Take Two Advil and ... What Ills Can the Pfizer-Wyeth Merger Cure?Published: February 04, 2009 in Knowledge@Wharton
When the giant pharmaceutical company Pfizer announced on January 26 that it was acquiring Wyeth for $68 billion, analysts immediately started questioning what benefits the deal would bring and for whom. Pfizer executives suggest the acquisition makes strategic sense by expanding the company into a range of new areas, and by helping make up for an expected loss of more than $12 billion in annual revenues once its Lipitor patent expires in 2011. But Wyeth also brings some liabilities to the mix -- notably, continuing lawsuits over its hormone replacement drugs and fen-phen diet pill. Knowledge@Wharton asked Wharton health care professor Patricia Danzon and marketing professor Jagmohan Raju to offer their views on the pros and cons of the deal.
An edited transcript of the conversation follows.
Knowledge@Wharton: Pat and Raju, thanks for joining us. Pat, does this acquisition make sense for Pfizer from a long-term strategic perspective?
Pat Danzon: I wouldn't bet on the long-term benefits. For the short to medium term, the hope is certainly that the merger brings both revenues, in terms of Wyeth's products, and the possibility of cutting costs and, therefore, driving net revenues by eliminating personnel, probably mostly from Wyeth. When we look at the previous mergers that Pfizer has done, they have followed up with fairly aggressive cost cutting. I would expect to see the same here.
Jagmohan Raju: I agree. If Pfizer had not done this merger, they would have been in deep trouble because they would have lost one quarter of their revenue in two years [from] Lipitor. From Wyeth's [perspective], there is also an opportunity, because, as you noted, they have all these potential liabilities. But they also have a window of opportunity where they don't have these [problems] staring at them. Pfizer can get new drugs. Pfizer has always been a very strong marketing company. They have taken other people's products to levels which other companies could not. For example, Lipitor, had it been in the hands of Warner-Lambert, would have probably been a $5 billion product. With Pfizer, it was $13 billion. I think they'll do the same thing with Wyeth products.
Knowledge@Wharton: What does Wyeth bring to this deal? And why would the company agree to it?
Danzon: What is in it for Wyeth is obviously a very good price. It may have been very hard for Wyeth to turn down that price. [And we may be seeing] hostile takeovers in the pharma industry. So there's a question of how much choice Wyeth had. Having said that, what Wyeth brings to this is both the products that are already on the market, and significant capability in biologics that they have built up over the years. They were one of the first pharmaceutical companies to move fairly aggressively into biologics. This is an area Pfizer has also invested in. The most promising hope in terms of long-term synergies is for putting together those two biologic divisions and getting more productivity out of [them]. The general idea that bigger is better -- and that, by being bigger or even more diversified, there is going to be benefit here -- is more dubious as we look at past experience.
Knowledge@Wharton: What do you mean by biologics?
Danzon: The biologic products are the products that are developed, in some way, involving live processes as opposed to the more chemical-based drugs that are the traditional tablets and capsules we're used to taking. The biologics tend to be more expensive. They go to specialty physicians rather than to primary care physicians. They're higher priced, both because they are more costly to produce, and because they are generally much more advanced therapies. All the drug companies have moved in the direction of switching from chemistry-based drugs to biologics. But Wyeth was one of the earliest, and they have done that both with their main portfolio, but also with their vaccine division. That is a strength that they certainly will bring to Pfizer.
Raju: I agree. I'm a marketing professor, so I hesitate saying this. But one of Wyeth's strengths is not just marketing biologicals, but manufacturing biologicals. I think many people can develop biologicals. But manufacturing these on a very large scale consistently requires a lot of skill. And [Wyeth's] factories -- I shouldn't call them factories, but manufacturing capabilities -- in biologicals are unmatched. In fact, their biological Enbrel is actually developed by Amgen, but marketed and produced by Wyeth on a large scale. Pfizer definitely needed that. To get into this business fast, you need the manufacturing capabilities.
From Wyeth's perspective, from the shareholders' perspective, the cash component of the offer is really very attractive. They're getting $45 billion in cash from this deal. You can do a lot of things with $45 billion these days.
Knowledge@Wharton: You have both noted the certainty of layoffs as a result of this deal. What will be the impact of the company's plans to cut 19,500 jobs and axe $4 billion out of its budget? And how difficult will it be to merge the cultures of these two companies?
Danzon: One of the interesting things about putting together these two companies is that both of them are, in fact, agglomerations of a number of previous companies. So both companies have a history of aggressively doing post-merger integration. They are geographically reasonably closely situated, and I don't see them as having very different cultures. I would expect them to move very quickly in trying to take out unnecessary duplicated functions. Having said that, they have both already recently made significant cuts, not just in the traditional marketing area, but also in administration and even in R&D. So it will certainly produce a much leaner company if they do go ahead with the sort of projected cuts they are proposing.
Knowledge@Wharton: Is there a danger they could pare down too close to the bone?
Danzon: In this day and age, I don't know that you can ever go too close to the bone.
Raju: I think there will be significant job cuts, not immediately, but as soon as Lipitor goes off patent. Today, the combined revenues are about $70 billion. But two years down the road, $15 billion will be gone. So one way or the other, they will have to reduce their expenses significantly.... I'm not sure if the Madison office of Wyeth will survive. And there will be a lot of cuts on the marketing side also.
Knowledge@Wharton: Pfizer's patent problem is shared by other big drug makers, like Merck, Bristol-Meyers Squibb and Eli Lily, which will face major revenue losses in the next few years. Given these and other challenges, how would you describe the state of the pharmaceutical industry in general?
Danzon: It certainly is challenged. They are facing unprecedented patent expirations. Lipitor is simply the largest in terms of loss of sales. But, as you mentioned, all the major pharma companies are looking at billions of dollars of lost revenue.... What most of them are trying to do is fill those foregone sales with new products that they bring in either by licensing from smaller companies or acquiring smaller companies. The general trend over the last few years has been to avoid the big horizontal mergers that were so common in the 1990s and, instead, go for the so-called vertical mergers where a big pharma company would acquire a smaller biologics company. Because the experience of the horizontal mergers was really mixed, at best, not to say negative, I think many people were surprised that Pfizer went ahead with this big horizontal merger. Having said that, they had little choice. So I would expect to see the other companies pursuing more of the strategy of acquiring mid-size and smaller companies, as well as being very, very aggressive in licensing.
Knowledge@Wharton: Do you see any deals that are actually getting done out there for these smaller companies, these mid-size companies?
Danzon: We've been seeing those sorts of deals over the last year. For example, AstraZeneca acquired Medlmmune, which was, I think, something like a $16 billion acquisition. Takeda acquired Millennium. So those sorts of mid-size to large bio-tech companies have been very attractive. They offer not only products on the market but also less risk that there will be overlaps in the portfolio of the two merging companies. One thing that made Wyeth attractive to Pfizer is there's relatively little overlap in the portfolios, so there's not an issue of divestiture, whereas other major mergers all pose issues of divestiture of overlapping products.
Raju: Going back to the state of the pharmaceutical industry, I think there are clearly difficulties, but also a lot of opportunities. We have an aging population. We have the rest of the world with incomes growing. We have European companies becoming very strong in R&D. At the end of the day, if governments start evaluating products for their innovativeness, the strong, large companies will have a better day because they can afford to be more innovative. And they can afford to spend the monies. So I think there are a lot of opportunities. That's why this industry has stood up a lot better during this downturn than either banking or automobiles. Many other industries, including diversified companies like GE, have suffered a lot more than any of the pharmaceutical companies. That says something about the industry.
Knowledge@Wharton: What are the pros and cons of this deal for consumers?
Danzon: I really don't see a big impact on consumers. I think consumers benefit enormously from the underlying cause of this -- the patent expirations that lead to the branded products being replaced by much cheaper generics. That is a huge benefit to consumers. But I don't see any big effect on productivity, availability of products. I think it's mostly shareholders and employees who are seeing the hit.
Raju: I agree. I think the impact on the consumer is likely to be minimal. And I think the patent expirations that are taking place will help all consumers. But to the extent that innovation is enhanced if more capitalists are behind it, at the end of the day, patients stand to gain.
Knowledge@Wharton: You've touched on this a little bit. The combined company is expected to have revenues of more than $71 billion. But the key question is whether they will be able to generate enough new sales to justify the deal. What do you think?
Raju: I think they will. My sense is, looking at the history, Pfizer has been able to historically do better with existing products than other companies. So if Lipitor is an example, I think Pfizer could take Embrel to new heights. Wyeth has a big portfolio of Alzheimer's [drugs] coming up. Alzheimer's is a huge disease that is very devastating. If Pfizer can help take these products to market faster, I think everyone stands to gain, including the shareholders. A lot of money is needed to take these products to market. We all think R&D costs are very high. But for every dollar spent on R&D, $2 have to be spent on marketing and sales to take a new product to market. Any efficiency we can get -- both in terms of how much we spend and how we spend it -- would help.
Danzon: I agree that Pfizer has an incredible track record in marketing. I think for the longer term there is a real question as to whether having an even bigger R&D budget, in fact, increases productivity. Many of the larger companies are trying to carve up their R&D divisions and induce a sense of smallness and innovativeness -- more like a small bio-tech company. In a way, creating this mammoth R&D division is counter to that trend. On the marketing side, I think no question that size is an advantage. But on the R&D side, it remains to be seen whether they can maintain true innovativeness in such a large company.
Knowledge@Wharton: An analyst in The Philadelphia Inquirer was quoted as saying that, "The promised land in pharmaceuticals was 10 years ago. Until we see a major technological breakthrough in pharmaceutical development, for now, it's all about working what you have." Isn't it a little early to be talking about the faded glory and past successes of the pharmaceutical industry? Isn't there a lot ahead that they have to look forward to?
Danzon: I think there is a huge amount of upside ahead. I think it is also true that, at the moment, we're in a trough between the previous high and the next one. Where one sees it mainly is in terms of number products approved, which, despite massive increases in R&D spending, has been flat. But as we move forward, I think there will be greater expertise with the new technologies. What everybody hoped would come from some of the genomics revolution will, I think, ultimately, come to fruition. But it hasn't happened yet.
Raju: I agree. It's not just genomics, but also, [the fact that] the new administration is more open to stem cell research. There is a merging between what we can do with biologicals and chemicals, and what we can do with the devices. So [with regards to] the future of the healthcare industry, we broadly define it as very strong. And you have juggernauts like Johnson & Johnson and Medtronic working on the device side, combining their strengths with the pharmaceutical industry. I think this has a great future.
Knowledge@Wharton: If you were the CEO of Pfizer, what would be the most important thing you could do to insure the success of this acquisition? And what would be your biggest cause for concern?
Raju: I think the biggest issue here is, as Pat said, maintaining the innovation in these two companies, getting the best out of the products that they have, and making sure good people stay with the company rather than jump ship. Eventually, this is a know-how and IP [intellectual property]-based company. It comes from people. So making sure good people stay would be the biggest challenge for the Pfizer CEO.
Knowledge@Wharton: That's what would keep you up at night -- trying to retain the talent?
Raju: I believe that.
Danzon: I agree. Post-merger integrations for companies of this size are a huge challenge. Trying to undertake that while, at the same time, maintaining full speed ahead and R&D productivity is going to be the challenge. I do think that, at the same time, moving aggressively with cost cutting will be part of what has to be done. And of course that tends to undermine morale and make it even more difficult to maintain productivity. But, having said that, both companies have experience with it and have done it very successfully in the past. Let's hope that they pull it off again.
Knowledge@Wharton: Thank you both for joining us.