Big Pharma's Goal: Less Mayhem in 2007

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big pharma By Robert Steyer, The Street.com

For the big drugmakers, next year could be the stock-market equivalent of Pushme-Pullyu, the two-headed creature of Doctor Doolittle fame that tried to go in different directions at the same time and ultimately got nowhere.

Maybe a little standing in place doesn't sound too bad to long-time investors in the sector, considering the management ousters, failed clinical trials and patent losses that have become commonplace.

Even better would be to find the 2007 edition of Merck, which despite mixed results on the Vioxx-litigation front turned in a gain of more than 30% this year, making it one of the best performers on the Dow Jones Industrial Average.

If Stephen Brozak of WBB Securities is right, the coming year should be one in which biotech companies, and to a lesser extent giant drug firms, do better than the economy in general. However, he warns that "a rising tide won't lift all boats."

With that in mind, analysts say the least-promising roster features names like Bristol-Myers Squibb, AstraZeneca and Pfizer.

Wall Street appears to have already decided who the winners should be, judging by the number of buy recommendations compared with the combined sells and holds tabulated by Thomson Financial.

Among the biggest drug outfits, the strongest sentiment is for Genentech, Amgen, Johnson & Johnson, Novartis and Wyeth.

Of course, along with the good come the bad and the potentially ugly.

Though both Bristol-Myers and Pfizer saw their stocks rise roughly 9% since the start of this year through mid-December, they managed to advance while whistling past the graveyard. To be sure, climbing at all in the face of the repeated challenges of 2006 is an admirable feat, but one has to wonder if anything even approaching a repeat is possible.

They withstood, even flourished, amid not-insignificant matters like executive shake-ups, patent wars and product disappointments. Therefore, investors can be forgiven if they decide to take their gifts and go home.

To paraphrase former Defense Secretary Donald Rumsfeld, Bristol-Myers and its partner Sanofi-Aventis face the "known unknown" of a serious patent infringement fight. If they lose their court case to protect the U.S. patent of their anticoagulant Plavix, both companies -- but especially Bristol-Myers, for whom the drug is its biggest seller -- will see their revenue take a hit in 2007.

The wait probably won't be long, because oral arguments start in January.

Even if Bristol-Myers prevails, it will still face generic competition in other areas. The same issue will trouble Pfizer, Merck, J&J and GlaxoSmithKline next year. As a result, don't be surprised if Big Pharma goes shopping, namely for smaller companies with existing products or promising R&D pipelines.

Brozak expects this year's flurry of dealmaking to continue as small biotechs are targeted for acquisitions, licensing deals or collaborations. "For Big Pharma to go forward successfully, biotech is the answer," he says. Right now, the amount of biotech research and development at the old-line companies "is nowhere near what it should be. They're still in the marketing, cash-cow business."

Les Funtleyder, health care strategist for Miller Tabak, is also looking for tie-ups, especially since "mid-cap pharmaceutical companies realize they will have to buy some R&D or they will get bought."

On the one hand, Funtleyder isn't expecting mammoth combinations because "it's generally recognized that mega-mergers don't work." At the same time, he figures that "once somebody does it, there will be more of them."

Generics in Heaven

The brand-name drug sellers might be facing a rocky road, but the counterbalance will be provided by the makers of low-priced generic products. The medical-data research firm IMS Health says $10 billion worth of brand-name drugs will go off-patent in the U.S. next year, down from $19 billion in 2006 but still a substantial pool of money for generic-drug makers to attack.

"Growth from new products will not be sufficient to offset the volume of branded drugs that shift to generics," IMS predicts. Worldwide, products with sales of more than $16 billion will "likely lose patent protection," the firm says, down from about $23 billion this year.

Parlaying patent expirations into extra profits will depend on how well generic-drug companies cope with the commoditylike profit margins in their line of work. If they can't grow by raising revenue, they'll try to grow via mergers.

Analysts expect more international takeovers, as U.S.-based companies look for less-crowded markets and foreign companies seek to increase their presence in countries with less regulation.

During the past two years, the generics industry has been on a marriage binge. Recent unions include Barr Pharmaceuticals (BRL) and Croatia's Pliva; Watson Pharmaceuticals' acquiring Andrx; and Mylan Laboratories' bidding for a majority stake in India's Matrix.

Standard & Poor's says this year's European deals "mainly appear to reflect concerns about critical size" because many involved midsize companies. S&P suggests the trend could continue as larger companies try to buy R&D pipelines rather than bolster them internally.

"The industry remains highly fragmented," says an October analysis by Moody's Investors Service. "While there is therefore significant scope for consolidation on paper," benefits don't always offset costs of deals, Moody's warns. Acquirers can always save money on production, marketing and sales, but creating large R&D operations "can prove to be somewhat less efficient."

Political Considerations With Democrats holding slight majorities in the House and Senate, some members of the new controlling party have made bold suggestions, such as having the government negotiate Medicare drug prices directly with drugmakers. That prompted angry reactions from Republican critics, who say more government involvement would damage the industry.

The thought of "Dems Gone Wild" has even provoked responses from dispassionate observers, such as the Morningstar investment research firm, which recently identified "Democrat-proof" health care stocks. Morningstar's favorites include GlaxoSmithKline for its non-U.S. market exposure, Novartis for its wide range of prescription and nonprescription drugs and MedImmune for its vaccine development.

Political changes "tend to be evolutionary rather than revolutionary," says Funtleyder of Miller Tabek. The passage of new laws is one thing, but "how the FDA interprets new laws will be the uncertainty," he says.

Funtleyder says all drugmakers will face a greater regulatory hurdle. Referring to a host of drug-application rejections and delays in recent months, he says the agency is taking a harder look at novel compounds. In addition, he says FDA approval for new drugs could contain more requirements, such as enhanced post-marketing surveillance.

source - TheStreet.com