Many people will consider GlaxoSmithKline (GSK) a good investment based on their record of delivering on late stage trials, of quickly separating out failures and of increasing dividends over 20 years. However, this is a company that has been lately showing consistent decline in revenues, which is often an indicator of bad things. Before going with the hype, let me therefore look into some of the following details before making a call:
GSK's financial results and the effect of patent expiry
Strategy - what is it doing to escape the patent cliff and declining revenue
Its product pipeline, the ultimate backbone of any biotech.
I am going to show that GSK is only taking small and non-constructive moves to combat revenue decline. It is not taking bold steps - like the major acquisition of a company with an immediate launch - that could see it mending matters in the short term.
Impact of patent expiration on previous year's results
Revenue decreased from $42.56 billion to $42.02 billion last year, and net income dropped from $8.2 billion to $7.54 billion. Revenue and net income have been on the decline since 2009.
The sales of Advair, the company's drug for management of asthma and chronic pulmonary disease (COPD), decreased by 3%. This drug is a 20% contributor to the overall sales of GSK, which amounts to about $8.4 billion. Bloomberg reported in 2011 that the approval of a generic version of Advair in Sweden has made way for future substitution of the original drug in other parts of Europe.
In the face of such challenges due to the launch of generics, companies should consider manufacturing cheaper versions of their drug themselves and establish a stronghold in the market by making their generic available first. They must also promote the fact that being the drug originator, their generic is of a superior quality since their understanding of the treatment approach and the details of the science involved is much better than that of their generic competitors.
2 non-constructive strategic moves
Expanding global reach of consumer brands and cutting costs - positive but small steps
PMLive reported that GSK is considering the expansion of their current Ribena and Lucozade drink brands to a global level to invest in their growth. The company is also planning a cost saving of about $1.54 billion by 2016, which would require an expenditure of about $2.3 billion. This would be achieved by cutting down on the size of its organizations in Europe.
In my opinion, reducing manpower in the sales department is a sensible move. Today much of the sales force in pharmaceutical companies is dispensable. Doctors find their time being wasted by a massive, incompetent and unconvincing sales force. Much of the information about drugs is now available to doctors through the internet and in fact, they are now connected sufficiently well to consult with their peers. An excessively hefty sales force has become a burden on the entire healthcare system and carefully pruning it would benefit any pharmaceutical major.
Expanding the reach of consumer products and cutting down on costs would help improve revenues and operating income in the short term but perhaps not in a significant way. Additionally, these measures will soon have to be supplemented with significant improvement measures in R&D and smart investment in promising late-stage drugs of smaller, niche businesses. GSK is not doing that, as we shall see shortly.
Increasing liabilities to maintain investor confidence - an unwise idea
One troubling aspect about GSK's financial management discussed in an article by fellow Seeking Alpha contributor Jeroen Jongbloed is that it has been increasing its debt to pay its high dividend yield of about 5%. Investors might think that despite revenues dropping, the fact that the company is paying such a high dividend shows the management's confidence in the drug pipeline momentum and the benefits of restructuring. However, taking on debt to pay high dividend yield does not make sense when the company is awaiting approvals for about 6 new drugs, and previous blockbusters are facing pricing issues post patent expiration. So let us not allow the high dividend yield to impact our investment decision significantly.
Instead of increasing debt to pay a hefty dividend yield, GSK can utilize borrowed money to invest in measures that would directly help in addressing the revenue decline or in partnerships and projects that possess strong likelihood of success over the short term. To prevent investors' confidence from decreasing due to lower dividend payout, the company can heavily market their investment plans and ensure investors are well educated about the company's strategy.
Drug pipeline status - no immediate launches
GSK is awaiting the approval of the lung drugs Anoro and Relvar, dolutegravir for HIV and dabrafenib and trametinib for skin cancer. The company will also submit albiglutide for treatment of type 2 diabetes in the near future.
Deutsche Bank estimates that there is a 40% probability of Relvar's approval, 70% for dolutegravir and 85% for dabrafenib and trametinib. They did not give estimates for Anoro and the type 2 diabetes drug. The results of 14 late-stage clinical trials are awaited in 2013 and 2014. One cannot be certain that regulatory approval is guaranteed for these.
Further, there isn't anything very promising close to launch, but competitor Novartis (NVS) has already gained approval for its TOBI Podhaler, which can be used to treat lung infections in cystic fibrosis patients. Yet another competitor, Forest Laboratories (FRX) is threatening entry into the COPD space which has thus far been primarily dominated by GSK. So GSK's R&D really needs to pull up its socks while the company tries to sustain itself for the time being by cost cutting and expanding the reach of it consumer products.
And a constructive move they are NOT making...
At this time, GSK is not looking at acquiring businesses with promising products in late stages of testing, rather the company is considering investment in innovative ways of therapy like electroceuticals and early-stage compounds. The company recently said in an Economic Times report that it would offer a $1 million prize to encourage innovation in the field of electroceuticals, which would involve treating diseases by targeting electrical signals in the body rather than cells and molecules.
This initiative may offer healthy returns in the long run; however, it is not going to help GSK with the damage control it strongly requires in the short term. Therefore, it doesn't look like a good strategy in my opinion. A solid candidate nearing launch is what GSK should consider buying to stop the decline in its revenues and buy time to boost its in-house R&D productivity.
GSK is a big pharmaceutical player and has been so for quite some time. Often, there is a tendency to look at a company's reputation and past successes in determining whether it is a good place to invest irrespective of any recent downswings. I believe that a strong reputation definitely counts, but it must be bolstered by good strategic moves made by the company in the face of challenging situations and recent performance decline. GSK in my opinion is not taking enough concrete steps to ensure that it can deal with the revenue and operating profit downturns.