In common with other European sectors, pharmaceuticals is often influenced by market confidence in the corresponding stocks in the US. Worries about Medicare issues hit investor confidence at the beginning of the year, and that combined with the hi-tech investment frenzy made for a disappointing beginning to the year. This plateau was replicated in Euroland, although some biotech start-ups did benefit from the performances of the euro.NMs.
As the year has gone on, however, US investors seeking a defensive sector, after the hi-tech shakeout, have seen pharmaceuticals show good quarter on quarter profit growth, and confidence has returned. The news in July that the US government might use the law to crack down on expensive drugs worried the market, however. The senate finance committee’s proposal to extend drug coverage to all 39m Medicare beneficiaries saw share prices fall. Goldman Sachs said that the proposal supported a “neutral at best” stance towards the sector, and the major shares were hit in London.
Although Europe has shadowed this relative recovery, the reasons behind it are completely different, and reflect a major shift in the industry. The bounce-back has been led by mid-cap stocks, rather than the heavyweight members of the sector, meaning that the performance has not been quite as strong.
Worries about the merger and acquisition plans of the bigger players have caused investors to question their future, but Philippe Cattet, senior analyst at Credit Lyonnais in Paris suspects that the moves may be misunderstood. “When large companies such as Glaxo Wellcome and SmithKline Beecham are asked why they are considering merger, they usually reply that it is a question of consolidating their research and development (R&D) departments.” The argument runs as follows; R&D has to be done on a worldwide basis in order that products can be launched simultaneously across Europe, the US and Asia. As Cattet points out, however, most of the innovative work is currently done by small start-ups.
“In the US a large company will work with small Bio-Tech start-ups in clusters. In Europe the larger companies do not adopt this approach. Despite what they may say in public about R&D the real reason for mega-mergers is the opportunity to cut administrative and sales costs. This is more easily done across Europe, where work is duplicated in separate country headquarters. The savings found there allow companies to invest in marketing drives in north America, which is still the most attractive market,” he said.
European companies are able to put pressure on their US counterparts due to such consolidation, and also because the strength of US firms is based on the R&D successes of the 1980s. Many of these drugs are now about to go out of patent with accompanying problems. With Europe’s R&D successes coming in the 1990s, they face no such generic threat.
The interest in biotech start-ups has been pronounced over the past few months, with companies benefiting from renewed investor enthusiasm. “People have made money in dot.coms and they are not sure about the future,” said David Porter, director of Nomura’s health care team. “They don’t want to go back into classical old economy stocks, they want something else in the new economy.” On the back of this enthusiasm last month Pharmagene became the first biotech start-up to float on the main market in London since 1988. Aim and Nasdaq have also seen new entrants in the past few weeks with substantial sums being raised.
Nevertheless biotech shares remain volatile, having peaked in March at the height of the hi-tech boom. Many analysts believe, however, that the market is not getting carried away, and that there will remain a good supply of money for quality companies, especially with institutions taking a long-term view of the sector. This may lead to the kind of consolidation and merger among smaller biotech companies that we have seen among the larger players.
“Earnings delivery cross the sector looks very good,” says Cattet. “That is based on the fact that European companies are delivering more new products, achieving savings from mergers, and using those savings to exploit the American market. Even if that market is less profitable than in the past, it will still be better than Europe.”