2009 Big Pharma DOTY Nominee: Pfizer/Wyeth

It's time for the IN VIVO Blog's Second Annual Deal of the Year! competition. This year we're presenting awards in three categories--that's 300% more fake prizes than last year!--to highlight the most interesting and creative deal making solutions of the year. The categories are: Big Pharma Deal of the Year, M&A/Alliance Deal of the Year, and Exit/Financing Deal of the Year. We'll supply the nominations (roughly half a dozen in each category throughout December) and you, the voting public, will decide the winners (by voting early and often, commencing once we've announced all the nominees). Strap yourselves in, it's The Race for the Roger™.
This, surely, is The One. Whether or not you agree with Jeff Kindler's strategy for Pfizer (plenty don't), the $68 billion Wyeth acquisition, announced on January 26, has to be the most obvious candidate for Big Pharma Deal of the Year.

Are we saying it's 2009's "most interesting and creative" deal making solution, in line with what these illustrious award nominations are supposedly rooting out? Creative, no. It was another, even-more-mega, mega-merger that cynics saw as a means to mitigate the impact of Lipitor's genericization. Solution? Too early to say. But what the deal perhaps lacked in creativity--at least, at first sight--it surely made up for in interest.

For this is the deal that marked the beginning of a new kind of Big Pharma. For better or for worse, it turns Pfizer from an R&D-focused, high-risk, high-reward company into a diversified, industrialized group whose investment appeal is less about growth than about dividends, efficiency and value.

In its scale, the transaction symbolized the scope of Pfizer's--and other Big Pharma's--challenges, and in its content, it captured--in one fell swoop--many of the individual strategies drug firms are pursuing in order to escape from their R&D productivity problems. The deal furnished Pfizer with biologicals--supposedly faster-to-develop, easier-to-protect than small molecules--and thus with a chance to compete in the much-vaunted biosimilars opportunity, too, which management is beginning to talk up. The deal also provided vaccines, once a dowdy corner of health care but now Big Pharmas' ticket to good government relations, emerging market access and--exemplified by the ongoing swine 'flu outbreak--pumped up revenues.

And Wyeth brought to Pfizer a significant consumer business (not as big as the one Pfizer sold to J&J only a few years ago, but still ...) thereby offering access to non-Western markets, and, as importantly, to a new, lower-cost range of products.

And that's the point: Pfizer has decided its only way to survive is by providing a far wider range of medicines, at a range of price-points, across a range of markets. What it sorely lacks in innovative R&D output it will make up in breadth-of-offering, economies of scale and lower costs. As a senior Pfizer source was quoted in this IN VIVO feature:

"The way to deliver earnings growth isn't what we did in the go-go days of the '90s, but rather, it's emulating what the consumer package goods companies, Coke, Pepsi, Procter & Gamble did. There was never great top-line growth there--3-8%. But if you grow your expense line at a much slower rate you can still achieve double-digit bottom-line growth--a predictable 10-13%."

All that makes sense, surely, in a payer-constrained world with increasing generics and where most future growth is predicted to come from generic- and OTC-dominated developing markets like China.

Maybe. But, you ask, isn't Pfizer chickening out of blue-sky R&D? If it's not the end of the story it's certainly the end of the chapter on blockbuster, primary care drugs. Pfizer isn't giving up internal R&D, but it's definitely demoting it, betting that purchases can fill the gaps. And it's betting, too, that it can create the kind of small-unit creativity within its far-larger walls that GlaxoSmithKline has so vocally advocated.

The deal's critics say Pfizer should have gotten smaller, not larger. It should have followed Bristol. Pfizer considered shrinking, and spin-offs, according to strategy SVP Bill Ringo. Too complicated and risky, he and his colleagues concluded.

But far from choosing the easy option, it's arguable that buying Wyeth was equally, if not more, risky. Even following the R&D re-org, headcount cuts and a 35% reduction in global R&D square-footage, questions remain. The Big Pharma-turned-GE hasn't yet proven that it has a new, sustainable lease of life, far from. But that it's daring to try--well, that deserves a gold-plated* DOTY award, surely? (*not really)

2009 Big Pharma DOTY Nominee: Dollars for Donuts

It's time for the IN VIVO Blog's Second Annual Deal of the Year! competition. This year we're presenting awards in three categories--that's 300% more fake prizes than last year!--to highlight the most interesting and creative deal making solutions of the year. The categories are: Big Pharma Deal of the Year, M&A/Alliance Deal of the Year, and Exit/Financing Deal of the Year. We'll supply the nominations (roughly half a dozen in each category throughout December) and you, the voting public, will decide the winners (by voting early and often, commencing once we've announced all the nominees). Strap yourselves in, it's The Race for the Roger™.
This is a no-brainer. The biggest deal for Big Pharma hands down in 2009 is the $80 billion deal struck by the brand name trade association PhRMA as its contribution to health care reform.

We call it "Dollars for Donuts" because a key element of the deal is the industry's commitment to offer a 50% discount on drugs purchased by Medicare beneficiaries in the Part D coverage gap, a.k.a. the "donut hole" in the prescription drug benefit for seniors and the disabled.

Okay, okay, its not a traditional biz dev opportunity, we admit. But if Big Pharma dealmaking is about anything, it is about paying up front for access to new commercial opportunities downstream. And this deal fits that model perfectly.

We've covered the deal itself extensively in The RPM Report, but in a nutshell, PhRMA agreed to the donut hole discount, to pay bigger rebates on drugs purchased by the Medicaid program for low-income families, to accept a pathway for follow-on biologics and to an excise tax on prescription drugs dispensed in the US. That is the $80 billion.

Of course, like any good deal, that top number includes a lot of biobucks. The $80 billion is tied to how the Congressional Budget Office scores the legislation, and includes some creative accounting. So the donut hole discount is scored as saving money for the government (even though it directly saves money for Part D beneficiaries). And PhRMA gets credit for the savings from follow-on biologics, even as its members salivate over using the new process to jump start their investments in biologics.

This also counts as an options-based deal, since Congress will have the final say on exactly what ends up in the legislation--and we figure that $80 billion price tag will go up to at least $100 billion when all is said and done. But, despite what you read, this really is part of the deal. PhRMA may hope to hold the line at $80 billion, but knew darn well that there would be pressure to add more. And, assuming the extra money comes in the form of rebates on Part D to help close the donut hole altogether, it only means that industry will end up paying more to get more.

And what did PhRMA buy? A bigger market in the US.

First off, filling in the donut hole is good for business. Generic drug dispensing in Medicare Part D is running above 70%, and manufacturers at least are convinced that they are losing business because of the real or perceived impact of the coverage gap. Obviously PhRMA would prefer not to pay rebates or offer deep discounts, but eliminating that gap is worth paying for. That's why we're convinced that dollars-for-donuts will happen even if health care reform itself collapses.

But for now at least health care reform looks inevitable. And health care reform means more people will have insurance (like 30 million more) and those with insurance will have better insurance (no more lifetime caps, more predictable copays, better coverage for products like vaccines). And companies don't need much of a boost from that coverage to recoup their investment in support: by our math, it will only take four new monthly prescriptions a year per newly insured life to make up the entire price. (Read our analysis here: it's hot off the presses.)

But like any classic drug development deal, the payoff is a few years away. The new coverage doesn't kick in until 2014--just when Big Pharma will be coming out the other side of the patent cliff. So think of this like the Pfizer/Wyeth deal: a big upfront investment that helps to position Pfizer for life after Lipitor. Only this investment will help position the entire industry for life after reform.

So Dollars for Donuts is a very big deal--and a very good one to boot.

Merck and Schering-Plough: Vive La Difference?

So Merck has overcome its institutional reluctance to commit to large-scale M&A and pulled the trigger on a $41 billion Made-in-New Jersey-deal with Schering-Plough.

Unlike a lot of observers who can lay claim to predicting this one, we counted ourselves among the skeptics that Merck would make this kind of move. That said, it's hardly a shocker, replete with cost-savings, synergies and other happy buzzwords that consolidation-hungry folks bandy about in discussing who's gonna pair up with whom. On to the highlight reel.

The deal specs:

• Values SGP at $41.1 billion in cash and Merck stock, a 34% premium to SGP's Friday close; Merck will borrow $8.5bb from JPMorgan to finance the deal.
• Allows Merck to get in on some of the diversity action Pfizer is after in its takeout of Wyeth. Merck gets Schering's animal health biz as well as its consumer unit, and bulks up its overseas presence (53% of the combined company's revenue will come from ex-US, 12% from emerging markets).
• Streamlines the firms' commercial activities and will account for $3.5 billion in annual cost savings by 2011 on top of what the two companies promised individually up until now.
• Gives Merck what it deems the necessary "critical mass" to absorb economic- and health-reform-driven shocks to the system, not to mention some interesting projects in a much deeper late-stage pipeline (like boceprevir in HCV and TRA in cardiovascular disease)
• And consolidates the operations and decision making from the two companies' cholesterol JV.

It also raises some interesting questions, including:

• Just how will Johnson & Johnson react to the quirky structure of the transaction, seemingly designed to allow "a new Merck" to hang on to the J&J-partnered rheumatoid artritis drugs Remicade and golimumab?
• Is the premium high enough?
• Despite being able to describe in detail earnings per share guidance for the combined company, why couldn't CFO Peter Kellogg break out the revenue numbers?
• For all the talk about very little overlap in the two firms' pipelines in terms of their molecules' mechanisms of action there's certainly plenty of therapeutic area overlap. Will this raise regulatory concerns?
• And how will adding sunscreen and dog-trackers to the famously science-driven Merck affect the company's DNA? And what was up with that spike in SGP trading volume and price last Friday?

We'll be all over this deal in the Pink Sheet Daily, the Pink Sheet and IN VIVO, tomorrow and in the days and weeks ahead, and of course we'll have some treats for you here on the blog too. Stay tuned!

Sticker Shock May Open Innovation in Pharma

Proposals advocating “open” or “collaborative” innovation in pharma R&D are suddenly cropping up throughout the pharma industry in a variety of forums and iterations. J&J’s head of global R&D Paul Stoffels talks about it, as does GlaxoSmithKline’s Andrew Witty. Not that collaboration itself is news – business development is a mainstay of pharma strategy.

These new ideas, however, refer to collaborations in areas where pharma previously feared to tread--at the earliest stages of research, across several companies--and involve sharing of intellectual property. In the past, such ideas were unthinkable, but pharma companies are well aware their R&D models need an overhaul, if for no other reason than sticker shock: Innovator companies spend $90 billion a year on global R&D, but stand to lose $32 billion in cash flow over the next five years as key products go generic. No one expects that they’ll be able to compensate for that loss – which means less money for R&D.

Enter the management consulting firm Bain & Co., which also strongly advocates moving the industry toward more collaborative research in this article just published in the most recent issue of IN VIVO. Recently the head of Bain’s North American healthcare practice, Chuck Farkas, spoke to IN VIVO Blog about his group’s thoughts.

In one of Bain’s models, groups of companies would “pool” research and development assets within a disease area or class of compounds, sharing in some manner in the commercial success of any compounds that emerge from the collaboration. Another very different model calls for sharing IP, resources, and talent to identify the best mechanism of action to tackle a particular disease, after which each company would compete separately in the marketplace.

That latter kind of open innovation wouldn’t necessarily limit the number of companies pursuing particular molecules and therefore wouldn’t create systemic efficiency, but it could eliminate duplicate investment in early-stage work and improve productivity by enabling scientists who would normally compete to work together, Farkas explains.

Especially in the latter model, commercial execution would be paramount. Competitors would win on the merits of their science—but the balance of power would likely shift to those with the most cunning in the market. That’s what happened in the consumer goods and certain sub-sets of the IT industries, where R&D pooling became a norm.

Today’s pharmaceutical R&D model, which industry is gradually restructuring, was formed around a bubble that has burst, Farkas observes. Companies are "asking how to share more of the R&D" he says. "There is massive pressure to be far more rational in R&D.”

Bain's ideas are part of a trend, of course, at least rhetorically. In a February 13 speech at Harvard Medical School, GSK’s Witty advocated patent pooling—that is when patent owners agree to license their patents to others—and said GSK is doing just that with assets aimed at treating certain neglected tropical diseases.

The head of global R&D at J&J, Paul Stoffels, a Belgian physician, has also been writing about and speaking publicly on what he calls “open innovation,” in which pharma companies network “across internal organizational disciplines and geographies” and externally as well “to share in both the benefits and costs of innovation.”

The extent of their commitments isn’t clear, however. Witty’s remarks received considerable publicity—but GSK’s program is directed at markets that don’t generate much profit, for big pharma anyway. And J&J’s minimal efforts involve small steps in niche markets.

But Farkas and others are adamant: the pressure of driving earnings as revenues fall “will force companies to look at dramatically different R&D models." And as they do, commercial competence--itself evolving in response to external pressure--will take on a whole new meaning.--Wendy Diller

image from flickr user benlyon used under a creative commons license.

The IN VIVO Blog Podcast: Thoughts on Pfizer-Wyeth

Why is Pfizer buying Wyeth? Will the Big Pharma of the future look like General Electric? Is there a good reason to relocate to Indiana? Answers to all these questions and more on this week's installment of The IN VIVO Blog Podcast.

Just click the image below to get started. Oh, and we're on iTunes now as well, so please subscribe to that (it's free).

Once in a Blue Moon: SGP's Stock Offering

When everyone and their pharmaceutical brother decides it's time to buy back their own stock, leave it to Schering-Plough to buck the trend.

The Big Pharma, fresh off the news it had emerged from the five-year old consent decree after righting all the wrongs at two manufacturing facilities ($500 million for the poorer, though), said it was selling a boatload of stock. The proceeds of this expected offering will cover some of the expense of its $14.5 billion cash takeout of Organon BioSciences, announced earlier this year (we covered the acquisition in depth, here).

The move marks the first time in months years decades? that a Big Pharma has decided to sell common stock to public investors (there have been plenty of debt financings and lots of cash raised via many divestments and spin offs, but zero equity offerings in a very long time as far as we can tell).

Schering-Plough is selling 50 million common shares (plus up to 7.5 million more in the greenshoe), which at yesterday's close would rake in nearly $1.5 billion toward the Organon tab. Simultaneously the company said it would sell $2.5 billion in convertible debt.

The fact is that Big Pharma rarely need to dilute shareholders since debt is readily available and they are often sitting on piles of cash that -- thanks to strong cash flow and goofy measures like the American Jobs Creation Act (oh yeah, how'd that go?) -- can resemble some of the minor peaks in the Alps. In fact most go out of their way to appease shareholders by buying back shares, the wisdom of which we question here.

But Schering-Plough has enjoyed success of late with Vytorin and Zetia, and has been growing both its top and bottom line nicely--so why not take advantage?

Private Equity: Muscling in on Big Pharma at Biotech's High Rollers' Table

Talk about co-dependency. Pharma needs biotech’s products; biotech needs pharma’s cash. Oh, they say they need other things, but when it comes down to it – that’s about the equation.

So if biotech had a different source of cash (or Pharma had a different source of products), well – this marriage would turn open.

That’s why private equity has become such an interesting game changer. PE firms, stuffed with too much cash as it is and incentivized with management fees to stuff themselves still further, are all chasing the same buyout opportunities, throwing ever greater sums at owners and managers in order to get into the deals.

Biotech, which certainly needs cash, doesn’t return money on anything like a PE firm’s preferred timeline. But biotechs are also relatively unmined territory. Therefore cheap. That’s why you’re beginning to see major private equity players doing things private equity rules say they shouldn’t do.

Consider this progression. In 2004, KKR put something like $200 million into Jazz Pharmaceuticals—a theoretically stable, spec pharma-ish kind of investment. The financing underwrote Jazz’s takeover of the commercial-stage Orphan Medical, so KKR at least got some cash flow, which PE investors like to see. And there was no discovery risk—but certainly development risk. (Not that it's worked out brilliantly, so far. See our recent post.)

Two years later, New Mountain enables the Ikaria/Ino deal – creating a theoretically self-financing company (like Jazz, it has a commercial organization providing the requisite cash flow) but it nonetheless depends for its success on the crapshoot of discovery.

And now The Invus Group is putting $205 million into Lexicon, with the potential to add another $345 million down the road. They’ll get a minimum of 40% of the company and could end up owning far more. But now the whole thing is based on discovery – and not just me-too discovery, but Lexicon’s novel-target, novel-compound approach (see our upcoming article in the July/August IN VIVO).

In short, private equity is moving into pharma territory, funding companies the way only pharmas once could. The whole point is to build organizations of such size that a biotech can do its deals on relatively equal terms with pharma – which means that if it doesn’t get its deal price, it can walk away and do its own development and commercialization, continuing to increase its assets’ value.

The theory underlying this game is that biotechs are still leaving way too much value on the negotiating table. That’s the value the PE investor needs to retain in order to counterbalance his basic disadvantage as a purely financial, not strategic, buyer. That strategic buyer—Big Pharma--can pay more for particular assets because they can do more with them (like shoring up a fading portfolio or keeping profitable and busy a sales they don’t want to lose). Can PE use its money to extract that strategic premium biotechs on their own can’t? It’s an interesting gamble: both biotech and Big Pharma need to get to know the new dice-throwers at the high-rollers’ table.

Look for the Union Label

Did you see that big acquisition that could change everything about the US pharma business? No, I’m not talking about AstraZeneca buying MedImmune, though it will be fun to watch AZ try to make that one pay off. (Chris Morrison and the IN VIVO crew can help you make sense of that.) I’m not even talking about the on-again, off-again talk of a Bristol-Myers Squibb/Sanofi Aventis link up. (Look for that one to be on again in about a month.)

No, I’m talking about the purchase of Chrysler by the private equity firm Cerberus Capital Management.

That deal means more to Big Pharma than you might think. Sure, it may put Chrysler back on the list for company cars at firms with Buy American policies. (Are there any companies like that left?)

But it could also go a long way toward redefining the landscape for pharmacy benefits in the US.

Assuming Cerberus (named for the three-headed hound that guards the gates of hell) lives up to its reputation, you can bet there are big cuts coming at Chrysler. And, as Steven Pearlstein points out in the Washington Post, that means a time of reckoning for the United Auto Workers union.

This looks like a watershed moment for labor relations in the US—and that has big implications for Big Pharma. Why? Because the “Big Three” union contracts go a long way towards defining the national standard for pharmacy benefits.

Some of the effect is direct. The automaker each decided to carve out their pharmacy benefits in the 1980s to help control drug costs, and in the process helped the fledgling pharmacy benefit management business take off. Chrysler, interestingly, recently moved its big PBM contract out of the hands of one of the US giants and awarded it to CVS Corp.’s Pharmacare division. But that business will end up with Caremark Rx again now that CVS has acquired the largest PBM in the US.

That contract covers about 280,000 lives (employees, retirees and dependents). That in itself is a lot of buying power. And Chrysler is the smallest of the "Big Three," so those contracts together add up to a lot of clout.

But the impact of the union deals is bigger than that. There is a direct feedback loop between the contracts—and especially the pharmacy benefit component—and federal policies in healthcare.

Unions are not the political force they once were, but they remain a vital constituency for the Democratic Party. And the “Big Three” are not the unstoppable symbol of American industry they once were, but when the CEO of an automaker has an issue to raise, you can bet he can talk to anyone he wants in Washington. What’s good for General Motors may or may not be good for America, but what General Motors gives its employees in health benefits sets a standard that it is hard for the government to ignore.

For almost two decades now, state Medicaid directors have complained that overly generous pharmacy benefits packages included in union contracts have tied their hands in trying to rein in drug costs. If the UAW negotiates an open formulary, it is hard for Medicaid to insist on a closed one. On the other hand, if the UAW agrees to a mandatory mail service provision, other benefit managers will be sure to adopt them too.

The power of union contracts to frame the health care debate is undeniable. Even President Bush’s seemingly progressive proposal to tax employer health plans that exceed $7,500 in value has to be understood in that context. On paper, the proposal looks like a tax on high wage earners with gold-standard health benefits. In reality, union workers are about the only people in America with a health plan that rich.

So when Cerberus sits down with the UAW, the pharmaceutical industry has a lot at stake. Maybe it will be business as usual, with nothing more than tinkering at the margins on the pharmacy benefit. But the time could be ripe for radical surgery. Medicare now offers a prescription drug benefit. Will Cerberus push for a new contract that dumps its retirees on the new program? Will the union agree to more aggressively managed benefits, with tighter formularies and even stronger incentives to choose generics?

One thing is certain: in the current political climate, the union can and will turn to Congress if it feels too squeezed. That could put Big Pharma in an interesting position: unions are not naturally allies of the drug industry, but if unions are fighting to protect generous drug benefits, Big Pharma may start to preach solidarity.

Is it Time to Buy Amgen?

Maybe it’s time to buy Amgen. Yeah, you heard right.

Many of Amgen’s shareholders—including the CFO—have scuttled over the past few months, frightened away by the seemingly endless series of blows to hit the US biotech. That’s why the stock’s at a year-low and down 30% since the start of 2007.

Over the last week, a dozen or so further percentage points were knocked off by May 10th's FDA advisory committee meeting and by the CMS’s proposal on Monday to curb Medicare payments for Aranesp in certain cancer patients.

Can it get any worse? Apparently some of Wall Street’s analysts think so. Several cut their ratings on the stock last week, according to the Wall Street Journal’s Health Blog, including long-time bulls Lazard Capital Markets.

Now, we’re not analysts. (Nor are we shareholders, nor are we share-tipping.) But, let’s face it, analysts have been known to be wrong. Dare we suggest there are whiffs of panic? Perhaps hints of lemming behavior—the slope on this once-loved stock has reversed now for, what, six months, so game’s up?

Now granted, there may be just one or two more potential hitches—the most significant being FDA’s planned fall meeting to discuss the use of EPO drugs in kidney failure. Nephrology makes up a far larger chunk of Amgen’s $6.6 billion EPO sales than oncology, and any ruling here could hit both Epogen and Aranesp.

But Amgen’s already trading at an almost 15% discount to its biopharma peers based on estimated 2007 EPS. And, as they say, in every cloud is a silver lining.

For one thing, any bad for EPO drugs is bad for Amgen’s competitors, too—including Roche's Mircera. Look out on May 20th , the Mircera PDUFA date: a bumpy ride for Roche may help Amgen.

And on a more positive note, Phase III pipeline drug denosumab may be the best in the entire biopharma sector pipeline, if you believe Mark Schoenebaum at Bear Stearns. “It could be a $5 billion drug, Amgen’s biggest ever,” he told IN VIVO last month. The first data is due by year-end. And if you believe Amgen, there’s also a wicked Phase II pipeline tucked away somewhere—if you haven’t heard about it yet, you will soon.

If investors don't start buying Amgen again soon, maybe, just maybe, the stock will hit a low that an acquisition-mad Big Pharma can't resist. The idea is around, if improbable.

But then, Merck & Co. came back, didn’t it?