Monday, January 26, 2009

Pfizer’s deal with Wyeth could be a blessing for shareholders, not as good for long term growth

There has been speculation on Friday that Pfizer might be looking to acquire Wyeth for 68 billion dollars. This morning PFE confirmed that it will indeed purchase WYE for $50.19/share - $33 in cash in addition to 0.985 shares of PFE. Despite the tough credit environment, Pfizer could still afford to get the financing to pay such a steep price since its balance sheet is conservative with over 26.8 billion in cash and equivalents for the quarter ending September 28, 2008. Furthermore pharma companies are seen as recession resistant enterprises, which makes lending to them a lower risk activity.
Various sources report that the deal could be financed through a compbination of debt and stock. Wyeth shareholders could receive up to $50.19/share in cash and Pfizer stock. Check out my recent review of Pfizer.

The major issue with Pfizer has been its inability to bring to market new blockbuster drugs, which would replace the revenues that the company would lose as a large portion of its drugs lose their patents around 2011-2012. Lipitor, which accounts for a quarter of company’s sales, is losing its patent in 2011. Despite spending between $7.2 and $8.1 billion annually on R&D over the past four years, Pfizer has not come out with any blockbuster drugs to replace the revenues its will lose from its major drugs that will be losing their patents. Some analysts estimate that Pfizer will lose 50% to 70% of its revenues by 2015 if it doesn’t bring new drugs to the market. Despite major cost cutting initiatives, the potential losses in revenues could potentially put the dividend payment in danger. Most recently Pfizer failed to increase its dividend to shareholders for the first time in 42 years. Right after the merger announcement, Pfizer's board also announced a 50% cut in its quarterly dividends to $0.16/share.

If Pfizer acquired Wyeth, it would be able to achieve an extra 23 billion in sales from Wyeth’s portfolio of drugs. Wyeth’s revenues are more diversified and unlike Pfizer the company does not rely on a single drug for a large portion of sales. Furthermore WYE has one of the best new product pipelines in the pharmaceuticals industry with over 60 news products in development. Some of the most important new drug launches include Tygacil, Torisel, Lybrel and Pristiq. Wyeth got three drugs approved last year -- antidepressant Pristiq, Relistor for constipation caused by narcotic painkillers, and the hemophilia drug Xyntha.

Some analysts are questioning whether a Pfizer/Wyeth merger is the best action for both companies, as it provides only a temporary solution to big pharma’s long term problems of focusing only on a handful of major blockbuster drugs which are harder to come, instead of creating multiple smaller partnership with biotech firms in order to capitalise on a wide portfolio of other drugs with lower revenues, which could grow much faster. It definitely seems as if Pfizer has been able to acquire its way in the drug business by merging with and acquiring rivals, including Warner-Lambert in 2000 and Pharmacia in 2003, instead of actually inventing useful drugs for treatment of diseases such as heart problems. Despite the fact that these two mergers have benefited earnings and revenues, Pfizer’s stock has lost more than two thirds of its value from its 2000 highs.

I view this merger very positively as a major development for Pfizer, which has spent the past few years mostly returning capital, instead of working on developing projects that would sustain current dividends and even promise increases in the future. The current acquisition will most probably lead to unchanged dividends for several years and Pfizer losing its dividend aristocrat status, as its board announced a 50% reduction in dividends. Most companies that are kicked out of the prestigious dividend index stop increasing their payments to shareholders because they are saddled with debt after acquisitions in their field. The good news is that at least the dividend payment is typically maintained in such cases. If the deal goes through, Pfizer shareholders will benefit in the near term. Without changing the company culture to actually create the drugs in house without paying a premium by acquiring rivals, Pfizer would face similar problems several years down the road, as some of Wyeth’s drugs face increased generic competition in the future, as they lose their patents.

Full Disclosure: None

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