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Pfizer: One Step Ahead of the Mudslide

Mentioning Pfizer/Allergan prompts me to strongly recommend this post by Bernard Munos: “Pfizer Does Not Need a Merger – It Needs a Rebellion”. He takes the long view, and the long view here is not pretty. Over the last ten or fifteen years, you’d have been better owning the S&P than Pfizer (and yes, that includes dividends). Over the last thirty, well:

As can be seen, neither acquisitions nor increased R&D spending had any detectable impact on the rate at which new drugs reached the market. Over the last 35 years, Pfizer brought 34 drugs (New Molecular Entities) to market, almost one per year on average. Yet, its acquisitions boosted R&D spending from $4.4 billion in 2000 to $9.1 billion in 2011 (+115%), before easing back to $8.4 billion last year, all for naught.

This could be a Red Queen’s Race, though – Pfizer may have had to spend all that money and tear up all those huge swaths of the industry just to keep that NME rate where it is. But that’s not what they were telling everyone at the time, of course – it’s probably not what they even thought themselves. For what it’s worth, you can go back to when they acquired Warner-Lambert in 2000, and read that they were going to create “the world’s fastest-growing major pharmaceutical company”. When the Pharmacia deal went through in 2002, the press release says that the new company was “positioned to deliver a stream of innovative new products and cost-effective health care solutions”. When they merged with Wyeth in 2010, the talk was of “enhanced ability to innovate”, a “distinct blend of diversification, flexibility, and scale (that) positions it for success in a dynamic global health care environment”.

The real take-home, though, as Munos puts it, is that “A company that needs repeated mega-acquisitions to keep afloat is inherently unsustainable“. And that’s the point: it’s not that Pfizer does these deals to become even larger, more dominant, and more productive. They’ve been doing these deals just to keep from sinking into the mud. You won’t get that from the press releases, that’s for sure, and you won’t hear it from Pfizer’s management now. But it’s true.

20 comments on “Pfizer: One Step Ahead of the Mudslide”

  1. anon says:

    I have just checked Pfizer’s 5 year stock prices. Nice increase. I am sure the shareholders are happy. I don’t think they are “sinking into the mud. “

    1. Bernard Munos says:

      To anon (#1): picking stocks in hindsight would make us all instant millionaires. Irrespective of the quality of a company, one can always finds two dates that would make a trade profitable. The money that Pfizer’s investors could have made in the last 5 years is but a fraction of what they lost during the previous 10.

      To Sam Adams: you are correct; pharma is an industry in which the probability of ruin is non-trivial. Given enough time, all companies will hit a dry spell that is long enough to break them. The implication of this for risk management are rather interesting, but, for another blog.

  2. Magrinho says:

    @anon
    The Big Boys for a 10-year window: PFE, MRK, JNJ, ROG.VX, NVS, S&P.

    Who finished last? PFE.

    Here is what the PFE investors really missed: BMY was up almost 200%. BIIB, REGN, GILD are through the roof.

  3. Rule (of 5) Breaker says:

    anon (#1) – Check any stock’s price in the last five years – they all look good. Most decent stocks have had a great run from the 2009 lows. Look over the longer term. Consider that Pfizer has spent more on acquisitions since 2000 than their current market cap, even including Zoetis. So if you buy Pfizer, what are you buying? Pfinancial engineering. The company is so large it it hard to move the needle with even a few new NME’s. Throw in the fact that their designer/synthesizer model has destroyed med chem morale there, and you have a company that needs a serious break-up into smaller entities. That is the only way they will ever see growth again – after the earnings growth that comes from the lower tax rate that is.

  4. b says:

    You could check almost anyone’s 5 year stock prices and say the same because of that little thing that happened in ’08.

    How about you try 10 years? 15 years? Doesn’t look so great then….

  5. Richard W says:

    pfe price on 11/30/2010 = 14.04. dividends since then is about 5.10 (over-estimate). stock now at time of writing = 32.75.

    {((32.75+5.10)/(14.04))^1/5} – 1 = 18.46% compounded annual return.

    not bad for a serial acquirer. yes, biotech did better but from a risk adjusted basis, pfe was not bad. i’d buy biotech for my young nephew but not for my aunt.

  6. Am I Lloyd says:

    Pfizer is like a patient who constantly needs heart transplants, kidney transplants and liver transplants just to stay alive. A pity he can’t get a brain transplant which is what he really needs.

  7. John M says:

    The linked Fortune piece contains this info:

    “From 2005 through 2014, [Pfizer] spent $80 billion in R&D, and got 10 drugs approved by FDA. In comparison, Johnson & Johnson spent $51 billion and got 15 approvals.”

    Using that as a very crude estimator you get:

    Pfizer’s average cost per approved drug: $8B
    J&J’s average cost per approved drug: $3.4B

    Both are far higher than the $1-2.5B range typically quoted, and disputed as too high.

  8. matt says:

    @Richard W is this what passes for thinking in the investment world these days? You cherry-pick a good starting date and good finishing date for your estimates on return, and then fudge your numbers further by some “risk adjustment” and conclude it’s a win? Have you considered doing a sensitivity analysis on your start date and end dates? Have you considered the 10 year window mentioned by others? What about comparisons to the other major pharmaceutical companies that could have been in your portfolio? I suspect you know how all these turn out. And that you started out with a financial stake in the company, and the handwaving is an attempt to justify your stake.

    Meanwhile, the industry lost Warner-Lambert, Wyeth, and Pharmacia; these companies were probably doing much better before they got carved up and spit out by the juggernaut.

    This may seem off-topic, but I find it very interesting how the government can block such mergers in the railroad industry. The Surface Transportation Board has apparently been given strict criteria by Congress in limiting mergers that may make the stock market happy but the customers of the industry sad.
    http://fortune.com/2015/11/25/canadian-pacific-norfolk-southern-merger/
    http://calgaryherald.com/business/local-business/cp-rail-ceo-sees-huge-cash-flow-from-selling-norfolk-southern-land
    http://www.wsj.com/articles/dealpolitik-canadian-pacific-deal-faces-steep-uphill-grade-1448601313

    Hmm, Bill Ackman again on the trail of “make-me-richer this fiscal quarter while screw the customers, the industry, and any long-term viewpoint.”

  9. Sam Adams the Dog says:

    Given the poor odds of drug discovery per unit R&D cost, I seriously find myself wondering whether the pharma industry, mergers and all, is best modeled by a pure gambler’s ruin model.

    What if the most important factor in drug discovery is pure luck? What if how good your scientists are, how good your managers are, and how many of them you have, the odds of success per dollar of expense is very close to the same?

    Drug companies have a finite pile of chips. If their R&D effort is failing to come up with new drugs, then, no matter how good the biologists and chemists are, it makes sense to spend some of those chips on trying to purchase an advantage in the form of some small company that appears to be luckier, even at the expense of laying off part of your staff. Or another strategy is to merge with another company that is more successful, if they’ll have you.

    In this picture, there are no bad guys. No incompetent managers, no bad chemists — nor any superb ones, either. Or if there are, they exist to an equal extent everywhere — in the lucky as well as the unlucky companies.

    I ask you: is this model so far-fetched?

    1. Kelvin says:

      The expected return on investment in Pharma R&D has been falling for years, is now close to zero, and may be as low as -5% according to some recent figures.

      To put this in perspective, the expected ROI of a roulette wheel is -2.7% (1 in 37).

      Thus, “gambling” may be a better analogy for drug development than “investing”, which may explain why companies like Pfizer and Valeant are shifting from R&D to M&A.

      Not that M&A creates any net value with innovation, either…

    2. Phil says:

      Sam Adams: Not farfetched at all, and also not limited to the pharma industry. We (humans) just have a hard time admitting that luck plays a role in our successes while rushing to blame it for our failures. It’s part of the imperfect cognition we have evolved.

    3. AndyM says:

      Agreed. It’s essentially impossible to know if you’ll eventually hit the jackpot, especially when you’re early in the discovery process. But a company can and should quantify how effectively they’re playing with a finite number of chips. http://blogs.sciencemag.org/pipeline/archives/2015/08/31/picturing-a-drug-efforts-progress including greater accountability of management, when bets are made on another company’s assets.

  10. biotechtoreador says:

    I think stock price is the incorrect metric to ascribe value in these situations. Looking at CEO compensation tells a more complete story who benefits from these transactions and why they get done. In 1999, PFE’s CEO earned $869,800 in salary and $1,093,000 in bonus for a total of $1,962,800. In 2014, PFE’s CEO earned $1,825,000 in salary and $3,000,000 in bonus for a total of $4,825,000. Thus, after 15 years of returning to investors less money than the market as a whole PFE was able to increase it’s return to its CEO by 264%! Now THAT is a pretty good increase.

  11. Anon says:

    The business of business is business. Not drug discovery.

    1. dave w says:

      Maybe the problem is the attempt to run drug discovery as such (i.e., as distinct from the “post-discovery” part – product/production development and marketing etc. based on “discovered” chemistry) as a “business” in the first place – whether or not that’s a useful model for that particular activity. (So often we see the assertion that “so-and-so should be run more like a business” – made in inappropriate contexts. What would we think if someone said that a store or a factory should be run “more like a grade school” or “more like a mental hospital” or “more like a drug-discovery project”?)

  12. Dr. Manhattan says:

    “In 1999, PFE’s CEO earned $869,800 in salary and $1,093,000 in bonus for a total of $1,962,800. In 2014, PFE’s CEO earned $1,825,000 in salary and $3,000,000 in bonus for a total of $4,825,000. Thus, after 15 years of returning to investors less money than the market as a whole PFE was able to increase it’s return to its CEO by 264%! ” It’s good to be the King! (Mel Brooks)

    Hey, you forgot the Henry McKinnell Early Farewell Package! From Forbes: “When Hank McKinnell stepped down as Pfizer’s CEO in 2006 the company paid him $188 million in severance pay.”

  13. Anon says:

    Pfizer’s share price will do whatever it does. The return over 15 years is awful because the price of the stock relative to its earnings power was very high. Investors were betting on major growth that never happened.

    A better way to judge a company (and managment) is earnings growth. Those numbers are grounded in reality and over the recent past they do not paint a pretty picture.

  14. Diver dude says:

    The pharma biz is, and has been since the early 90s, a series of cargo cults masquerading as drug companies. No one really knows what they are doing and so we build a series of increasingly elaborate facsimiles of what we think are productive companies in the hope of attracting the attention of the magic pixies in the sky. It’s all luck and deep down we know it but we can’t admit it because the stock prices would crater. So we keep on burning sunk R&D value until there’s nothing left while desperately praying something will turn up.

    This is why I left the industry.

  15. Anon says:

    All of that R&D spending doesn’t matter when there’s constantly a new big round of restructuring before things settle down from the last one. I recall very little got done in the last several months at Rohm and Haas after they announced the company’s acquistion – Pfizer scientists have been in a similar situation for the last 10+ years, always worrying about whether they’ll still have a job 3 months into the future. I’m not surprised they don’t accomplish much in that kind of mental state.

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