Obama battles big pharma

"We will lower drug costs by allowing the importation of safe medicines from other developed countries, increasing the use of generic drugs in public programmes and taking on drug companies that block cheaper generic medicines from the market." The wording of President Obama's healthcare policy could not be clearer and should send a shiver through the boardroom of every major pharmaceutical group in the world.

For some time, the big players in the drugs market have faced a simple problem. Treatments that the likes of Pfizer, Novartis and GlaxoSmithKline (GSK) have spent years and millions of dollars developing are increasingly coming under threat from the generics companies, which invest nearly as much energy in challenging patents and developing cheaper alternatives. The established groups may consider the generics firms parasitical, but the likes of Barack Obama and the European Commission are tiring of the big beasts hiding behind patents ensuring that healthcare is more expensive to the ultimate user.

The European Commission said in November that the pharmaceutical groups are blocking the entry of new, cheaper drugs on to the market and that this cost EU healthcare providers, including the National Health Service, an estimated €3bn between 2000 and 2007. It added that it "will not hesitate to open antitrust cases against companies where there are indications that the antitrust rules may have been breached."

President Obama also intimated that he will allow Medicare, the US national health insurer, to negotiate directly with drugs groups to set prices, adopting a policy similar to that used in most European countries. Currently, the companies are able to deal with a raft of smaller organisations and take advantage of their scale. "According to independent sources, this could drive down prices by up to 40 per cent [in the US], with savings estimated at $30bn or about 10 per cent of total market value," say analysts at WestLB, who add that the legislative move is likely to come next year.

The drugs giants are slowly starting to concede defeat in the battle against lower drug prices and generic competition. While most will contest individual cases against the generics groups, they recognise that the game is up and an alternative strategy to having bulging research and development departments working on the next blockbuster drug is needed. That is why the world's biggest drugs group, Pfizer, confirmed yesterday that is set to buy its US rival Wyeth for $68bn in a cash and shares deal. Pfizer, which is most famous in the UK for the being the maker of the impotency treatment Viagra, is set to lose patent protection on its blockbuster, $12bn a year, anti-cholesterol drug Lipitor in two years' time and it has been desperate to find alternative revenue sources. Pfizer's move for Wyeth follows a time-honoured trad-ition in the pharmaceutical sector of big companies buying other giants to tap the best selling drugs in a competitor's portfolio: indeed, Pfizer is a past master of the "mega-merger" as industry analysts call it, with the $89bn takeover of Warner-Lambert in 2000, and the $60.7bn deal for Pharmacia Corp in 2003, already under its belt.

But times are changing, say analysts, and with President Obama's election promises still reverberating around the industry, the buyout of Wyeth is simply storing up problems for the future. The ink was barely dry on the agreement yesterday, before industry experts were taking swipes at it. Jeremy Batstone-Carr, head of research at Charles Stanley, said: "There are certainly positives in this deal, most crucially that Pfizer is buying access to the important biologics and vaccines markets. However, by deciding that big is best, Pfizer is only delaying its current problems and buying a portfolio of products that are approaching the end of their patent lives. I cannot imagine that this will lead to a series of tit-for-tat mega-mergers, especially with what Obama has been saying about the generic companies." Mick Cooper, an analyst at Blue Oar, described the deal as simply "deferring the pain".

Others were kinder, but sceptical that the deal would prove a success. Chris Stirling, European head of chemicals and pharmaceuticals at KPMG, said: "Pfizer is in a more precarious position than most [in relation to the loss of revenue associated with Lipitor losing its patent protection], and now is certainly the right time for more deals, especially given the balance sheet power and strong cash positions of most pharmaceutical companies. The problem is that it is difficult to see too many more mega-mergers like this one. They haven't generally worked in the past and there is certainly no reason to think that they will now."

Pfizer's chairman and chief executive, Jeffrey Kindler, was typically upbeat, saying that "the combination of Pfizer and Wyeth provides a powerful opportunity to transform our industry. It will produce the world's premier biopharmaceutical company whose distinct blend of diversification, flexibility, and scale positions it for success in a dynamic global health care environment."

Despite the dual threats of generic competition and hostile administrations, the drug groups have the advantage of being sheltered from the worst of the global recession, given the non-cyclical nature of the drugs market. With most in the envious position of still having the advantage of strong cash flows, the companies are in a position to circumvent the industry's troubles, whether it is by buying big rivals in the case of Pfizer, or targeting more subtle deals in more specialist markets. The UK's biggest pharmaceutical group, GSK, formed in 2000 by the $79bn mega-merger between Glaxo Wellcome and SmithKline Beecham, is shunning the type of deal completed by Pfizer yesterday. Andrew Witty, who became chief executive last May, signalled on taking the job that GSK would target the rapidly growing emerging markets, or smaller companies that worked in GSK's areas of "core competences", such as respiratory disease. While careful not to directly criticise the Pfizer/Wyeth deal, a spokesman said it was "highly unlikely" the company would look for a mega-merger of its own. "It would be necessary to dem-onstrate the value of a mega-merger and Andrew Witty has stated that he does not see that as the best way to go." In recent months, GSK has bought a handful of emerging businesses and announced UK job losses in plants that manufacture treatments approaching the end of their patent protection.

The Anglo-Swedish group AstraZeneca says it is more likely to seek licensing partnerships, rather than engaging in mergers.

Many people are expecting a sea-change from President Obama's new administration. For the global pharmaceutical industry, it may not be a welcome one and with the drugs groups scrambling to find the best way of protecting revenues and breaking into new, higher margin sectors, the market may well see more unlikely merger deals, some of which are certain to be in need of drastic surgery some way down the line.