Big Pharma – First Cracks Appearing?

Larry and I have been blogging for a while about the health (no pun intended) of Big Pharma. Earlier, we had even drawn comparisons to Big Auto. We’d left the theme for a while – there’s never a shortage of stories about this industry. But, a couple of weeks ago, I came across an interesting article in Barron’s and I felt that I was no longer a lonely voice crying in the desert. There may actually be fellow travelers!

In the June 1, 2009 issue of Barron’s, Vito J. Racanelli in his column, The Trader, questioned the supposedly solid financial results of the pharmaceutical industry. He cited analytical work done at First Global by Kavita Thomas which reported that the superior return on equity (ROE) recently at large pharmaceutical companies was not a result of improved operating results but of also of charges to equity and stock buybacks. The types of charges noted arose from foreign exchange losses and pensions. Vito cited examples of Pfizer (PFE), Eli Lilly (ELI), Johnson & Johnson (JNJ) and Merck (MRK) where these activities took place.

Vito cites Kavita’s work as a potential leading indicator for the health of the pharmaceutical industry. He’s right. While I’ve been blogging about product pipelines and government intervention, Kavita has supplied the financial analysis that can be used to see where the industry is going. Interestingly, Vito comments on pharmaceuticals’ debt levels implying that they are not excessive although debt ratios are rising, again, because of falling equity numbers.

Both Thomas and Racanelli ask how long will the pharmaceuticals use creative financing and expense reductions to support their earnings. As we’ve seen in other industries as of late, it won’t last.

So, what next? I expect that we’ll probably see more creative accounting and attempts to reduce costs. But, it’s a zero sum game. Many of the pharmaceutical companies are sitting on large cash reserves and probably have access to other sources of funding. There won’t be a dramatic deterioration overnight in the financial situation of Big Pharma overnight. Possibly, some of the vendors supplying outsourcing and similar services may have a temporary surge until the money lasts and all cost cutting avenues have been exhausted.

One final word, watch those cash reserves at Big Pharma. Ford (F) is still alive, barely, but alive, because it had the foresight to arrange for lines of credit before they needed them. General Motors (GM) and Chrysler didn’t and had to go cap in hand to Washington looking for money. If the Obama administration succeeds in reducing drug costs in this country then Big Pharma may be having to follow the same path. Hopefully, they’ll leave their corporate jets at home.

As always, we welcome your feedback. Please contact us at larryrothmansblog@gmail.com. We look forward to hearing from you.

Contributed by Guy de Lastin

Coincidental Indicators

Lately, I’ve been wondering about where we are in the economy and its long expected recovery. We all know it’s going to come back, it’s just a matter of when. Big Pharma has more reason than most to wonder when the turnaround will occur. For them, the question is do they get their legs under them before the Obama administration pulls the carpet again.

As I’ve been noting in the business press there appear to be signs of continual slowing down for Big Pharma. The most recent indicator was in the May 25, 2009 issue of Barron’s. The staff writer, Michael Santoli penned a piece on Thermo Fisher Scientific (TMO), a leading manufacturer of laboratory equipment and supplies. While reviewing the economy’s negative impact on Thermo Fischer’s operating results, he noted that the consolidation underway in the pharmaceutical industry could reduce spending for research materials. Although, he didn’t expect this to be a major consideration for Thermo Fischer. But, this got me thinking. If the drug companies are cutting back on their expendables what’s going on? Yes, one reason for these mergers is to leverage purchasing power and unnecessary facilities. But, I doubt that all of these research and development programs are pursuing the same drugs. Are we beginning to see the long heralded cutback in pure research by pharmaceutical companies?

Another article that I came across recently in this same vein was in the May 25, 2009 issue of BusinessWeek. In Michael Mandel’s column, Mandel on Economics, he writes about the increasing productivity being experienced by US industry which could negatively affect future growth. One statistic caught my attention. Michael (beats me why all these guys are called Michael) noted an 11% decrease in research and development at Johnson & Johnson (JNJ).

Now, when I think about Big Pharma’s pipeline problems, I see what I think are coincidental indicators of cutbacks in new drug development. If they’re buying fewer research supplies and cutting back in professional staffs as Mandel implied in his article, then what is the future for these companies? How much overcapacity is there in the industry?

Larry and I have blogged about this theme before and drawn parallels with Big Auto. Now, today, this may seem a bit extreme. But, how long ago were General Motors (GM), Chrysler, and Ford (F) considered viable investments? For that matter, anyone remember American Motors Corporation?

We would be interested in hearing from our readers about what coincidental indicators they are seeing in the healthcare industry or which ones we should be watching. We’ll follow up on these in future blogs.

As always, we welcome your feedback. Please contact us at larryrothmansblog@gmail.com. We look forward to hearing from you.

Contributed by Guy de Lastin

Where’d Everybody Go?

I know that I’ve been a little distracted lately and been off the wire a bit, but, when I resurfaced I was surprised at how quiet everything had suddenly become in the life sciences sector, Big Pharma especially. I e-mailed Larry asking where everybody had gone (except for Mike Huckman, who’s out in LA chasing a story on Dendreon. Check it out at http://www.cnbc.com/id/30033861 .). He replied with his characteristic wit and insight asking that wasn’t this supposed to be my job? Larry did have a point.

A short while ago, everyone was talking about Merck (NYSE: MRK) and Schering-Plough (NYSE: SGP), and Johnson & Johnson (NYSE: JNJ); Roche (SWX Europe: ROG) and Genentech (NYSE: DNA); Pfizer (NYSE: PFE) and Wyeth (NYSE: WYE); and, Abbott Laboratories (NYSE: ABT) and Celera (NYSE: CRA). Now, nothing.

OK, the wise guys out there may say, ‘Isn’t this enough?’ (I won’t get into that maybe it was too much. I’ve flogged that poor horse too much already.) One day, we’re all merging and going to dominate the industry. The next, there’s not enough players around for a pickup game of stick ball. Something’s up.

The media aren’t really covering these deals or other possible outcomes presently. Maybe the other news stories are pushing Big Pharma into the back pages, or, off altogether. I have to admit last Sunday’s purported story about President Obama calling General Motor’s (NYSE: GM) CEO, Rick Wagoner, at home and firing him made for a heck of lot better copy than the purported value of Schering-Plough’s pipeline. The stock market’s recent rally has certainly been another distraction, probably, also throwing some deals economics into question. Finally, Treasury Secretary Timothy Geithner’s plans for toxic bank debt haven’t hurt neither has his rock star boss’ concert tour of Europe.

My point, the markets and the media are digesting a lot of new news. Much of which will change the rules that Big Pharma had been playing by until recently. First, share prices will rise. Those deals won’t be looking so good to shareholders. Next, government is getting more involved with American business management. Industries and their companies should be expecting their own phone calls from Washington if they get into trouble. Or, maybe executives’ pay will just seem too exorbitant when politicians are just trying to make more drugs more affordable to more people who can’t afford them. Finally, Big Pharma has nothing new to say. As Larry and I have blogged repeatedly, this is an industry that could be the next Big Auto.

So, where has everybody gone? I believe that they’ve gone to ground looking for cover. First quarter earnings are due out soon. Annual shareholders’ meetings will be taking place. I still don’t think that there will be much good news. You can only get away with saying that you’re doing better than General Motors for so long.

As always, we welcome your feedback. Please contact us at larryrothmansblog@gmail.com. We look forward to hearing from you.

Contributed by Guy de Lastin