Symptoms grow worse for world's drug companies
By Adrian Michaels in New York
Published: January 14 2002 19:53 | Last Updated: January 14 2002 23:21

The largest pharmaceutical companies could soon run out of euphemisms to describe what looks like being a tricky, even horrible, year.

For Bristol-Myers Squibb, facing patent expiries of key drugs and a pipeline unlikely to deliver much in the near term, 2002 is a "bridge year".

Over at Merck, once a byword for blue-chip reliability but now hit also by patent trouble, stuttering sales and falling margins, this year is a "transition year".

At Schering-Plough - which on the evening of the Friday before Christmas told the world that it might soon be paying US regulators half a billion dollars to settle a dispute over manufacturing quality - last year was the "watershed year". This year's earnings estimate "remains subject to a number of factors".

This year most of the world's largest healthcare groups will have to deal with difficulties that expose the stresses in their current business models.

European governments and individual US states will continue to demand deep price cuts. Regulators will seek longer and larger clinical trials before approving drugs and, as Eli Lilly has been finding, becoming more stringent in their examination of manufacturing facilities.

These trends highlight how dependent the largest companies have become on the phenomenal success of one or two blockbuster drugs with annual sales over $1bn. Some small regulatory delay, or lowered price, and the earnings numbers need heavy revision. Part of this is due to outsize investor expectations, which some of the companies could now be accused of trying too hard to meet.

Investors have come to expect double digit revenue and earnings growth. And in the age of blockbuster medicines they have been prepared to pay a hefty premium for pharmaceutical shares.

A run of bad news last year eroded that premium, and now expectations are lower.

Paradoxically, top-line sales growth is not likely to be worse than recent years. Pharmaceutical companies are still selling high-margin products to ageing populations with more diseases and larger wallets.

The consultancy IMS Health expects global pharmaceutical revenues to grow 9-11 per cent this year to about $430bn, higher at the top end than it has been in the past five years. But if that does not sound too bad, the gloom at some companies can be attributed to an earnings slowdown: the revenues may be growing but at a cost to the bottom line.

In particular, as research and development have failed to keep pace with revenue expectations, the largest companies have been paying far more for the drugs of smaller competitors.

"Cash generation over the last decade has increased in-licensing and acquisition premiums," said Jim Kelly, analyst at Goldman Sachs. That has helped to boost the bargaining position of smaller companies. Bristol paid ImClone Systems $1bn in equity and up to $1bn in incremental payments for a cancer drug that would help improve its very sparse near-term pipeline.

But when the Food and Drug Administration said this month that ImClone's trial data were not satisfactory and put what could be a long delay on the drug, Bristol's huge investment suddenly looked a little foolish.

It is clear that pharmaceutical groups are having trouble managing their patent cycles.

AstraZeneca's earnings are set to dive, for example, if it loses a court case in the US over the patents for its best-selling ulcer pill, Prilosec. This is despite the group of new products the company has to cushion the potential blow, including Crestor for the reduction of cholesterol.

After all these difficulties, it is the relatively unexciting outlook of Pfizer and GlaxoSmithKline, the world's largest drugs groups, that makes them among the strongest this year. Neither has pressing patent problems, and that in itself highlights the fact that the drugs sector has fewer unifying characteristics.

Additional reporting by Geoff Dyer in London.

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