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SMITHKLINE -- "IF YOU CAN'T LICK 'EM, BEECHAM": MERGER OF DRUG BUSINESSES, BREAKUP OF NON-DRUG OPERATIONS COULD BE WAY OUT OF MARKET PLAY FOR SMITHKLINE

Executive Summary

SmithKline's defense against the turmoil and uncontrolled future as a Street play may hinge on the prospects of a merger with Beecham. Several recent moves by SmithKline make that deal appear more feasible -- including SmithKline's recent decision to break with KabiVitrum and exit the thrombolytic therapy field, clearing away any potential conflicts with the pending Eminase application. Beecham's interest in SmithKline has been a favorite Street rumor for months. It reached the headline stage at the end of March with a major midweek story in SmithKline's hometown paper, The Philadelphia Inquirer. A March 29 story, relying on an unnamed source, said that talks had occurred but stalled over the issue of eventual control. Merger mania was heightened on Friday, March 31 with a report from Beecham that it had hired the merger specialists Wasserstein Perella & Co. as financial advisers. Those reports drove SmithKline's stock up sharply on Friday to close at 60-7/8, up 5-1/4. There is no clearly discernable end-point or deadline for major decisions on SmithKline's future. The continued speculation in the stock is keeping the heat on and could push the issue to a flash point. If the speculation cools and SmithKline stock plummets, it would make control of the company's future more problematic for current management. For any deal to come to fruition between SmithKline and Beecham, a structure will have to be found to appease the short-term speculator pack on SmithKline's heels and to create a milieu for the long-term development of a newly merged Rx business. The Wasserstein Perella (previously the top guns at First Boston) merger group hired by Beecham has the type of reputation to convince the Street that it can satisfy both needs. The key to a Beecham deal appears to be the ability of the two companies to raise substantial amounts of cash from spinoffs and divestitures of non-drug businesses. If sufficient cash can be raised from businesses such as SmithKline's Beckman Instruments and the clinical labs operations, then a merged Beecham-SmithKline might be able to buy off the short term speculators with a special dividend or another kind of one-time payout. The merger itself would probably not produce enough excitement or short-term payback to satisfy the current investment enthusiasm. SmithKline also has a jewel in Allergan. However, the status of Allergan execs within the company and the obvious fit for of that business in a plan based on a pharmaceutical grand scheme probably make it appear a divestiture-of-last-resort. SmithKline has been saddled in the financial community with the image of a vulnerable floundering leviathan during the last nine months. A good case, however, could be made that the company has slowly been making progress toward changes which would allow it to effect a merger with a suitor like Beecham. During the recent months, the company has begun to get control of its key products and eliminate redundancies and product conflicts with Beecham. Most recently, SmithKline wrapped up its Kabikinase arrangement with KabiVitrum. That deal would have been an obvious impediment to a Beecham merger, conflicting with one of Beecham's most bally-hooed pipeline products, Eminase. The SK&F-Kabi streptokinase deal was unveiled with fanfare in late 1987, coinciding with the market's first blush of excitement over new thrombolytic therapies and indications. It was folded with an unheralded letter to the trade two weeks ago on March 15. A SmithKline spokesperson said that the discontinuation of the agreement with Kabi "generally speaking is consistent with our restructuring of resources." Fenoldopam, under development by SmithKline for the treatment of congestive heart failure, was to have been included in an eventual joint venture with Kabi. SmithKline will apparently be getting back the rights to that research compound. An NDA was filed for it in December. Similarly, SmithKline has been wrangling with Bristol-Myers for months to recover complete marketing rights to OTC cimetidine. With its OTC strength, a merged Beecham-SmithKline would logically want full rights to such a product. Looked at as pre-merger preening, SmithKline's cuts in recent months, including top management, could also facilitate the first stages of fitting that are necessary in the merger of large ongoing operations. SmithKline is laying off roughly 1,600 employees and closing its Spring Garden Street manufacturing plant in Philadelphia. The company also has granted more autonomy to its non-drug units -- Allergan eye and skin care; SmithKline Bio-Science Labs, its clinical testing subsidiary; and Beckman Instruments diagnostics. As part of the independence effort, SmithKline recently offered 16% of Beckman Instruments stock to the public. For Beecham, the merger would provide the quantum leap in size in the pharmaceutical business that the newly recruited U.S. top management has indicated as a primary goal. Beecham appears to have a better pipeline than SmithKline. Intriguingly, some of Beecham's development compounds (such as in the 5HT receptor class) are in competition with Glaxo. Those Beecham compounds layered onto an effective U.S. sales operation like SK&F could present a threat to Glaxo's product line in the middle of the next decade. Beecham execs have been aggressive in telling the outside world about their interest in a wide range of deals to build the company's pharmaceutical business. In late November last year, the company said it is actively seeking a number of outlicensing projects ("The Pink Sheet" Dec. 5, p. 5). In addition to Beecham, some merger watchers continue to keep an eye on Roche based on its interest in Sterling in 1988. A Roche attempt on SmithKline would be complicated by the lucrative Glaxo/Roche co-promotions. However, the company's interest in an acquisition and its latitude of movement as a closely-held Swiss firm buoy speculation. The Roche Labs exec committee recently journeyed to Basel headquarters; but the trip was reportedly to celebrate the birthday of a senior Swiss official.
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