Jeremy Warner's Outlook: Lack of new product at AstraZeneca is a worry as GlaxoSmithKline surges ahead

Interest rates: a Chinese surprise; A shot in the arm for online gaming?
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The Independent Online

Both GlaxoSmithKline and AstraZeneca, Britain's two Goliaths of the pharmaceuticals stage, announced excellent first-quarter figures yesterday. Wouldn't the logical thing be for them to merge and take Britain on to the next stage of global pharmaceuticals consolidation?

That's long been a favourite stock market talking point, with the larger, Glaxo, said to be about to pounce on the smaller, Astra. Yet though superficially an attractive proposition, allowing huge cost savings to be pushed through in duplicated sales forces, administration and research and development, it's just not going to happen. Let me explain why.

Reason number one is that claimed synergies, however mouth watering in the anticipation, don't always generate the value they promise. Six years after the merger of Glaxo Wellcome and SmithKline Beecham into the leviathan we see today, the company is only now beginning to show the potential it was meant to deliver.

Of course, things might have been a great deal worse for both companies had they not merged. We'll never know for sure on that score, but six years is an awfully long time to wait for results, and there is no doubting that the early years of the merger were a disruptive and dispiriting mess, with two very different corporate cultures struggling to come to terms with one another. Mergers are not as simple as £100m of cost savings equal £1bn of extra value. The real world rarely works as precisely as that.

Execution risk is only the part of it. The major reason such a merger won't happen is that Glaxo doesn't want to do it. As one insider puts it, which part of no does the market not understand?

Yesterday's performance from Astra was outstanding; there's no denying that. Yet this is a company which though it might be selling well at the moment faces a worrying dearth of promising new discoveries to replace the old ones as they fall off patent. The up coming drought in new drugs is demonstrated by an increasingly desperate series of deals, where Astra pays top dollar for compounds in the early stages of development, many of which are unlikely to make it to market.

GlaxoSmithKline, by contrast, has already had its time in the Gobi desert and is now emerging the other side with one of the most promising pipelines anywhere in the industry. If all it would be buying in AstraZeneca is a costly salesforce with little in the way of new products to put through it, what would be the point of that?

It would be wrong to view Astra as a completely busted flush. Things are never as black and white as that. Yet the gap between the two is set to widen markedly over the next five years, as Glaxo hammers home its advantage. With a whole welter of promising new products expected to come to market from the autumn onwards, some of them with blockbuster potential, the outlook for Glaxo has never looked better.

While Astra struggles to hold R & D expenditure at 14 per cent of revenues, Jean-Pierre Garnier, the chief executive of Glaxo, expects to be able to boost his spending from the present 17 per cent of revenues to as much as a quarter in 10 years' time and still have plenty left for dividend growth.

Having finally got Glaxo firing on all cylinders again, is this the right time for JP to be hanging up his boots? The City assumes he'll go in October next year, when coincidentally his contract expires and he reaches the age of 60. However, that conversation has yet to be had, and there's little sign of him wanting to live life at a gentler pace.

Interest rates: a Chinese surprise

Will yesterday's rise in Chinese interest rates be the straw that finally breaks the camel's back - the pin that pops the commodities bubble and decimates other asset prices in the process? In recent weeks I've argued that the present, extraordinarily benign outlook for the world economy is set to continue for some while yet, and the interests of consistency, I'm not about to change that view now.

The Chinese interest rate rise caught the markets on the hop; they were expecting a credit tightening, certainly, but had assumed the Chinese authorities would pursue this aim by imposing higher reserve requirements on the banks. By imposing a rise in rates, the People's Bank of China seems to be signalling a new get tough policy with China's overheated economy. Yet I'm not sure why this should be seen by markets as a negative move.

In the first quarter of this year, China's economy grew an astonishing 10.2 per cent on an annualised basis. By Western standards, to raise interest rates by just 0.27 per cent to 5.8 per cent would be thought a wholly inadequate response to such rip-roaring growth. Many pundits are beginning to bet that the next rise in British interest rates will be up too, even though the UK economy grew by just 2.2 per cent in the first quarter. This rather puts the Chinese increase in perspective.

What's more, though lending rates are going up, deposit rates are being left unchanged. If there is a problem with the Chinese economy it lies not with excessive consumption, but with too much investment - the very reverse of the imbalance we see in the UK economy. The Bank of China wants to encourage the banks to lend less but Chinese consumers to spend more. This might in the short term mean a little less demand for raw materials, but this is surely just the sort of rebalancing that international policymakers would wish to see.

Still, though the move seems easily justified on domestic grounds, it cannot be seen as wholly benign. Almost everywhere, monetary conditions are being tightened, The excess liquidity which has sustained world demand this past five years is being withdrawn. As this happens, some emerging markets which have benefited from the oversupply of money may suffer.

Yet so far, there's no sign of a hard landing. Growth of 10.2 per cent, even in an economy where per capita income remains low by Western standards, is surely unsustainable and needs to be dampened at some stage. The Bank of China is acting on the stitch in time principle. The upshot ought to be that the boom continues for longer than otherwise, albeit in more sober fashion.

A shot in the arm for online gaming?

Online gaming stocks were in demand again yesterday after the American Gaming Association said it was dropping its objections to the internet version of its industry and was instead urging Congress to set up a commission to see how online gaming might be regulated and taxed.

If the AGA, a powerful lobby in Washington, is officially moving closer to supporting the online industry then the risks of a crackdown by Congress are correspondingly reduced. Online gaming might even find itself officially legalised in the US.

But is this as good news for PartyGaming and other online gamers who derive the bulk of their revenues from the US as the stock market reaction suggests? If the industry is put on a proper legal footing, then it must be, mustn't it?

This has long struck me as the wrong way of looking at these Gibraltar registered curiosities of the London stock market. The reality is that they exist only because of the dubious legality of their trade in the US, which means that traditional American gaming companies, or US-based internet service providers, won't touch it. They would find themselves sued to oblivion if they did. The entrepreneurial upstarts we see quoted on the London stock market have done well only because they face so little competition. The questionable legal status of the industry in the US has acted as a highly effective barrier to entry.

PartyGaming and the others benefit most from a continuation of the status quo, where the activity is illegal but tolerated in the US. The last thing they want is for the industry to be legitamised, for the moment it is, not only will they be taxed and regulated in the US, but they'll face a flood of competition which in all likelihood will wipe them from the map. Here's to illegality. Long may it persist.