When the medicine cabinet is bare, it is time to go shopping. Cash-rich pharmaceutical companies that find they are running short of blockbuster drugs have decided it makes sense to go looking for another company with attractive products.
They've turned 2009 into the year of the pharma megadeal:
Pfizer Inc., with generic competition for its popular cholesterol drug Lipitor expected in 2011, agreed to acquire Wyeth to expand into vaccinations and biologics. It also gains drugs whose patents expire further into the future.
Roche Holding AG struck a deal to buy the remaining 44 percent stake of Genentech Inc. that it didn't already own. This gives it a full grasp on that biotech firm's prolific drug pipeline.
Merck & Co., facing patent losses of its major drugs Cozaar and Hyzaar in 2010 and Singulair in 2012, agreed to purchase Schering-Plough Corp. It gains potential blockbuster drugs in cardiovascular and rheumatoid arthritis treatment.
Besides adding profitable new drugs to replace those soon to lose sales to generics, such deals usually help diversify companies by adding product lines less dependent on traditional research. Most experts believe the dealing isn't over.
"With their big patents expiring, pharmaceutical companies need more `shots on goal' in product development, and these acquisitions will allow for that," said Linda Bannister, health-care analyst with Edward Jones & Co. in St. Louis. "Mergers also allow them to cut back their sales representative staffs, as well as move forward with their best drugs rather than simply duplicate those of competitors."
Because it is difficult to accurately predict dealmaking and what new drugs will be approved and become profit centers, an investor should construct as multifaceted a health-care portfolio as possible, Bannister said.
Her typical investor portfolio would include large pharma stocks such as Eli Lilly & Co. and Pfizer, a generic drugmaker such as Teva Pharmaceutical Industries Ltd., a devicemaker such as Medtronic Inc. and an orthopedic company such as Stryker Corp. Other holdings she considers worthy are Johnson & Johnson and Abbott Laboratories.
To add the bright promise of biotechnology but spread out its volatility and risk, she recommends the exchange-traded fund SPDR S&P Biotech.
That ETF tracks the Standard & Poor's Biotech Select Industry index of 27 stocks from the S&P Total Market index. Although the fund includes a few established biotechnology firms, nearly half of the companies in its portfolio don't have drugs on the market.
"Every drug introduced has to be a $1 billion blockbuster to support the spending on research and development that went into it," said James Molloy, pharmaceutical analyst with Caris & Co. in Boston. "Pharmaceutical companies have the cash and the capacity to take on additional companies that might be a good fit or will deliver a new portion of the market for them."
The slower regulatory process of recent years has taken its toll on new discoveries and added to the desperation of companies whose reputations were built on popular drugs. The steady demand for pharmaceuticals and the aging of the Baby Boomer generation continue to bode well for the industry, but companies cannot escape patent expirations and generic competition.
"Drug development drives pharmaceuticals, and there hasn't been a whole lot of that development for five years," said Les Funtleyder, health-care strategist for Miller Tabak & Co. in New York. "There are companies that need drug pipelines, and there are smaller companies that have it."
Although pharmaceutical firms have consolidated for a long time, megamergers don't always create greater shareholder value, Funtleyder said. Drugs are an innovation business, and mergers won't help unless they lead to new products, he said. Nine out of 10 drugs fail, and it is crucial to produce successes to make up for those failures, he said.
Exchange-traded funds are gaining popularity as a means of diversifying risks of the pharmaceutical industry.
SPDR S&P Pharmaceuticals, an ETF that tracks an index of the 22 pharmaceutical firms in the S&P 500, is recommended by both Funtleyder and Molloy. Finally, Molloy recommends iShares Dow Jones U.S. Pharmaceuticals, which is an index fund that measures performance of the U.S. pharmaceutical market, and PowerShares Dynamic Pharmaceuticals, which includes 30 U.S.-based drug stocks chosen quantitatively.