Outlook: Glaxo's Garnier struggles under mountain of patent lawsuits

Interest rates; Stagecoach
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The Independent Online

Forget drug discovery, the pharmaceuticals industry seems these days to be much more about patent protection than research and development. Rarely does a day goes by without news of some new lawsuit. The smaller drug companies accuse the bigger ones of stealing their products, the big ones accuse the generics of patent infringements, and the larger companies quarrel among themselves about who's copying what. The only people guaranteed to make money out of the legal merry-go-round are the lawyers who specialise in this obscure branch of the civil law.

Forget drug discovery, the pharmaceuticals industry seems these days to be much more about patent protection than research and development. Rarely does a day goes by without news of some new lawsuit. The smaller drug companies accuse the bigger ones of stealing their products, the big ones accuse the generics of patent infringements, and the larger companies quarrel among themselves about who's copying what. The only people guaranteed to make money out of the legal merry-go-round are the lawyers who specialise in this obscure branch of the civil law.

Yesterday brought news that Pfizer is suing Eli Lilly and GlaxoSmithKline (GSK) for allegedly using one of Pfizer's proprietory ingredients in the dash to develop alternative products to the anti-impotence drug, Viagra. The case is only the latest in a burgeoning mass of similar lawsuits. Some of them are serious, but many are essentially just try-ons, designed to illicit what Glaxo's chief executive, Jean-Pierre Garnier, calls "go away money".

Most of these cases occur in the land of the frivolous lawsuit, the US, but as the pressure from health authorities around the world for ever lower drug prices grows, they are becoming more common elsewhere too. Even when the defendant is on strong ground, it often costs less to settle out of court than to fight the case, which is why GSK has decided to start making provision for patent settlements against profits.

It was this charge that provided the real surprise in third-quarter figures from GSK yesterday. The shares fell more than 6 per cent on figures which, although broadly in line with expectations, contained the unexpected nasty of a £145m provision for paying off litigants. Mr Garnier, or JP as he likes to be known, suggests the figure is more of a one-off than an ongoing charge, but he's not prepared to be definite about it, and in the absence of specific reassurances, the market is beginning to fear the worst – that GSK has become saddled with a £500m a year operating expense that wasn't there before.

The merger of Glaxo Wellcome with SmithKline Beecham, now nearly two years old, cannot be described as an unmitigated success. The merger seems to have delivered on most if not all its cost cutting promises and there's no denying that the combined monster is throwing off cash like there's no tomorrow. But there is little sign so far of the great outpouring of product discovery which the merger's architects anticipated. As a percentage of sales, the research and development budget is being cut, presumably for the purpose of boosting the bottom line. Meanwhile, the company is spending more by an order of magnitude each year on share buybacks than it is on R&D. That hardly bodes well for long-term earnings growth.

None of this is really JP's fault. The pharmaceuticals market is simply a lot tougher than it was even two years ago as governments, employers and insurers attempt to grind down their health care costs, and it can reasonably be argued that Glaxo and SmithKline would be in much worst shape today had they remained apart. Even so, the pipeline of future products seems to consist too much of copycats and product enhancements. Not until a new blockbuster appears on the horizon will investors be convinced that GSK has returned to the growth stock status which the merger promised.

Interest rates

Ever since I've been in financial journalism, and probably from long before as well, commentators have tended to depict the economy as poised on a knife edge, with the interest rate decision particularly difficult to call and the fiscal judgement never harder to make. The explanation for all this angst is obvious enough. Nobody knows what the future holds, and the idea that everything is about to go horribly wrong often seems all too plausible. Every policy decision therefore takes on an enormity which, with the benefit of hindsight, it really didn't deserve.

It is therefore amusing to see that in minutes published yesterday to the Monetary Policy Committee's last meeting, the interest rate decision was described as being particularly "finely balanced". This time, of course, it really was true. The decision had never been more difficult, not since the last time anyway, and as if to prove the point the MPC was split, with three members voting for a cut but the majority carrying the day for no change.

The arguments are well rehearsed. The economy continues to look pretty sick, despite some resumption in growth. The only thing that's really holding it up is consumption, which in turn is being buoyed by the strong housing market. Cut interest rates again and it might put a further rocket under house prices, which should help maintain consumption in the short term, but plainly cannot be sustained for ever. The longer it goes on, the more likely it is to end in tears.

Furthermore, maintaining the boom in consumption is bound eventually to prove inflationary. The general assumption is that inflation is pretty much extinct, but just look at the yield on 10-year bonds, which has crept up from 4.4 per cent to 4.7 per cent in the past three weeks, and you can see that the capital markets are beginning to have doubts. The quid pro quo for a further cut in short-term interest rates may well be a rise in long-term rates. In such circumstances it is not clear the MPC will have achieved very much.

I argued strongly for a further cut in the repo rate ahead of the last MPC meeting, but actually the economy has turned out to be a bit stronger than I thought it was. Meanwhile wage claims are growing, particularly in the public sector, taxes are rising, further increasing the pressure for compensating pay rises, and the public finances are showing worrying signs of leaving the rails again The MPC may have been right to leave rates unchanged.

Stagecoach

Brian Souter has made a personal fortune out of Stagecoach, the business he launched 22 years ago as a cheap and cheerful alternative to the train.

But for shareholders who climbed on board when the company floated 13 years later, it has been a story of riches to rags. Yesterday's profits warning, the fourth one since Mr Souter over-extended himself with the £1.2bn purchase of Coach USA, has left the shares sitting at an all-time low. From a peak in 1998, the company has lost 95 per cent of its value.

Stagecoach owed its early good fortune to Mrs Thatcher's deregulation of the UK bus market, a policy which enabled it to scoop up bus companies left right and centre and launch ruthless price wars against anyone who dared step on to its territory. As Mr Souter once admitted: "Don't misunderstand me, ethics are not irrelevant, but some are incompatible with what we have to do because capitalism is based on greed."

For the last three years Stagecoach has been a poor advertisement for capitalism. Stagecoach's mesmerising growth was largely built on acquisitions, but then, as ever, came the deal too far. The acquisition of Coach USA in 1999, funded by a monster rights issue, has proved Mr Souter's nemesis. The deal began to go wrong almost as soon as the ink was dry.

It took only eight months for Stagecoach to sound the first profits warning. Since then it has been responsible for a further three profits warnings and a £375m hole in the balance sheet. It has also claimed the scalps of two chief executives, forcing Mr Souter reluctantly back into the driving seat. The review of Coach USA, due in December, promises to dismember most of Mr Souter's American empire, leaving him to concentrate once again on his core UK bus and train businesses.

With a badly deflated share price and £725m of debt, there are questions about whether Mr Souter can keep the show on the road. He points to Stagecoach's highly cash-generative UK operations, and poo-poohs any suggestion that he's going bust. But to many it sure does feel that way.

jeremy.warner@independent.co.uk

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