New-look mergers for drug giants

Date: 27/06/1996

By Tim Jones

WHEN Swiss pharmaceuticals firms Ciba-Geigy and Sandoz announced they were joining forces at the beginning of this year, they closed a chapter on the merger flurry which has marked the recent development of the European drugs industry.

With the formation of the new 48-billion-ecu giant Novartis, the round of mega-mergers that got under way seven years ago with the aim of minimising research costs has probably come to an end.

First off the mark were SmithKline Beckman and Beecham, who linked up in 1989, followed last year by Rhône-Poulenc's acquisition of Fisons and the Pharmacia/Upjohn merger.

But the biggest and most telling example of this aggressive merger boom came in January 1995, when Glaxo took over Wellcome for 7 billion ecu, thus creating the world's largest pharmaceutical firm.

But with the friendly merger between Sandoz and Ciba-Geigy, a page has been turned.

Most of the companies with capitalisations of close to 10 billion ecu have gone. From now on, new-look mergers will tend to be either in the form of agreed link-ups between two already large firms, or aggressive and concentrated on small ones.

The companies most vulnerable to hostile take-overs are the mid-sized European firms with annual sale revenues of less than 2 billion ecu. Schering and Böhringer Ingelheim in Germany, Zeneca in the UK and Nova-Nordisk in Denmark are often talked about as being potential targets.

So far, only Ciba-Geigy/Sandoz has run into problems with the European Commission's anti-trust authorities. Until now, the Commission had taken the view that the drugs market was global in nature and tended to avoid concentrations of commercial power. Novartis, however, is currently under investigation amid fears that it could dominate in a handful of product markets, particularly in France.

The origin of merger frenzy lies in the huge costs of funding research and development - the life-blood of companies which rely on inventing new treatments that governments and hospitals are prepared to pay handsomely to use.

These costs - estimated to average 300 million ecu per treatment - have to be recouped, and a major firm will be involved in 30 areas of research at one and the same time.

Pharmaceutical firms claim that job losses of 100,000 in the industry over the past two years result from the need to control these costs while, at the same time, drugs prices are capped by governments.

“The merger wave will continue because the pressure is so enormous now on reducing drug prices, increasing the profitability of the industry and achieving critical mass in R&D,” says Jan Leschly, chief executive of SmithKline. “We have to save somewhere else and that will be through - among other things - consolidation.”

Throughout the early Nineties, pharmaceutical share prices languished as the Clinton administration threatened to cap drugs prices in the US under a major healthcare reform programme and European governments went through a round of hefty health spending cuts.

But stock prices went into orbit last year, helped by the abandonment of the Clinton healthcare plan. Prices outpaced the rest of the stock market by 25&percent; and the capital value of US drugs firm Merck alone grew by 20 billion ecu.

The mergers have all been followed by major cost-cutting. Within a year of its take-over of Wellcome, Glaxo announced savings of 850 million ecu as the two companies' R&D budgets were merged and duplication removed.

Similarly, Novartis - even before it receives regulatory approval - has announced plans to invest 2.2 billion ecu every year in the merged R&D programmes of Sandoz and Ciba-Geigy. Staff numbers will be cut by 10&percent; from more than 140,000 at the moment, including 3,000 in Switzerland alone.

Against this backdrop of cuts and cost pressures, the industry is concerned that the EU is not doing enough to help. They point out that European firms make up half of the world's top 20 pharmaceutical groups and a third of the 215-billion-ecu world-wide market.

In their view, regulation of the healthcare system throughout Europe focuses too much on the size of the drugs bill and not enough on overall healthcare costs. Moreover, the varied methods for pricing drugs in the Union cause serious difficulties for firms trying to market their products. As a result, prices vary hugely between the north and south of the Union, with the unit price of the ten best-selling drugs in the EU differing by as much as 220&percent; the last time they were compared in this way two years ago.

The variety of price control systems makes it difficult for companies to establish a consistent pricing policy or to recoup their R&D costs.

These variations were taken into account when Spain and Portugal joined the EU in 1986: their lack of patent protection meant their drugs were banned from export to the rest of the Union.

But that agreement will soon expire and northern firms claim they will lose more than 1.5 billion ecu a year in sales because of drugs coming in at lower prices from the Iberian states.

This highlights the linked problem of 'parallel imports' which is a constant source of irritation to drugs companies. If registered in two member states, drugs can be bought in one country by a wholesaler and sold to pharmacists or hospitals in the other at markedly different prices. In 1995, parallel imports were worth 600 million ecu.

So upset are they by this phenomenon that pharmaceuticals makers have occasionally taken drastic action. Only last year, the Commission fined Germany's Bayer 3 million ecu for refusing to supply its Adalat heart drug to French and Spanish wholesalers who wanted to re-export it to the UK, where the drug's price was higher.

But although firms want free pricing, they are unlikely to get it for some time, given how jealously member states guard their powers in this area.