can be readily issued for an acquisition.

These characteristics will allow Forest Laboratories to spend billions over the next several years to enter a world that is currently dominated by the likes of Eli Lilly (NYSE:LLY), Schering-Plough (SGP) and Bristol Myers Squibb (NYSE:BMY). In doing so it will be better able to compete for the small drug companies that will eagerly sell themselves to the titans of the industry in return for substantial monetary rewards.

Forest Laboratories has done tremendously well for its shareholders over the last several decades but it is simply unable to compete and its dependency on key products will be the firm’s undoing unless it grows through acquisitions. The firm’s large cash flow, cash on hand and large borrowing capacity have the potential to make the company a deal maker in the drug industry.

Two potential targets exist that would allow Forest Laboratories to revolutionize itself. It has been readily acknowledged by most industry insiders that the drug companies that wish to prosper must participate in the world of biotechs, specialty pharmaceuticals and generics. That is why an acquisition of Mylan (NASDAQ:MYL) and Endo Pharmaceuticals (NASDAQ:ENDP) would go a long way to truly diversifying Forest Laboratories, while at the same time providing the company with exciting avenues for growth.

The addition of Mylan would provide generic exposure to the company as well as prepare it for the loss of its two blockbuster drugs while at the same time positioning the company well in the exciting biogenerics field. While in acquiring Endo, Forest Laboratories would be adding increased exposure to pain management to its repertoire of branded drugs.

As it marches into the future, Forest Laboratories has the opportunity to build itself into a world-class drug maker thanks to its strong balance sheet and ability to purchase its competitors at rock bottom prices.

If the company were to hypothetically buy a Mylan or an Endo, it would move much closer to the proven model of Teva Pharmaceuticals (NASDAQ:TEVA).

Such a model is clearly successful and should be followed by all of the drug makers that are in search of a future that is better than the environment that they are currently immersed in.

Disclosure: No positions.