A Fork in the Road for Pharmaceuticals

FEBRUARY 3, 2011    THE WALL STREET JOURNAL

By HESTER PLUMRIDGE

Already this week, Pfizer has responded to coming threats to drug sales and near-historic low stock-market multiples by cutting costs, GlaxoSmithKline is selling a noncore business, possibly to fund a share buyback, and Sanofi-Aventis has stepped up its pursuit of U.S. biotech firmGenzyme. But which course of treatment will prove most effective?

Annual results confirm that patent expirations on best-seller drugs are starting to bite.AstraZeneca's 2010 sales rose only marginally from the previous year. Pfizer forecasts sales will fall 5% by 2012. That makes it tough for boards to meet investor expectations of increased share buybacks and higher dividends, even in a cash-rich sector in which annual dividend growth traditionally has exceeded the wider market.

Many firms are responding by cutting costs. Pfizer announced Tuesday that it will cut its research-and-development budget by up to 24%, or $1.5 billion to $2 billion, and be more selective in the areas it targets. Roche Holding expects to make $2.5 billion in cost savings from 2012, boosting earnings per share by up to 10%, according to Bank of America Merrill Lynch.

Sanofi-Aventis is responding to weaknesses in its pipeline through its attempted acquisition of Genzyme. A deal appears imminent that would value the U.S. firm at about $20 billion, a 45% premium to its prebid share price. That is a much more traditional, albeit expensive, bet on the ability to deliver new blockbuster treatments.

GlaxoSmithKline and AstraZeneca are going down the opposite route, disposing of noncore businesses. Glaxo is selling its Quest Diagnostics stake for $1.7 billion, while AstraZeneca is expected to raise a similar amount from the sale of its AstraTech division. Both companies are likely to use the cash to fund buybacks. For AstraZeneca, targeted net purchases of up to $4 billion by 2011 could deliver a 10% boost to earnings.

To add to the confusion, companies such as Glaxo and Johnson & Johnson are diversifying into areas such as vaccines and consumer health, an apparently sensible attempt to reduce reliance on pharmaceuticals, given just 21 new drugs were approved in the U.S. last year, the lowest number since 2007. But others, such as AstraZeneca, are increasing their focus on higher margin prescription drugs, betting on their pipelines to deliver.

For investors, it is hard to choose between these different strategies. Stock-market performance will be determined largely by the performance of the pipeline, given the impact of a single new blockbuster treatment. That suggests while the biggest returns may come from lowly rated Pfizer or AstraZeneca, the surest returns should come from highly rated Bristol-Myers Squibb, whose pipeline offers more short-term promise.