View From City Road: Leschly takes a big mouthful

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The Independent Online
Jan Leschly has never made any bones about his desire to turn SmithKline Beecham into a company with tentacles in every corner of health- care. The speed at which he is betting the company is none the less beginning to raise eyebrows.

In May, fresh from slipping into his new role as chief executive of the drugs company, he announced the dollars 2.3bn purchase of Diversified Pharmaceutical Services, a US pharmaceutical benefit manager (PBM).

Now comes the dollars 2.9bn purchase of Sterling Health, transforming SmithKline overnight into the world's biggest purveyor of over-the- counter medicines of the like of Milk of Magnesia and Panadol.

Even for cash-generative businesses such as drug companies the resulting gearing of up to 300 per cent and debts of more than pounds 3.2bn looks a mouthful.

His strategy is digestible enough, though. PBMs make their money buying drugs as cheaply as possible from pharmaceutical companies on behalf of latterly pennypinching healthcare providers. By acquiring a PBM, SmithKline can substitute for profits squeezed out of prescription drugs - by PBMs - and pick up essential patient treatment data into the bargin.

Sterling is also about responding to more straitened healthcare circumstances. The average cost of a visit to the doctor in the US is dollars 45. So healthcare providers like the idea of persuading as many people as possible to treat themselves. And, for drug companies, OTC products provide a useful way of continuing to make money from successful drugs when they come off patent.

So the logic seems faultless enough, even though it is still unproven. What about price? On the one hand, while at three times sales and about 18 times earnings, it looks reasonable, SmithKline is diversifying from profit margins of 30 per cent on its prescription drugs to about 17 per cent on OTC products. (No one knows what sort of margins PBMs might throw up; the market is as yet too immature to judge.)

But the sum of the healthcare whole is arguably worth more than its individual constituents: ethical drugs feeding OTC products as they come off patent; PBMs feeding essential information on the efficiency of ethical drugs, and so on.

Given that interest cover will still be a very comfortable 20 times, the risk is more one of red faces in hindsight for paying more than necessary rather than losing the company. Hence the market's predisposition to give Mr Leschly the benefit of the doubt. His task now will be to eschew the thrills and spills of wheeler-dealing in favour of milking his purchases for all they are worth.

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