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Three strategies for pharma

Created:

9 February 2010

Written by:

Mick Cooper

There is now more choice for pharmaceutical investors inspite of the sector struggling to overcome a lack of productivity in research and development (R&D), and the prospect of losing the patents on a number of important blockbuster drugs. There are three main strategies in play - the mega-merger path, diversification route, and the focused prescription-drug strategy - each with a different risk/return characteristic.

Merck & Co and Pfizer have resorted to mega-mergers with Schering-Plough and Wyeth, respectively, to delay the impact of falling off patent-expiry cliffs. They are hoping that this will give them sufficient time to improve their R&D productivity, as they gradually attempt to reinvigorate their operations without significantly altering their business models. Unfortunately, this approach has been unsuccessful in producing major new products over the last 10 years.

By contrast, GlaxoSmithKline, Sanofi-Aventis and Novartis are transforming themselves into balanced, diversified healthcare companies. Either organically or through bolt-on acquisitions, they are expanding their non-branded pharmaceutical capabilities, such as animal health, generic and over-the-counter (OTC) businesses, to reduce their exposure to patent cliffs and develop sustainable businesses with predictable revenues.

The last group of companies are sticking to 'prescription medicine' pure play strategies. They are radically changing their operating procedures, streamlining operations and overhauling their R&D operations. They have expanded into the biologics area, using greater outsourcing and accelerating drug development. Those following this path are AstraZeneca, Bristol Myers Squibb and Eli Lilly. They have a greater risk profile than the diversified companies, but do offer the prospect of a greater return if they develop blockbusters such as Brilinta and Onglyza.

Swiss giant Roche is the only major pharmaceutical company not struggling to re-invent itself. It was more progressive in changing its business practices and had the foresight in initially forming a partnership with Genentech before recently acquiring it fully. Roche is a leading diagnostics company, but its strategy is more closely aligned with the third group of companies, as its prospects are closely tied to those of its oncology franchise, and its diagnostics division is key to it positioning itself to becoming a leader in personalised medicine.

An extra consideration for investors is geographic exposure. The key markets for the industry are the US and Western Europe, but this is changing with the growth of opportunities in the emerging markets. China is expected to have risen from being the ninth largest pharmaceutical market in 2008 to the third in 2012. This is one reason why we believe AstraZeneca, which is a leading multi-national company in China, is significantly undervalued despite the patent cliff it faces.