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Break-up pressure


Big pharma’s business model under the microscope


By Andrew Ward and David Crow, Financial Times



Some of the world’s biggest pharmaceuticals groups are facing calls to break up their diversified businesses in favour of greater focus as shareholders push for higher returns on investment. 

In recent days, Johnson & Johnson has been urged to review its sprawling portfolio that ranges from baby oil to cancer drugs, and there were questions for Novartis over the future of its struggling eyecare business. 

This week, Pfizer will update shareholders on plans for a potential break-up, while GlaxoSmithKline is likely to be pressed on whether it is considering a similar move. 

All four cases are part of a wider debate: should companies hedge the risks of drug development by diversifying into adjacent markets such as contact lenses (Novartis), toothpaste (GSK) and knee implants (Johnson & Johnson)? Or is it better to focus resources on the higher-margin business of making medicines? 

Disposals of non-core assets by several big pharma groups in recent years has put the latter approach firmly in the ascendancy. Merck of the US, for example, jettisoned its consumer healthcare business - with brands including Coppertone sunscreen and Dr Scholl’s footcare - to sharpen its competitive edge against “pure-play” drugmakers such as Bristol-Myers Squibb, AstraZeneca and Gilead Sciences. 

Meanwhile, Abbott and Baxter, two diversified US healthcare groups, spun off AbbVie and Baxalta, respectively, as standalone pharma companies. 

Even drugmakers which remain relatively diversified have taken steps to slim down. Novartis (animal health and vaccines), Bayer (plastics), Sanofi (animal health) and Pfizer (animal health) have relinquished unwanted businesses or are in the process of doing so. Pfizer is planning to go further with the likely separation of its “established products” portfolio of older drugs by 2019. 

“We will continue to see pharma companies shrink to grow,” says David Butts, head of international life sciences mergers and acquisitions at CMS, a law  firm. “You could say this is a move towards  . . .  pure play, as companies unlock value in non-core businesses, then use cash to shore up the core  business.” 

Muddled management 

This trend has left the most diversified drugmaker, J&J, looking increasingly out of step. Pharma is the US group’s largest business but accounts for less than half of total sales; the rest comes from medical devices and consumer products including Tylenol painkillers and Listerine mouthwash. 

Critics say this model leads to muddled management as businesses with different growth rates and capital needs vie for resources. In an open letter last week, Artisan Partners, an investment manager with a $480m J&J holding, called for a spin out of the consumer and medical devices units “so that new, focused and accountable management teams can lead them into the future”. 

However, there has so far been little sign of other investors rushing to back a break-up. Alex Gorsky, J&J chief executive, said last week that the conglomerate model had been “a significant driver [of growth] in the past and we expect it will be more important in the future”. 

J&J says it benefits from research and development collaboration between different parts of the group; it also touts the ability to jointly market drugs and devices to hospitals - giving it greater bargaining power at a time when US health systems are clamping down on costs. 

Matt Miksic, a healthcare analyst at UBS, says there will always be worries about J&J’s conglomerate structure “making them slower and harder to manoeuvre”. 

He agrees, however, that its breadth of products promises to be an advantage in an era when President Barack Obama’s Affordable Care Act has created greater incentives for hospitals to bulk-buy. 

J&J executives argue that the company would not have weathered  the financial crisis nor its big patent cliff - the loss of market exclusivity on branded drugs - were it not for the stability of its medical devices unit. 

“The management view is that the device business is a kind of anchor and cash generator, with slower, but less volatile growth that can support the pharma division,” says Mr Miksic. However, he adds: “The rationale for keeping a consumer division is a little more frayed.” 

Healthy buffer 

GSK is likely to face similar questions when Sir Andrew Witty, chief executive, delivers full-year results tomorrow. About 45% of its revenues come from vaccines and consumer healthcare, including Sensodyne toothpaste and Panadol painkillers. 

Like Mr Gorsky, Sir Andrew argues that these businesses create a healthy buffer for the risks and volatility of the pharma market, where a failed clinical trial or loss of patent protection can upend a pure-play drugmaker overnight. 

Moreover, GSK executives point to synergies from manufacturing and selling prescription drugs, vaccines and over-the-counter products through shared supply chains. 

“If you split the businesses up you would end up duplicating a lot of things that are currently done efficiently together,” says one executive. 

However, GSK is under pressure from some investors for a shake-up after a long period of weak performance. 

Neil Woodford the high-profile UK fund manager and big GSK shareholder, told the BBC this month that the group was “like four FTSE 100 companies bolted together” and did not “do a particularly good job of managing all of the constituent parts”. Like at J&J, there has not so far been a groundswell of investor support for his view. 

But Sir Andrew has become increasingly open in acknowledging the possibility of a break-up even though he says he does not believe it makes sense today. 

He told Bloomberg TV this month: “The consumer division is so big in scale, it could one day have a life of its own.” 

Benefits from diversification 

Joe Jimenez, Novartis chief executive, told the Financial Times that there were still benefits from diversification provided the components were all “leading businesses with global scale and innovative power”. 

Analysts say the jury is out on whether the Swiss group’s Alcon eyecare unit fits that criteria after disappointing financial results last week. 

Until recently, the attitude of investors seemed clear. Shares in Bristol-Myers Squibb, a pure-play pharma company among the leaders of a new generation of high-value cancer drugs, have almost doubled since the start of 2013, compared with rise of just 3% in GSK. 

However, in the year-to-date, Bristol-Myers Squibb is down 11% and GSK is up nearly 5%. J&J is also up since the start of the year. This could reflect rising hopes of restructuring ahead. But it might also be a sign that, as the global economic outlook dims, investors are reconsidering the merits of a business model designed to reduce volatility and spread risks. 

Copyright 2016 The Financial Times Limited

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