M&A deals slowly starting, says Barclays Wealth

Amidst the gloom and doom, life does go on. Deals continue to made, some of them large. Look for example at the pharmaceuticals sector. In the last few months there have been three major deals announced, note Barclays Wealth analysts. Earlier this year, Pfizer revealed a $68 bln bid for Wyeth, and Roche a US$46 bln offer for the remaining minority holding in Genentech. Earlier this week, Merck announced a $41 bln takeover of Schering Plough.
Five of these six firms are US-based, which should come as no surprise. As Barclays Wealth analysts have noted before, US pharmaceuticals have underperformed their European counterparts by quite a margin over the last year. Various factors have piled on the pressure for rationalisation in their “big pharma” world. Some of these are long-standing, notably the lack of new potentially big-selling drugs coming through the development pipeline. This is at a time when many existing drugs are reaching the end of their patent protection period. Merck, for example, faces imminent patent expiration on lucrative existing asthma and blood-pressure treatments.
Merck will covet some of the drugs currently in the Schering Plough’s pipeline, notably some promising hepatitis C and blood clot approaches. Merck also has deeper pockets to fund development than Schering Plough. But even if these drugs do not yield big future rewards, the acquisition should give scope for cost savings, at a time when overall sales are coming under pressure. In recent weeks, uncertainty over the new US healthcare plans – and its implications for spending levels has provided a further incentive for consolidation.
Within Europe, there is clearly the potential for some big mergers, although it isn’t yet clear whether we will follow the US example. But, even if we don’t, these US mergers probably have positive implications for the share prices of their European peers. Any bidding war for Schering Plough (there have been rumours of a possible counter-bid from Johnson & Johnson, for example) would be a positive. It would place higher value on pharmaceutical assets, depressed in recent years by the factors outlined above.
In fact, Barclays Wealth analysts think that the valuations on pharmaceuticals are undemanding, even if the outlook remains challenging for them. Remember that these big pharmaceutical firms still have reasonably dependable cash flows and strong balance sheets – as is evidenced by the availability of cash to help fund these deals. In the UK pharmaceuticals sector, we would highlight AstraZeneca, which is currently trading at a price of under 6 times the consensus forecast for its 2009 earnings. GSK also looks attractive as well, although we reckon that it doesn’t offer such a good prospects for share price gain. In Europe, we continue to think highly of Roche and Novartis.
So while we don’t thing that big-scale mergers and acquisitions are necessarily going to become a feature of the European scene, we do think that consolidation in the US could make current pharmaceutical valuations look extremely attractive.