Wednesday, September 12, 2007

Big Pharma: Beware the Coupon Clippers

A few days ago, we were talking with a small group of senior executives from one of the Big Pharmas. We were making the point that Big Pharma’s investors now need cash reasons to stay in the stocks—big dividends and share repurchases, specifically. The only kind of investor that such a strategy attracted, we elaborated, was the coupon-clipper – not the growth investor. And Big Pharma, I off-handedly assumed, certainly wasn’t interested in that kind of investor.

Why not? asked one of our interlocutors.

Because the coupon-clipper—the C-C--wants maximum coupon, thus maximum cash flow, minimum risk. He wants an earnings flow he can count on – a stock that behaves like a bond. But given the risks of R&D investment (and perhaps of primary-care marketing investment, too), the C-C will always vote “no” on spending that won’t bring in the near-time dime. Already, shareholders in Big Pharma are unwilling to pay for Big Pharma R&D. The share prices, by various analyses, including one we wrote about here, reflect largely the value of marketed products, not the pipeline.

Maybe that’s ok – since the drug industry is, at least right now, very much not a growth industry. A little spreadsheet work with Microsoft’s Moneycentral tells us that the top eight biotechs by market cap have, on average, grown their top lines by 28% since the previous fiscal year; the top thirteen Big Pharmas by 5%.

And yet we think that the drug industry can, through various strategies, once again become a growth business--we describe some of them here and here--but all of those strategies will require it to take risks C-Cs don't like, risks that could interrupt the steady flow in dividends.

That wouldn’t be so serious if Big Pharma was willing to ignore its shareholders. But that’s dangerous to do.

We are increasingly interested in the lessons Big Pharma can take from biotech’s struggles with its business models. Most importantly, we think that biotech’s willingness to disaggregate the value chain – focusing, for example, on unlocking corporate value by doing a few particular things very, very well (e.g., taking a compound from preclinical testing through clinical proof-of-concept, then selling off rights) is one model with tremendous applicability to Big Pharma. Bristol’s biotech-ization, which we’ve touched on here and here, makes our point nicely.

But there is another lesson, too—the trouble companies run into when they take strategies counter to the investment philosophies of their shareholder bases. Take, for example, the brick wall of shareholder intransigence that Enzon and NPS ran into when they tried to merge. Enzon’s shareholders were the biotech equivalent of C-Cs, expecting nothing to threaten the cash flow generated by royalties of PEG-Intron, the hepatitis drug marketed by Schering-Plough. NPS was a swing-for-the-fences investment: get blockbuster value from selling a blockbuster deal for their late-stage program, the recombinant human parathyroid hormone for osteoporosis, Preos.

Strategically, the deal made a lot of sense: combine Enzon’s pipeline, niche products and commercial organization with NPS’ breakthrough-possibility pipeline. But shareholders killed the deal—NPS’ shareholders hated the idea of sharing Preos’ returns with Enzon’s shareholders – and Enzon’s shareholders hated the idea of spending any more money on research that would have the effect of diluting their earnings from PEG-Intron.

If Big Pharma likewise wants to do something dramatic to turn around its fortunes – and we believe they need to do just that – they’ll need shareholder support. Our advice is: make sure you’ve got the right growth-oriented shareholders when time comes to lay out the growth strategy.

1 comment:

Anonymous said...


If only pharma could choose to have the right kind of share holders!

But is the "right kind of growth-oriented share holders" not the sole remit of a few priviledged privately-held pharmaceutical companies?

If not. Are we going to witness a shift towards the reign of private equity taking over pharma, as suggested by Andrew Jack in the FT recently ?(

Time will tell.