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PAR AND BOLAR ARE "F-D-C" INDEX WINNERS IN 1987; MERCK AGAIN LEADS RESEARCH/BRAND FIRMS; INDUSTRY VIEWS OWN STOCKS AS BARGAINS AFTER FALL(ITEM 010)50(2): 14-22

Executive Summary

Two generic firms, Par Pharmaceuticals and Bolar Labs, were among the major stock success stories in the pharmaceutical industry in 1987. Both issues showed strong net gains in trading over the previous year and strength against the ebb following the market's fourth-quarter debacle. Par stock, up 10-1/8 for the year to 19-7/8, jumped 96% on the depth of its combined injectable and oral lines. Bolar, up 8-7/5 to 18, advanced over 80% riding the coattails of the firm's approval for the first generic version of Dyazide. Of the other 45 stocks listed on the "F-D-C" Weekly Index, only Robins (up 12-5/8 to 20-1/2), turned in a better performance, its price increasing over 160%. Currently in reorganization under Chapter 11, Robins was actively courted by at least four suitors in 1987. Alza, with a full-house of NDAs pending for products it developed, also had a big percentage gain over 1986. Closing at 26-7/8, the "therapeutic systems development" firm had a net gain of over 44% in 1987 trading, on top of a 21% gain in 1986. After almost two decades of leadership by the founder Alejandro Zaffaroni, Alza's operating management shifted during the summer of 1987. The firm is now headed by Chairman Martin Gerstel and President Jane Shaw. Merck and Marion also continued their recent strong year-to-year gains: Marion with a net gain of almost 30% for the year and Merck almost 28%. However, because of the declines they suffered along with the rest of the market in the second half of the year, their positive performances paled in comparison to Par and Bolar. Par's move from the NASDAQ to the New York Exchange in 1987 may have helped the company's visibility within the financial community. Despite a record number of ANDA approvals in 1986 and a strategic move into the generic injectables arena, Par's stock price declined 8% that year. The firm's Quad subsidiary received ANDA approvals for 24 different molecular entities, including 10 post-1962 drugs, while Par itself had 16 different drugs approved as ANDAs. Par appears to be on its way toward becoming a $100 mil. company in 1988, nine years after its founding. Sales approximately doubled in fiscal 1987 (ended Sept. 30), from about $39 mil. the previous year to $78 mil. During the same period, net earnings increased over 130% -- $4.6 mil. to almost $11 mil. Par noted in its most recent annual report that the company's five-year average return on equity has been 37%. Both Par and Bolar stock prices have also shown resilience since the market's top-out last summer. Bolar's 1987 close was about 26% below its yearly high; Par's about 27%. The declines were slightly less than that of the Dow Jones average, which fell 29% from its 1987 high, and among the best performances of issues listed on the Index. In general, the publicly listed drug companies lost ground more rapidly than the leading market indices during the final four months of 1987. Against the trend, Bolar's stock price doubled in the third quarter, when the company became the first to receive an ANDA approval for a triamterene/hydrochlorothiazide combo in the same formulation as SmithKline's Dyazide. FDA's Aug. 21 approval took the "Street" by surprise, although there had been indications several months prior that FDA was losing patience with SmithKline's protracted exclusive position with Dyazide based on low bioavailability ("The Pink Sheet" Feb. 23, p. 10). The August Bolar approval caused the stock to jump seven points in one day, adding market valuation to Bolar during the quarter equivalent to about half of Dyazide's total $300 mil. annual U.S. sales. Only two years earlier Bolar stock had been reeling under the effects of an FDA-ordered recall. A comparison of Bolar and Par to other generic issues in the "F-D-C" Index highlights the market's focus on company specifics and not an unquestioning, across-the-board approval of the generic industry. On the downside for the year, Mylan dropped 2-7/8 (to 8-1/4) and Zenith dove 5-1/2 (to 3). The surest way to catch the financial community's interest is to get the first generic approval for a major brand or to keep a steady flow of new ANDA approvals. Another effective strategy is to establish a niche specialty, as has Biocraft (up 1 to 16-1/2) in the antibiotics area. One current valuation of an ongoing generic specialty business is carried in the documents on the proposed Sanofi purchase of control in Robins. In supporting material for Sanofi's offer, Robins estimates the value of its Elkins-Sinn generic injectables business at $376 mil. -- for a business with sales probably in the $100 mil. range and current sales problems. Elkins-Sinn sales declined 16% in the third quarter of this year. Mylan, one of the largest of the generic companies at about $100 mil. in sales, has had its recent fortunes tied to Maxzide, a triamterene/hydrocholorthiazide product marketed by Lederle. The sudden competition with Bolar's generic version of Dyazide negatively affected the market's view of Mylan. Maxzide's own exclusive position evaporated at the end of 1987 with an ANDA approval and successful patent challenge by Vitarine. In addition to the product produced by Vitarine, a number of generic versions of Maxzide should enter the market in the spring of 1987. While Zenith had a number of first-time ANDA approvals in 1987 and made a move into generic injectables, the company is still recovering from 1986 manufacturing compliance problems and a subsequent FDA recall of over one-third of its product line. Since last summer, Zenith has been trying to restructure its short-term obligations while trying to negotiate the sale of certain production facilities. One of the Wall Street proponents of the generic industry in 1987, Swergold Chefitz drug analyst Jerry Treppel, noted in a report issued in late October that generics have been the fastest growing segment of the pharmaceutical industry over the past three years. Putting the current generic business in the U.S. at $4.7 bil., Treppel estimates that volume will reach $8.4 bil. by the early 1990s. The generic industry's share of the U.S. prescription market could grow during that period from 27% to 35%. Treppel views the near-term shortage of new oral products available for ANDAs as a phenomenon that will cause more manufacturers to expand into already crowded products lines and thus lead to increased pricing pressure. Examples include the recent moves by Par and Zenith into injectables and the entry of a major brand-name company, Squibb, into the generics market. One result of such a trend, he believes, would be the acquisition or shut-down of regional tablet and capsule producers. "The scenario we envision suggests that the industry will begin to shift away from its commodity business origins into more value-added products," Treppel concludes. "In essence, the two major segments of the pharmaceutical industry are expected to become more like each other." If the market decline in the fall hit the major drug companies disproportionately, it also stimulated the trend toward self-investment by the firms and stock buy-backs. Prices for many major pharmaceutical stocks rode the bull market during the first half of 1987, reaching their historical peaks by mid-summer. The drugindustry took advantage of the price softening in the second half of the year, particularly after the market's 500-point drop on Oct. 19, as an opportunity to repurchase shares at bargain prices. Merck, for example, capitalized on the opportunity and completed a major $1 bil. share repurchase announced at the market's mid-summer zenith. The company completed the program before year end, purchasing approximately 5.7 mil., or 4%, of its roughly 140 mil. outstanding shares. Squibb took advantage of the market's third-quarter turmoil with the repurchase of 2.4 mil. shares of common stock. That figure represents more than 4% of its total shares outstanding. Similarly, SmithKline (up 1 to 48-1/2) repurchased about 4 mil. shares, or about 3% of its outstanding stock in 1987. With few products emerging from its R&D pipeline in the near term, the company is squeezing consistent growth out of its existing businesses, in particular Dyazide and Tagamet. As part of its commitment to steady growth, SmithKline has been aggressively using its strong balance sheet and price increases to maintain that growth. Other drug firms taking advantage of a retreating market to announce share buybacks in the second half of 1987 included: Lilly (up to $1 bil. worth); Rorer (1 mil. shares); Schering-Plough (6 mil. shares); Upjohn (7.5 mil. shares); American Home Products (5 mil. shares); Baxter (8.5 mil. shares); Bristol-Myers (25 mil. shares); Forest (2 mil. shares); Sterling (3 mil. shares); and Warner-Lambert (6 mil. shares). SmithKline joined the complicated world of pharmaceutical cross-licensing and cross-marketing in 1987 with a deal to enter the thrombolytic market with KabiVitrum's streptokinase product, KabiKinase. More recently, the firm recently swapped U.S. comarketing rights to OTC cimetidine with Bristol-Myers in exchange for a second-generation H[2] antagonist in late development. SmithKline is also working on a deal for co-marketing of Tagamet by DuPont. A potential side effect of the numerous co-marketing deals among drug companies could be a disruption of Wall Street's short-term view of the industry. The complications that these arrangements add to projections for individual companies may make revenue and earnings projections for individual companies more troublesome. Because of the new players, specific market segments will be more difficult for analysts to track, and the typically secret royalty or marketing fee arrangements will make revenue predictions more problematic. Merck will begin 1988 with one of the more interesting co-marketing agreements to watch: the agreement with ICI to market two brands of the second-generation ACE inhibitor lisinopril. Merck is risking a slowdown in its successful ($500 mil. worldwide) first-generation product Vasotec and letting the aggressive ICI into the ACE business. Merck will get rights to an aldose reductase inhibitor, ponalrestat, from the deal. Up 34-5/8 to 158-1/2, Merck remained among the top-performing Index issues. Merck stock, which traded as high as $223 per share at mid-summer before closing the year with a solid 28% advance, was also one of the issues least affected by the market's autumn fall, losing about 29% of its value. The depth of Merck's R&D pipeline and the company's ability to move drugs predictably through FDA, combined with the emergence of Chairman Roy Vagelos as a business personality in the limelight, made Merck one of the top stories in U.S. industry in 1987. For the second consecutive year Merck was voted the most admired firm among 306 firms in a Fortune magazine survey of 8,000 individuals. The business press found Vagelos, and his background in research, a convenient way to convey the positive side of the drug research story in personal terms. While that telling may be good for the industry as a whole by drawing attention to the new product potential in the industry, the creation in the media of a cult of personality at Merck undervalues the significance, longevity and overall strength of Merck as an organization. Squibb, Merck's head-to-head competitor in the ACE class and a predicted competitor in the cholesterol-lowering HMG CoA inhibitor class, prospered through much of the year with the financial community. Squibb was up a net 4 points to 61. Squibb remains one of two drug companies -- Merck is the other -- to carry the Value Line investment survey's highest ratings for both safety and timeliness. "With Capoten, plus other heart drugs now in research and joint ventures likely to keep earnings on a 20-25% growth path, this stock's three-to-five year appreciation potential appears good," Value Line analyst Rudolph Carryl writes. Carryl projects Capoten's 1988 sales at $825 mil., up from $675 mil. in 1987, despite stiff competition from Merck's Vasotec and the two brands of lisinopril. Another market favorite with a dominant brand in the cardiovascular market, Marion (up 5-5/8 to 24-1/2), authorized a 2 mil. share repurchase program in the third quarter, of which slightly more than half was completed by year end. Marion's 30% runup in 1987 made it a leader among brand name companies. However, the pace was well off the stock's 247% price growth during the 1985-86 two-year period. Marion's P/E, which had been in the 40 range over the last two years, declined with the market in the second half of 1987, dropping into the low 30s. Marion's 1987 closing reflected a 40% devaluation from the stock's yearly high-water mark. In 1988, as sales of the company's flagship product, Cardizem (diltiazem), approach $500 mil., the calcium channel blocker could receive an added push if FDA broadens the drug's indication to include mild to moderate hypertension. Marion may also be closing in on a more convenient dosage form of Cardizem. Its development partner on a twice-daily version, Elan Pharmaceuticals, says the new dosage form is near approval. New products continue to fuel investor trends, with many products within one year of marketing already fully valued, or over-valued, by the market. Lilly, for example, added a third of its value in 1986, primarily in anticipation of the antidepressant Prozac (fluoxetine). At the end of 1987, the company got the approval for fluoxetine and a heart drug and is close to approval for an H[2] antagonist ulcer drug. However, the imminent launches were less enticing than the prospect was a year earlier. For 1987, Lilly had a net gain of 5%. Its close at 74-1/4 was off more than 32 points from its high mark of the year. One cloud on Lilly's horizon is competition for its oral cephalosporin Ceclor from Glaxo and Roche with Ceftin (cefuroxime), approved in December. Another company with a major introduction in the near future also lagged in the market runup. Through the first half of 1987, Schering-Plough (up 7-1/2 to 47), for example, had achieved earnings growth of at least 20% in each of the previous six quarters. As of September, the price of Schering stock was riding up at a slower rate than other drug companies (about 30%). "This unglamorous valuation has been related to the company's lack of a 'blockbuster' product," Goldman Sachs analyst David Musket suggested. At a recent analysts meeting, Schering President Richard Kogan predicted that the non-sedating antihistamine (which is in a class of Schering's traditional strength) could eventually add $200-$300 mil. annually to the firm's worldwide pharmaceutical business. Warner-Lambert stock, up 8-7/8 to 67-1/2, received a late-year life after publication of the long-awaited Helsinki Heart Study. Results of the five-year study of more than 4,000 subjects with elevated cholesterol showed a lower incidence of heart attack in patients taking Lopid (gemfibrozil) than those receiving placebo. The Helsinki study is key to Warner-Lambert's efforts to expand the labeling of Lopid, and the company has made public plans to file quickly for a cholesterol-lowering/heart-disease prevention indication for the product. Such an indication would likely increase sales of Lopid well beyond the current $80 mil. level. However, the company stands to lose patent protection in 1989. Lopid is the only patented product currently marketed by Warner-Lambert, and the company is lobbying heavily to have the patent extended another five years. A safe haven during the market's turmoil appeared to be Bristol-Myers (up 3/8 to 41-5/8), a company with a strong balance sheet and an established presence in both the anticancer and consumer products areas. Through its Genetics Systems subsidiary, Bristol-Myers is bidding for an exclusive license to market two anti-AIDS compounds, as well as developing an AIDS vaccine. Bristol's experience in the cancer field as a licensee of developmental compounds from the National Institutes of Health could also help the firm's efforts in the AIDS area. In 1986, American Home (off 4-1/8 to 72-3/4) was forced to reevaluate its new drug development effort, when the company's NDA for Alredase (tolrestat), a new class of antidiabetic agent, was rejected by FDA. In 1987, American Home merged its Wyeth and Ayerst divisions into one operating entity. Combined with an increase in R&D spending, the move is intended to increase productivity in that area and begin to fill the gaps left by Inderal's patent expiration. Despite the second-half beating for pharmaceuticals, Index issues overall fared better in 1987 than the market at large. The Index Composite, which closed the year at 964.9, managed a 6.8% increase despite the market uncertainty in the second half. By comparison, the Dow Jones average closed at 1938.83, a positive move of 2.26% for the year. During the summer, the Dow had closed as high as 2722.42. The dollar's decline in 1987 has helped drug firms in terms of their non-U.S. sales. Typically, 40-60% of the volume of U.S.-based multinational firms occurs in foreign markets, and this business segment has been helped by a falling dollar. In announcing financial results during the year, Merck, Squibb and Upjohn, to name a few, all cited the positive effects of the declining dollar on their foreign operations. If the dollar stays low, companies like these may choose to place greater marketing emphasis outside the U.S. The low stock prices and a low dollar are of most importance to the industry as a stimulus for overseas investment in U.S. pharmaceutical companies and potential buyout offers. Hoffmann-LaRoche's $4.2 bil. cash offer for Sterling on Jan. 4 elicited immediate response from the market and a spate of predictions about other potential targets. The last time a low-market and low-dollar coincided in the late 1970's, several major foreign companies made first steps into the U.S. market -- Bayer with Miles, Nestle with Alcon, and Boots and Glaxo with smaller businesses. During the last quarter, Sterling (up 8-3/4 to 55-1/8) began to appear on the buy list of several brokerage houses, however, the fundamentals were in place before then. Very early in 1987 Vanguard Special Health Fund manager Edward Owens recommended Sterling, noting that the stock had then been trading below the market multiple. He added that the company's size, the smallest of the major drug firms, made it potentially vulnerable to a takeover. Roche's offer had the effect of a massive capital infusion into the industry, recovering some of the lost ground from 1987 and perhaps making defense against other offers a bit easier because of the higher starting costs for unsolicited offers. Among those speculating on other hostile moves, Prudential-Bache analyst Neil Sweig said: "The odds have greatly increased that there will be another hit or two." Not only are market conditions conducive, Sweig noted, but competition has become keener for deal managers, with commerical banks now going head to head with investment bankers. "The world is becoming more and more hostile," the analyst observed. Smith Barney analysts Rick Stover and Adele Haley told clients on Jan. 5 that "in the current environment, we anticipate valuation upgrades for the drug stocks across the board, with the possible exception of Merck [because of its size] as investors anticipate similar scenarios" to Sterling. Recently, Pfizer (off 14-3/8 to 46-5/8) has been a subject of the takeover rumor mill. Despite the drop in the price of Pfizer stock, the company currently carries a $9 bil. market valuation, which would have to be sweetened for a successful acquisition. S. G. Warburg analyst Viren Mehta estimates that it would take over $15 bil. to purchase Pfizer. Pfizer, ironically, may have brought some of the takeover talk on itself through its relations with the financial community. The company's aloof attitude toward the financial community may have subtly contributed to efforts to put the stock in play. The more probable acquisition targets, according to Mehta, are, in ascending order based on the size of the deal: Rorer; American Cyanamid; Warner-Lambert; Schering-Plough and SmithKline. These companies could fetch $1.2 bil. to $12.5 bil., with the smaller firms the more likely first targets. His list also includes Erbamont (off 4-1/8 to 18), which has announced that it is for sale. Charts omitted.
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