This is the first in a series of blog posts on healthcare industry topics that will be discussed at the upcoming Columbia Business School Healthcare Conference on November 21.

As growth slows in the pharmaceutical sector, shareholders are putting pressure on companies and their executives to make some difficult decisions. Pure-play companies — the ones focused on discovering, developing and marketing breakthrough prescription medicines — must decide whether to remain as is, diversify into other healthcare businesses, merge with another global pharma company or find other means to grow their businesses and/or diversify their risk.

Major pure-play drug companies generate more than 90 percent of their revenues from branded, not generic, prescription drugs. Top-line industry growth is slowing from the double-digit figures we saw between 2000–2003 and is now expected to reach low single-digit growth over the next five years. There are several reasons for this:

  • Companies face patent expirations of their largest drugs and eight of the 10 largest products today will lose exclusivity in the next four years, which represents more than $50 billion in sales
  • New product approvals in the past year were the lowest in a decade
  • Cost–containment efforts by third parties that pay for drugs (governments, insurers) are forcing companies to prove that their drugs are not only safe and efficacious but are also cost-effective

On the plus side, there remain large areas of unmet need (cancer, Alzheimer’s disease, obesity, diabetes, vaccines) and new developing markets (BRIC) to penetrate. As well, better technology is improving drug’s chances for success. Despite the industry’s declining growth rate, these pharma companies have among the highest profit margins and most are sitting on hordes of cash with little debt. They are among the highest valued companies in the world — a far different scenario compared with other industries under assault (auto, airlines, financial services, retail, etc.).

Diversify or stay “pure”?

So is this the time to pursue a new diversification strategy for these global pharma companies?

Drug giant Novartis apparently thinks so. In the past few years, the company has spent $8 billion to acquire a large generics business (Hexal), $5 billion to acquire a vaccines and diagnostics company (Chiron) and recently announced a two-step $40 billion acquisition of a 77 percent interest in an eye care company (Alcon).

Contrast that strategy to drug company Bristol-Myers Squibb, which spun out its orthopedics business (Zimmer) and sold its U.S. consumer health business (to Novartis). It recently announced the sale of its wound care business ConvaTec and plans to spin out a portion of its nutritionals business (Mead Johnson). All this is in order to focus more on its core branded prescription pharmaceuticals business.

A major acquisition of a large, faster-growing healthcare-related business may diversify the risks inherent in drug development and enhance growth; however, companies will pay for this growth in high acquisition costs (using cash and/or lower PE stock) without assurance that sufficient synergies will be generated to cover the acquisition premium.

Purchasing a large generics business may be a possible solution given the large number of drugs coming off patent, the attractiveness of “biogenerics” and use of generics in emerging markets. However, operating margins are lower in that competitive segment due to heavy price competition (especially in the U.S.), and the generics business is a very different business/operating model from the research-based branded pharma companies.

The “urge to merge” was strong in the mid 90s. Today it has lost some luster. Companies (and investors) are concerned about the integration risks of combining two global drug companies and question whether this would indeed enhance top-line growth.

Stay the course

The likelihood is that these major pure play pharma companies will stay the course — at least for now — with the belief that their research pipelines, augmented by targeted acquisitions, will generate a sufficient number of innovative drugs and vaccines to sustain competitive growth rates. Payers and investors should continue to reward innovation. Meanwhile the companies are cutting costs and seeking efficiencies in their global businesses to sustain modest growth, high profit margins and favorable dividend yields.

Will this strategy work? Stay tuned!

Photo credit: Michelle Tribe