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Summary

  • Pfizer's revenues are eroding quickly amidst patent expirations.
  • Continued cost-cutting in R&D impacts the pipeline and prospects for future growth.
  • Spending over $100 billion to acquire AstraZeneca, followed by cost cuts will not solve top line growth worries.

Pfizer (NYSE:PFE) continues to dominate the news headlines these days. The pharmaceutical giant best known for Viagra and the once top-selling cholesterol drug, Lipitor, is losing sales at a rapid pace.

Lipitor has already generated more than $140 billion in cumulative sales for the company, but generic introductions are impacting Pfizer on a big scale.

Underinvestment in R&D and a focus on cost-cutting limits the possibilities for a rapid recovery of sales, part of the reason why the company aims to resort to a $106 billion acquisition of AstraZeneca (NYSE:AZN). I don't think that it is that easy for Pfizer to buy its way out of troubles; instead it should focus more on organic growth.

First Quarter Reveals That Revenues Remain Under Pressure

Pfizer reported a rather steep 9% drop in top line revenues, which came in at $11.35 billion. About a third of this drop in revenues is attributable to adverse currency movements.

The pharmaceutical giant reported a mere 2% drop in adjusted earnings to $3.66 billion, while non-GAAP earnings increased to $0.57 per share, thanks to share repurchases.

Given the large discrepancy between GAAP and non-GAAP earnings, it is important to focus on the GAAP earnings as well. Reported income fell by 15% to $2.33 billion, with diluted earnings per share falling by two pennies to $0.36 per share.

Top Line Weakness Seen In All Major Divisions

The global established pharmaceutical segment reported a 13% drop in sales to $5.99 billion. The loss of exclusivity of Detrol LA in the U.S. in January of this year and loss of exclusivity of Viagra in some European countries in June of 2013 were to blame. European sales of the famous blue pill fell by 38% to $133 million.

Revenues at the global innovative pharmaceutical segment were down by 7% to $3.08 billion. The expiration of the co-promotion term for the collaboration for Enbrel in the U.S., with royalty payments being lower than revenues under the old agreement, were behind the declines.

Some upside was seen by the performance of top-selling drug Lyrica, which reported 8% sales growth to $1.15 billion, being Pfizer's biggest drug at the moment. Eliquis, which is being developed together with Bristol-Myers Squibb (NYSE:BMY), performed well, while revenues of Xeljanz rose sharply to $52 million up from just $11 million last year.

The vaccines business reported unchanged sales at $925 million, while oncology revenues managed to increase by 7% to $488 million. Strength of Xalkori and Inlyta drove results of the oncology business.

2014 Guidance

Full year adjusted revenues are anticipated to come in between $49.2 and $51.2 billion reflecting a full year contribution from Celebrex in the U.S. without the introduction of generic competition.

Non-GAAP earnings are seen between $2.20 and $2.30 per share with this guidance again assuming no generic competition for Celebrex.

Focus Remains On AstraZeneca

The big news overshadowing the earnings release remains the offer and revised offers which the company is making for UK-based AstraZeneca. The company recently hiked its offer for the company to $106 billion, while increasing the cash component of the offer as well, trying to persuade AstraZeneca's shareholders. The UK business quickly rejected the offer, stating that it undervalues the business.

So what exactly does Pfizer get for a potential $106 billion price tag? AstraZeneca reported revenues of $25.7 billion for 2013, on which it earned $2.6 billion. This values the company at 4.1 times annual revenues and 41 times earnings.

These are not too compelling multiples, as Pfizer's interest for the company is based on avoidance of tax repatriation charges on foreign-held cash balances, lower tax rates, synergies and AstraZeneca's pipeline to rejuvenate top line revenue growth. While no synergy estimates have been given, Pfizer has seriously cut costs in recent years, weighting on the pipeline development. To illustrate, company-wide research and development expenses fell from $11 billion in 2009 after acquiring Wyeth to $6.7 billion last year.

While taxes and synergies are important, Pfizer most likely has targeted AstraZeneca for its pipeline. A key promising drug is diabetes drug Symlin, which might actually be used to target people suffering from Alzheimer's. While this appears to be the most promising drug of the company, AstraZeneca has a solid line-up, as seen in a recent drug pipeline overview.

Pfizer's own pipeline is rather full as well, yet quality counts more than quantity in the world of pharmaceuticals, a world in which blockbusters make all the difference.

Valuation

At $30 per share Pfizer has a market valuation of $191 billion. Its market capitalization has been under pressure, as the company has aggressively repurchased shares after divesting assets, like its animal business Zoetis (NYSE:ZTS), over the past year.

Roughly 700 million shares have been repurchased over the past year at a current cost of little over twenty billion. Despite the spending spree, cash stands at $32.4 billion while the net debt position is just $4 billion.

After repurchasing $1.7 billion worth of shares so far in the calendar year of 2014, Pfizer aims to repurchase $5 billion worth of shares for the entire year. On top of this, investors receive a quarterly dividend of $0.26 per share for an annual dividend yield of 3.5%.

Pfizer's stand-alone business is now valued at 3.8 times annual revenues, 13 times non-GAAP earnings and 19-21 times estimated GAAP earnings.

Implications For Investors

Pfizer currently commands a $191 billion market capitalization at $30 per share. The company held a net debt position of $4 billion by the end of 2013, but holds over $32 billion in cash.

Now let's add a potential $106 billion acquisition of AstraZeneca to that with a third of the sum being financed in cash and the remainder by issuing new shares. The new combination would hold a net debt position of about $40 billion if a deal where to occur at the latest terms, while equity in Pfizer would be valued at $260 billion following the offering.

Combined, both companies are on track to report revenues of roughly $75 billion while reporting GAAP earnings of about $12 billion-$13 billion. On top of this come tax synergies and cost synergies which could easily run at $2 billion-$4 billion per annum. Even then a $14 billion-$17 billion profit estimate does not sound very appealing to me at 16-17 times earnings in let's say one or two year's time.

Obviously the debt position will limit the opportunities somewhat going forward, and new products should really drive results instead of cost-cutting.

Instead of paying a big premium and repeat the trick of cost-cutting to boost short term earnings, it is time for Pfizer to think more long-term and focus on higher R&D investments and productivity, thereby avoiding costly mega-deals to shore up future growth prospects.

Source: Pfizer: Spending More Than $100 Billion To Rejuvenate Revenue Growth Will Not Create Long-Term Value