Do Pharma Stocks Deserve Takeover Premiums? Read This First
As the annual JP Morgan (JPM) conference gets under way today, the proceedings were notably missing one element that, in the past, had often characterized the frenzy of financial forecasts, bouncy presentations, behind-the-scenes jockeying and endless schmoozing – a big, old-fashioned acquisition.
There are any number of reasons for this, of course, but one explanation may be that the largest drugmakers lack the so-called firepower to undertake big deals right now. Although the 16 biggest drugmakers delivered total shareholder returns of more than 17 percent last year, they are ill-equipped for big M&A. Instead, big biotechs are better positioned.
Prior to 2010, big pharma generally kept pace with the global drug market. That changed in 2011, when the overall drug market grew faster than big pharma — a difference of about $20 billion — and 2012, when the gap widened to $50 billion, primarily due to the patent cliff. But this gap is projected to reach $100 billion by 2015.
Big pharma has less cash for deals because the patent cliff and pricing pressures have diminished operating cash flows and spending on earlier deals, stock repurchases and dividends. Big pharma has also taken on more debt, in part to fund some huge mergers and pay for higher dividends and stock buybacks. Below we see generally rising debt levels among Pfizer (PFE), Novartis (NVS), Merck (MRK), GlaxoSmithKline (GSK) and AstraZeneca (AZN).
The industry debt-to-equity ratio jumped from 9 percent to 18 percent over the past five years. In one respect, E&Y says this is a good thing, because big pharma has historically been underleveraged. But of course, this also means these large drugmakers now have less flexibility to do a big deal.
As for using stock, consider that share prices have “fallen significantly” since 2006, despite stock repurchases and dividends, E&Y notes. So even if there is a brief pop, the ability to use “stock as a currency is significantly diminished compared to a few years ago.” In short, the tool chest is lacking enough of the basic tools.
And so, E&Y calculates that big pharma firepower declined by 23 percent between 2006 and 2012. At the same time, specialty pharma and big biotechs with 2012 revenues between $1 billion and $20 billion — saw a big gain. Last year, big biotech firepower jumped 61 percent relative to 2006, thanks to premium pricing and a lack of generic competition.
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Ed Silverman, a contributing editor of YCharts, is the founder and editor of Pharmalot. He previously reported on the pharmaceutical industry and other business topics for the Star-Ledger of New Jersey, New York Newsday and Investor’s Business Daily. He can be reached at firstname.lastname@example.org.