Jeremy Warner's Outlook: Northern Rock caves in over dividend

Cocktail of challenge for new GSK man; Last of the GEC legacy is taken out
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The Independent Online

Well there's a surprise. Northern Rock's determination to push ahead with payment of an interim dividend always looked incomprehensible given the difficulty the bank finds itself in. Last night, directors were finally embarrassed into bowing to the inevitable and cancelling it.

On almost every level, it was indefensible to be paying a dividend at a time when the company has been forced to borrow more than £3bn at a penalty interest rate from the Bank of England. The lender of last resort facility is there to prevent a banking crisis, not pay a dividend.

That Northern Rock's deposits are also guaranteed by Her Majesty's Government – which means that in essence the bank continues to exist only by virtue of state subsidy – made the payment doubly suspect and only added to the sense that here was a board that had lost all touch with reality.

Yet the evident glee with which the politicians received news of last night's climb down may be misplaced. The purpose of continuing with the dividend was to demonstrate to the City that Northern Rock was still a viable company with essentially sound assets and a sustainable business model. It may stick in the craw to think that shareholders and management should salvage anything from the mess they have created, but it is going to be a big problem for the Government if they don't.

The Government's guarantee of deposits was sold to the nation on the basis that it ultimately wouldn't cost the taxpayer anything. If a negative value is eventually assigned to the company and the whole business goes into run-off, then that assumption starts to look questionable. Remember, in a British insolvency, depositors rank below many other creditors.

From the Government's perspective, it is therefore much better that this company survives than it goes to the wall. Besides, there are 6,000 jobs in the Labour heartlands to think about. Payment of a dividend that would have cost around £60m is in the scale of things neither here nor there and probably wouldn't have made any difference to whether the company lives or dies.

Yet it may have helped maintain the pretence of life. The danger now is of things being seen to spiral out of control, of the company being viewed as so fundamentally holed below the water line that it is almost bound to sink. Nobody, other than Northern Rock's competitors in the mortgage market and short-selling speculators will gain from that.

Directors claimed last night to have received a number of approaches. How real they are, or what the terms might be, is anyone's guess. A takeover still remains the Government's best hope of wriggling off the hook of the guarantee but it's touch and go. If the perception takes hold that the company is worth nothing, ministers are going to find themselves in some difficulty.

Cocktail of challenge for new GSK man

GlaxoSmithKline is close to making a decision on a successor for Jean-Pierre Garnier, the man who as chief executive has led Britain's largest pharmaceuticals company for the past seven years. The chairman, Sir Christopher Gent, promises to name his man by the end of January. Talk in the City is that he will do it sooner, possibly within the next month. It's about time. This has been one of the longest drawn-out processes of assessment for a major UK company that I can recall, and, though it is obviously essential that GSK chooses the right person, it is not clear that it has been entirely healthy.

The selection process has been benchmarked against external talent, yet it is certain that one of three internal candidates will get the job – David Stout, the chief operating officer, Chris Viehbacher, the president of US pharmaceuticals, and Andrew Witty, the president of European pharmaceuticals.

The year-long assessment must have caused internal tensions as the three establish their support bases and jostle for position. Team spirit was one of the qualities the board was looking for, so any obvious attempt to shaft the competition would immediately have disqualified the offending candidate.

Even so, the three are only human, and rivalry between them must have been intense, to the possible disadvantage of the company. You are hardly likely to share your best ideas with your fiercest rival for the job when you know that at the first available opportunity he'll try and use them as his own. Equally certain is that there will be fallout when the board finally bites the bullet and chooses its man.

At stake is a big prize, but it is also a heavy responsibility. The challenges facing Big Pharma have never been greater. I'm not referring here to the particular controversies that swirl around GSK right now – the safety of the company's diabetes drug Avandia, whether the balance sheet is leveraged enough or whether or not GSK should be selling off its consumer products division.

These are all minor distractions compared with the wider storms that have begun to build around the Big Pharma business model more generally. In a nutshell, the problem is this. The blockbusters of yesteryear are proving ever more difficult to discover and bring to market at a time when the pressure on pricing for established products is irresistibly down.

The year to look forward to is 2012, when the post-war baby- boom generation starts to retire en masse. On one level, this is good news for the industry. Drug use rises massively after the age of 65. But this huge rise in demand is also certain to create intense pressure for much lower prices.

In America, still around half the world market for pharmaceuticals, health care tends to get paid for by companies and state-funded medicare arrangements. Many of these legacy companies are in trouble and there are obvious limits on the state's ability to fund enhanced medicare spending.

The introduction of formal pricing controls, similar to those operated in Europe, into the world's largest drugs market therefore looks inevitable. Replacement of patented products with cheaper generics will also gather pace. And just to complete this cocktail of negatives, the efficacy of treatments is increasingly challenged.

That's in turn going to make the still-substantial sales forces employed by Big Pharma look unviable. A vicious, downward spiral is threatened. As it happens, GSK is as well placed as any among the top pharma companies to withstand these pressures. Part of JP's legacy is what looks to be an exceptionally healthy pipeline of promising new products. In theory, it therefore doesn't have as big a problem with patent expiry as others. The share price tells a more worrying story.

Last of the GEC legacy is taken out

I'm not sure I'd like my pension to be managed out of the tax haven of Guernsey, but that looks like being the fate of 63,000 former GEC employees. After Marconi went bust, they bizarrely found their pension schemes left in the hands of a tiny little technology services company called telent. The only redeeming feature of these arrangements was that the fund seemed to be in surplus and £500m was put into an escrow account against the possibility of any shortfall.

Ever since, financiers have dreamed of getting their hands on this money. Now Edmund Truell's Pension Corporation has succeeded where others have failed. Assuming the pensions regulator doesn't step in to stop him, his £398m acquisition of telent together with its £2.5bn of pension assets and liabilities looks a done deal. By managing these assets better through a stronger company, which is financed rather differently, Mr Truell hopes eventually to persuade the regulator that he can tap into the escrow. It seems an undignified end to the last remaining bit of Lord Weinstock's legacy, but that's the creative destruction of capitalism for you.