Pharmaceutical Industry Merger Mania: Consolidation vs. Diversification

by: Larry Rothman

Consolidation in the Pharmaceutical and Biotechnology Industry has been grabbing headlines lately and of course we have a strong point of view about how this may shape or mis-shape the industry going forward. While the biggest headlines involve the Pfizer (NYSE:PFE) - Wyeth (WYE), the Merck (NYSE:MRK) - Schering Plough (SGP) and Roche (OTCQX:RHHBY) - Genentech (Private:DNA) consolidations, we feel compelled to discuss these and alternatives that may have been considered and the landscape that may develop as a result of these moves.

Let's look at some of the alternative strategies that can be deployed given that most CEOs would acknowledge that the combination of low ROI from R&D investments, patent expirations, demise of the blockbuster model, ineffectiveness of the sales force armies, excess manufacturing capacity, increased regulatory oversight, significant pricing pressures, and the lack of success (failure?) of large consolidations wreak havoc with long term direction.

Chris Viehbacher, the new CEO of Sanofi (NYSE:SNY) characterized two strategic camps in a recent interview with Bloomberg News: they are the “Consolidation Camp” and the “Diversification Camp”.

To us, Pfizer (PFE) is the prime example of the Consolidation Campers with expenditures of nearly $200 billion in the last several years to acquire Warner Lambert and Pharmacia along with several other smaller acquisitions, only to have its stock market cap for the consolidated company reach under $100 billion despite loads of restructuring, re-engineering and synergy targets. It appears that once synergy targets are met (1-4 years), company values as measured by stock market capitalization seem to wane quickly and the quest/thirst for more consolidation continues at a frantic pace.

For us, the leaders of the Diversification Campers are Johnson & Johnson (NYSE:JNJ) and Abbott (NYSE:ABT). Both companies have major lines of business outside traditional large molecule pharmaceuticals with significant and growing businesses in consumer healthcare and medical devices and diagnostics. Their acquisition strategy seems to be small to mid size chunks, notably J&J's $16 billion+ acquisition of Pfizer's Consumer Healthcare Businesses as well as numerous biotechnology companies, while Abbott has acquired Advanced Medical Optics (AMO), Guidant's Vascular Intervention and Endovascular businesses and Kos Pharmaceuticals (KOSP).

Both J&J and Abbott seem to have incremental “bite sized” acquisitions, all meant to provide a portfolio of “health care” lines albeit balanced among multiple sub segments of the industry. Both companies seem to have accelerated the success of these acquisitions by leveraging existing franchises and/or management and infrastructures. Notably one wonders why they haven't or if they might look at generic pharmaceuticals and/or animal health to round out their portfolios.

We will next discuss our opinions of the recent merger wave and who were the smart ones (could it be Pfizer, Merck or Roche??). Stay tuned and we will look at other alternatives we think may be developing.