Thus spake Sir David Barnes, chief executive of the UK pharmaceutical company Zeneca, after its demerger from chemicals giant ICI. In an interview with trade magazine Chemical Week in April 1998, he noted that the most successful drug companies were those that had stayed single - citing, among others, Pfizer (US: PFE). "No merged pharmaceutical company has ever gained market share. There's no evidence that size confers any enduring advantage. In R&D there is actually an inverse ratio - the smallest companies tend to have the most productive R&D."
Within eight months, however, Sir David was vaunting the merits of a 'merger of equals' with the Swedish company Astra. The combined group, AstraZeneca (AZN), would cut 6,000 jobs, achieving $1.1bn of cost savings, he promised. Having demerged from ICI in 1993 at £6 and risen steadily through the mid 1990s on the back of profit growth, Zeneca's shares rallied to £26 on the news.
A year or so later, Pfizer would take over Warner-Lambert, marking the start of a corporate transformation through big M&A that continues with the company's current courtship of AstraZeneca. This latest deal raises once again the old question answered so eloquently by Sir David above. Do big mergers between pharma groups have an operational rationale - or are they merely a vehicle for cost-cutting in a sector desperately short on growth?
It's notable that Zeneca's pattern of consistent stock market outperformance came to an end a year or two after its merger with Astra. AstraZeneca's shares tacked back and forth within the £20-£35 range for nearly 15 years before breaking out on this year's takeover hopes. They now trade at about £47, reflecting some confidence in Pfizer's improved Friday offer of £50, which AstraZeneca has rejected.
Judging by most attempts to analyse the performance of M&A, AstraZeneca's humdrum track record is not unusual. This is a complex field in business academia, but a useful summary of the relevant literature in Thomas Straub's 2007 book 'Reasons for Frequent Failure in Mergers and Acquisitions' puts the failure rate at about two-thirds. A more recent McKinsey analysis of shareholder returns over the period 2000-10 suggested that bolt-on deals work, while companies making big transformational acquisitions tend to underperform.
Of course, the usual caveat about correlation not necessarily implying causation applies. Perhaps companies underperform because they have made indigestible acquisitions. Equally, however, they may engage in M&A because they are underperforming; the merger is a symptom, not a cause. This certainly seems likely for big pharma, which is haemorrhaging profits to the generics industry.
Interestingly, the success of Zeneca's demerger from ICI may also be typical. Fund management company Saracen has analysed the performance of the 31 companies on the London Stock Exchange and Aim to have demerged since 2000 (admittedly, a small sample). On average, their shares outperformed by 24 percentage points over the four years after demerging - led by Burberry (BRBY) and P&O Princess Cruises (now Carnival).
There's another lesson in AstraZeneca's history: a parochial attitude to company ownership misses the point. This is an Anglo-Swedish company, run by a Frenchman, that makes only about a quarter of its sales in Europe (the UK is too insignificant to feature in its sales split). The more distinctive half of its name - Zeneca - was dreamt up by a branding agency two decades ago ("I asked Interbrand to find a name that was phonetically memorable, of no more than three syllables and didn't mean anything stupid, funny or rude in other languages," Sir David told The Telegraph.) Whether it retains its R&D and administrative functions in Britain ultimately depends on how effective they are and how much they cost - not their ownership.
Some private investors might justifiably lament the loss of choice: if Astra goes, London's big pharma sector will contain just GlaxoSmithKline (GSK) and, arguably, Shire (SHP). But investing in overseas shares is becoming easier - although it's not necessarily cost effective, see Unfair Forex Fees - by the day. Whether AstraZeneca survives as an independent entity should be judged by shareholders on purely financial grounds. Just beware of companies that find nothing to do but link arms, fire staff and cut taxes.
