City & Business: Drugs trio grit teeth as others bite the tablet

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The Independent Online
THERE hasn't been a hostile bid for a British drugs company for 22 years - when Beecham bid unsuccessfully for Glaxo. But times have changed. I wouldn't bet on the pharmaceuticals sector staying as peaceful for even the next 22 weeks.

The industry is in flux, faced with deeply uncomfortable choices. Customers across the world are demanding better value. Patents on blockbuster drugs are expiring. Competition from generics is intensifying. Developing new treatments gets ever more expensive and the regulatory hoops more demanding. All the signs are that executives at the top of our largest drugs groups aren't sure what to do in this harsher new environment.

One option has simply been to get bigger. This is the approach of American Home Products, which launched an dollars 8.5bn (pounds 5.5bn) unsolicited bid last week for a rival pharmaceuticals company, American Cyanamid. Mergers yield scale economies, wider geographical spread, overhead savings and, most important, a better chance of hitting the jackpot in the expensive search for new treatments.

Option two - very fashionable, this one - has been to buy up your own customers. Merck, the world's biggest drugs group, Eli Lilly and the Anglo-American group, SmithKline Beecham, have headed down this route, each snapping up a pharmaceuticals benefits manager or PBM. PBMs look after the healthcare needs of millions of people on behalf of their employers and are bulk buyers of drugs. They have mushroomed in the United States and look set to arrive in Europe in modified form.

Diversification is option three. Sandoz of Switzerland seems to be taking this approach, reducing its drug dependency. Already a substantial food manufacturer (responsible for Ovaltine among other products), it recently paid dollars 3.7bn for Gerber, the baby food maker.

Ciba, also of Switzerland, seems to prefer option four, which is to pull in the horns, slashing R&D expenditure to the lowest proportionate level of any large drugs group. Last year it sacked 3,000 people.

In contrast to all this activity, Britain's big three pharmaceuticals groups (not counting SmithKline) all seem to have plumped for an inscrutable option five: do nothing. Glaxo, Wellcome and Zeneca (the old ICI drugs and agro-chemicals business), while acknowledging the fat years are past, have yet to make any radical change in direction.

True, they have set up small alliances and made modest acquisitions. Wellcome, for example, put its over-the-counter business into a joint venture with Warner Lambert. And it is actively seeking out an acquisition in Japan, to the extent of having a main-board director resident there. But the big, noisy deal has so far eluded them.

This may be wise: mergers can be disruptive, divisive and counter-productive; joining the PBM set means paying very fancy prices. And diversifying is hardly likely to impress a stock market eager to see companies slim down to core businesses.

But it may also be interpreted as indecisive weakness. That could be dangerous. The raid on Cynamid shows drug companies are prepared to consider hostile bids. The consensus view is that there will be many more mergers and takeovers in the industry, which by some measures is highly fragmented. The biggest four companies have less than 15 per cent of total sales; the biggest 15 have less than 40 per cent.

The share prices of Wellcome and Zeneca raced up last week on takeover interest. Takeovers would be difficult. Apart from anything else the Wellcome Trust, which still holds 40 per cent of Wellcome, would have to go to court to reduce its holding below 25 per cent. Then there are monopoly considerations. In 1972 the Monopolies & Mergers Commission blocked that bid for Glaxo on the grounds that it would reduce the number of independent research centres in Britain.

It might seem improbable that anyone would have the determination and the firepower to bid for Wellcome (currently valued at pounds 5.5bn), Zeneca ( pounds 7.5bn) or Glaxo ( pounds 16bn). But I'd be very surprised if those companies weren't urgently putting together defence plans, just the same.

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