AstraZeneca's Shrinking Act Could Increase Its Appeal

| About: AstraZeneca Group (AZN)

From 7,300 new job cuts to a contracting cost base and lower revenue guidance, in many ways AstraZeneca (NYSE:AZN) is the incredible shrinking company. With chief executive David Brennan ruling out transformative acquisitions, the company appears to believe less should be able to deliver more.

One measure that is growing is returns to shareholders – the annual dividend climbed 10% and the company plans to spend $4.5bn buying back shares this year – and, once again, earnings per share climbed impressively. But the annual results announced Thursday will be the last time the company’s management team delivers investor-pleasing EPS growth for a number of years, as the loss of huge revenue-generating products wipes out attempts to improve profitability by slashing the cost base.

Less is more

One of the weaker of the big pharma pack from a pipeline perspective, AstraZeneca’s attempts to plug the gaping holes that will be left by Nexium, Seroquel and eventually Crestor have yielded little so far. The double blow of TC-5214 in depression and olaparib for ovarian cancer, which both failed in the last few months, was just the latest in a string of R&D setbacks (Pipeline setbacks hurt AstraZeneca, December 20, 2011).

Under the new restructuring programme announced Thursday, 2,200 of the job cuts announced will fall in R&D; in the previous two restructuring rounds 5,330 R&D positions were affected. Astra has been cutting jobs in all departments, but for a company set on innovating its way out of a hole rather than buying its way out, heavily cutting back in this area only means one thing – that innovation must be bought from outside.

In terms of M&A, deals of the size of MedImmune, which cost $15.6bn, are off the table, Mr Brennan told journalists.

My belief is that, ultimately, success of a research based pharma company is driven by success in research and development, and it's not obvious that scale in and of itself delivers a linear improvement in that output, he said.

There are a number of opportunities out there that we look at that tend to be smaller in scale. So we are not looking at transformational types of activities. But we are looking at opportunities to bring things in. And we are not cash constrained.

Spending wisely

As Seroquel and Nexium approach the end of their patented lives, these hugely profitable products will be generating huge amounts of cash. Seroquel contributed 26% of the company’s EPS last year and Nexium 11%, according to EvaluatePharma’s NPV Analyser.

But that cash flow will soon dwindle and Astra needs to spend it wisely. The $200m spent buying rights to depression drug TC-5214 looks like money down the drain, and it remains to be seen whether the $125m paid for two gastro-intestinal agents and the $100m for RA therapy fostamatinib will yield returns.

As a strategy, paying a lot of money for promising late stage assets while shrinking your own R&D base could well prove to be a more efficient use of capital. But Astra needs a late-stage success to establish that this as a viable way to sustain a pharmaceutical company currently worth $62bn.

Increasing appeal?

AstraZeneca is undoubtedly shrinking. Revenues that reached $33.6bn last year are forecast to fall to $27.4bn by 2016, consensus data show, an outlook that could easily deteriorate should key patent cases go against the company or important growth products disappoint (Big pharma's key events for the next six months, January 19 2012). The jury is certainly still out on Brilinta, which generated only $5m in the last quarter of 2011.

However from a financial perspective, Astra has been very effective at extracting profitability from the business. Its gross margins – which improved 0.9 percentage points to 81.8% last year – are among the highest of big pharma.
A perennial takeover target, should events cause Astra’s shares to take a tumble the company could easily become attractive to some of its big pharma peers. The future for a few key products probably needs to become clearer before suitors take a serious look, but the eventuality cannot be ruled out.

The new restructuring programme announced Thursday should make the company even more lean and mean. Should the elusive late-stage successes be found Astra will be growing from a strong base, and those takeover rumours could resurface.