Bayer’s $14.2 billion Merck buy shows pharma strategy split

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What’s an $11 box of Claritin worth to a global pharmaceutical conglomerate?

Quite a lot, apparently. The allergy medicine is among the Merck & Co. over-the-counter products for which Bayer AG agreed to pay $14.2 billion Tuesday. The latest in a series of big pharma deals, it exposes a deepening split in the way drugmakers approach their portfolios.

Bayer is in a growing group moving into brand-name treatments that can be sold straight to consumers, things like pain pills, cold drops and bunion pads. Others have held back, preferring to stick to the higher-margin, higher-risk business of developing new drugs for deadly diseases like cancer.

In the long run, diversification may give the biggest drugmakers a more dependable stream of revenue to pour back into research, said Hans Bishop, a former Bayer executive who now leads oncology biotech Juno Therapeutics.

“It’s a conscious risk-management strategy,” Bishop said. “When you get big in pharma, it’s difficult to make your pipeline deliver predictably.”

By owning different businesses, Bishop said “you immunize yourself against those peaks and troughs.”

Over-the-counter and elective products also face less interference from payers and regulators, while strong brand recognition makes people willing to pay for them out of pocket, said Thomas Rudolph, a senior partner at McKinsey & Co. in Stuttgart, Germany.

High-margin Botox

That’s especially true for high-margin dermatology and aesthetics products such as Botox -- technically a prescription medication but widely used electively -- which is driving Valeant Pharmaceuticals International Inc.’s unsolicited $45.7 billion bid for Allergan Inc., he said.

“Big pharma is looking for more de-risked portfolios,” said Manfred Scheske, the former head of GlaxoSmithKline Plc’s consumer unit in Europe who now runs Infirst Healthcare in London. Along the way, he said, they’re vying with so-called “fast-moving consumer goods” companies such as Procter & Gamble Co. and Reckitt Benckiser Group Plc.

Reckitt, which dropped out of the race to buy Merck’s assets, will “continue to be a predator,” Scheske said.

Market leaders

For now, the world’s biggest pharmaceutical companies dominate the list of leading over-the-counter drugs makers. Tuesday’s deal solidified Bayer’s spot at No. 2, according to Euromonitor International. A joint venture announced April 22 between Novartis AG, the biggest drugmaker in the world by sales, and Glaxo, the U.K.’s biggest, will sit at No. 1.

Johnson & Johnson, Sanofi, Pfizer Inc., Boehringer Ingelheim GmbH and Taisho Pharmaceutical Co. are also in Euromonitor’s top 10. None has more than 5 percent of the global consumer health market.

“It’s an exceptionally fragmented market,” Helena Strettle, a London-based analyst for Sanford C. Bernstein Ltd., said before the latest deal was announced.

Today’s breakdown of market share won’t stay that way for long, Strettle said, predicting industry aggregation. “The shares at the moment aren’t hugely important; it’s how the industry will look going forward.”

The consumer business is all about branding and merchandising, she said. That’s another reason scale helps. And pharmaceutical companies may need to pay up to participate.

Prized assets

“You can see that these are pretty highly prized assets,” Sanofi CEO Chris Viehbacher told investors after the French company reported earnings on April 29, citing the prices then said to be in play for the Merck unit. People familiar with the talks had said at that point that the unit could fetch more than $14 billion.

The price Bayer wound up agreeing to pay works out to 21 times earnings before interest, taxes, depreciation and amortization. That’s more than twice as expensive as Bayer itself, according to Sam Fazeli, a London-based analyst for Bloomberg Industries.

Among those happy to sit out the bidding war are Roche Holding AG, the world’s biggest cancer-drug company, as well as U.S. pharmaceutical makers Eli Lilly and Co. and Bristol-Myers Squibb Co. Pfizer weighed whether to get rid of its consumer-health business in 2011, deciding to keep it.

“This business is not necessarily as profitable as the high-end innovation, for example, on the oncology side,” said Norbert Hueltenschmidt, a Bain & Co. partner and head of the firm’s health care practice in Europe, the Middle East and Africa. “What you are seeing is a little bit of a matrix that companies need to manage. Where do they go into more high-risk innovation? Where do they go into more predictable revenue streams?”

Merck investment

Merck said it would put the money from selling its over-the-counter business into new drugs, including the experimental MK-3475, which uses the body’s immune system to fight cancer.

Bayer has said a portfolio of new drugs including blood thinner Xarelto and eye medicine Eylea will eventually generate more than $10.4 billion in annual sales. But its target is also to be No. 1 in consumer health, Bayer CEO Marijn Dekkers has said.

“I would say every five to seven years you see sort of a flurry of merger and acquisition activity,” Dekkers told journalists on a conference call yesterday, referring to the past month of dealmaking and not only to Bayer’s announcement.

Looming patent expirations drove the last deal cycle, Dekkers said. “In this case it’s driven by companies really wanting to focus on that which they are good at.”


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