Pfizer’s Acquisition Strategy: Will Pfizer Still Go For A Big Acquisition? (Part 1 of 2)

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We believe that Pfizer (NYSE:PFE), which is still the largest pharmaceutical firm in the U.S., is at the cusp of making a major strategic decision. The company is facing strong competition from generics which has resulted in a sharp revenue delcine in recent years. Its recently failed bid to acquire AstraZeneca to revive the growth and reduce the costs does beg the question:  will the pharmaceutical giant attempt another big acquisition or will smaller acquisitions and collaborations suffice? If the answer to this question is ‘big acquisition’, then which companies can be potential targets besides AstraZeneca? Based on the company’s history, its strategic focus and management philosophy, we believe that a big acquisition may be in the cards. In this analysis we will touch upon these points, and follow our post with another analysis in near future discussing potential acquisition candidates.

Our price estimate for Pfizer stands at $35, implying a premium of about 15% to the market price.

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Pfizer’s Corporate History Suggests That A Big Acquisition Is Due

Pfizer has a long history of making big acquisitions. Even though its CEOs have initially taken a position against deploying a strategy of acquisition to drive growth, they have inevitably made some of the industry’s biggest business purchases. In 2000, Pfizer acquired Warner-Lambert for $112 billion primarily because it didn’t want to lose the control of Lipitor, which went on to become one of the highest selling drugs the pharmaceutical industry has ever seen. In 2003, Pfizer bought Pharmacia for $60 billion in stock. This acquisition was driven by its interest in blockbuster Arthritis drug Celebrex. In the year 2009, the company made another acquisition. This time, the target was Wyeth for which Pfizer paid a price of $68 billion. The rationale behind this move was not a single product, but cost synergies and portfolio diversification.

It has been more than 5 years since then. Looking at Pfizer’s acquisition history, its recent attempt to acquire AstraZeneca, and the fact that Pfizer is facing a crunch when it comes to drugs with strong potential for growth, we feel that the company may still continue to try for a big acquisition. It certainly has the market credibility to finance such a deal. At the end of Q3 2014, Pfizer had net cash balance of around $6 billion. While this is certainly not enough, we believe that Pfizer could raise enough debt and structure rest of the deal in stock if a prospect of a big acquisition were to emerge.

However, one should keep in mind that considering that pharmaceutical industry in general is facing growth pressure and a decline in R&D productivity, companies may not be much inclined to go for deals that are heavily financed by stock instead of cash.

Pfizer’s Market Dominance Could Be At Risk, A Big Acquisition Will Ease The Concern

Although Pfizer is still the biggest pharmaceutical firm in the U.S. by revenues, its sales have declined from $67.8 billion in 2010 to $51.6 billion in 2013 due to the loss of patent exclusivity of some major drugs, including Lipitor. We expect the figure to further come down to $49.65 billion in 2014. The continued impact of generic competition, as well as the expiration of certain co-promotion agreements for drugs such as Enbrel, have weighed on the company’s revenue growth this year. Pfizer had pinned its hopes on some recent drug launches, but the market adoption has been rather slow. For example, its kidney cancer treatment drug Inlyta and lung cancer treatment drug Xalkori have seen weak sales over the last few years. The kind of pricing and negotiating power that the company enjoyed over the large decade could fade if the situation doesn’t improve soon.

Except for oncology and the Prevnar/Prevnar 13 franchise, Pfizer’s revenues, in our view, are likely to fall across all sub-segments including cardiovascular, immunology, metabolism and musculoskeletal. It is clear that that there is company-wide pressure on revenue growth and one or two segments can not make up for that. It this seems plausible that the company is interested in acquiring a company with a broad and growing portfolio of therapies, or at least with enough growing products so as to offset the overall revenue decline. For instance, AstraZeneca’s drug pipeline could have been the answer to Pfizer’s problems. AstraZeneca’s management is targeting a growth of 75% in its revenues by 2023. Earlier this year, the company presented promising clinical trials data on two of its experimental drugs for the treatment of lung cancer. The peak sales for each of these drugs have been estimated to be between $3.0 billion and $6.5 billion. [1] Overall, the company expects to launch 10 new drugs in the next seven years.

A big acquisition can ease Pfizer’s concerns over market dominance and consequently, over the pricing power of its drugs.

Large Scale Synergies Can Quench Pfizer’s Thirst For Cost Savings

One of the rationale behind an acquisition of large magnitude is cost savings that result from the streamlining of operations and removal of redundant processes. Cost synergies big enough to meaningfully lift Pfizer’s value can only be realized with a big acquisition. Pfizer seems to be showing some interest in this area. Let’s take the example of its recent attempt to acquire AstraZeneca.

The acquisition of AstraZeneca could have provided an opportunity for Pfizer to shift its headquarters to the U.K., thus resulting in a lower tax rate and significant savings that would boost its earnings. A 6% to 7% reduction in its tax rate could potentially help Pfizer save up to $1 billion. Additionally, Pfizer states that it only keeps 10%-30% of short-term funds in the U.S. tax jurisdictions, with the remaining funds kept overseas. Repatriation of these funds in the U.S. would have implied a significant tax liability for Pfizer. The company wanted to circumvent this issue by shifting its tax base. Although the recent changes in the U.S. tax rules seem to have nullified this advantage, there is no doubt that Pfizer wants to stick to some financial discipline. In fact, its current CEO has created a lot of shareholder value since he took over and a large part of that has come from cost optimization and financial discipline. We believe that Pfizer will continue to scout for viable candidates which can offer significant cost synergies.

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Pfizer Gets Drug Approval For Hot Flashes, Targets 33 Million Women In The U.S.

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The FDA recently granted approval for Pfizer’s (NYSE:PFE) Duavee, which has been developed by its wholly-owned subsidiary Wyeth in collaboration with Ligand Pharmaceuticals Inc. [1] The drug introduces a novel approach to treating hot flashes in menopausal women, and is also approved for the treatment of postmenopausal osteoporosis (common bone disease due to low estrogen levels). Unlike other drugs in the market, Duavee pairs conjugated estrogen (CE) with an estrogen agonist/antagonist (also known as a selective estrogen receptor modulator). The drug has the advantage of protecting uterus lining against hyperplasia, which increases risk of cancer of uterine lining and can happen with estrogen-only treatments. [1]

Given the reduction in cancer risk, we expect the drug to gain traction. There are approximately 33 million women in the U.S. between the ages of 45-59 (menopausal), and most of them experience hot flashes. [1] The quality of life can get significantly affected if this common condition is left untreated. Pfizer’s existing drug Premarin, which primarily consists of conjugated estrogen, earned over $1 billion in revenues in 2012. We expect Duavee to cannibalize some of Premarin’s sales starting from the first quarter of 2014. Furthermore, given that Pfizer is a well diversified company with several other major drugs, Duavee’s success will lead to only a small incremental value add.

Notes:
  1. AstraZeneca shares fall after Pfizer walks away from deal, The Guardian, May 27 2014 []