P&G DEEP POCKETS AND DIFFERENT "HERITAGE" ARE UPSETTING WALL STREET’s VIEW OF PROSPECTS FOR OTC INDUSTRY: ARE ANTACID MARGINS HARBINGER OF WARS TO COME?
Procter & Gamble's reputation for high ad budgets and lower margin demands is shaking Wall Street's traditional image of steady and sustainable market shares and profit margins in the OTC drug business. In two separate presentations on the financial community's view of the OTC business at the Non-prescription Drug Manufacturers Association annual meeting May 7-8, P&G's recent acquisitions and alliances were referred to as a potential cloud on the OTC business prospects and a precursor of destabilizing attacks on the existing OTC business by large outside firms (see related story, page 13). Looking at the "darker side" of the entrance of larger firms like P&G, Francis Morris, senior equity analyst for the DuPont Pension Fund, raised the spectre of margin pressures. As "more powerful companies with the dollars to spend come in, one wonders [about the future] when you have a business with very high profit margins and you start to get into some marketshare battles," Morris said. None of the existing companies in the OTC business, Morris predicted, is "going to give up market-share easily...until your margins in your part of the business start to slide a little." Similarly, Morgan Stanley mergers & acquisitions principal Conrad Meyer observed a recent "small caution" about short-term "potential profitability pressures in the OTC business." Meyer told a session on how the financial markets value businesses in the OTC industry that "as we have seen an increasingly concentrated and powerful group of participants, in the OTC business, it probably stands to reason that we will see some more competitive pressures in the business." Meyer referred to the image of deep pockets and competitive spending power noting that the entrance of companies with "a somewhat different heritage" and possibly "different views of acceptable short-term levels of profitability" is likely to change the "competitive landscape." The first signs of the effect of new competition, Meyer noted, are visible in the antacid area, where J&J-Merck (Mylanta) and P&G (Maalox) are fighting for new positions. "I think this really all comes home, as you are quite aware, with some of the developments that we are seeing in the antacid area -- where at least temporarily the margins have been depressed, Meyer observed." The key issue, Meyer noted, "is whether these pressures are short-term pressures as people settle down into market shares that they are comfortable with or whether it presages a longer term trend of pressures on profitability." Viewing the P&G acquisition activity in the OTC business as part of a trend, DuPont's Frank predicted more pressures on the OTC market through the 1990s. "I see companies coming in through mergers and alliances that are big spenders and all trying to carve out a niche in your business," he told NDMA. I think you are going to have to protect against that. I think that is going to provide some very interesting and significant competition." The new entrants are bound to create some dislocations in the industry, but the predictions of long-term changes in spending and profit patterns may be premature. P&G's corporate ad-to-sales spending ratio across its $21 bil. in sales is generally believed to be about 7.5%. That compares to a corporate ad-to-sales ratio for American Home Products in 1988 of about 8.5% on one quarter the total volume. P&G's pretax profit margins in the laundry and personal care businesses are believed by Wall Street analysts to be in 10-11% range. Those margins compare to 27% operating profit margins for Beecham's OTC drug business prior to the merger with SmithKline. While the effects of new companies coming into the OTC business are now beginning to catch the attention of the financial community, the dominant investment community view is still focused on the attractiveness of the industry -- especially in the context of the relation of the OTC business to the ethical/Rx drug business. DuPont's Morris noted that "securities buyers" are beginning to question how far the ethical companies can maintain the profit improvements of the 1980's. "My own opinion," Morris said, "is that ethical companies are starting to run out the string -- if it has not already run out. So we need a source of more predictable, more sustainable earnings growth. That is where [the OTC industry's] opportunity comes in. I think it is your turn." The long product life of consumer promoted brands is weaning some analysts away from the pure ethical drug businesses. Bear, Stearns Senior Managing Director Joseph Riccardo told the NDMA meeting: "In my opinion, the importance of balance of OTC is critical to survival" of pharmaceutical firms. Riccardo referred numerous times to Warner-Lambert's $250 mil. Listerine as the epitome of product stability. "You could sell Listerine for 400 years," he declared. "It sells itself: 90% gross margin." Riccardo contrasted that longevity to the limited patent lives of major prescription brands. Morgan Stanley's Meyer noted that the recent successes in the prescription drug business actually feed the perceived need for balance between Rx and OTC businesses. "The last five to ten years has also been an unusually productive period for new product development" on the ethical side, Meyer observed. "As we move forward over the next five or ten years," the Morgan Stanley mergers specialist said, "there is potentially a real product shortage on the ethical side of the businesses. It is going to be very difficult for many houses to repeat the successes that they have had over the last five or ten years in that sector." Robert Friedman, managing director at C.J. Lawrence, Morgan Grenfell, countered the predictions of possible price wars with a global view of the market, stressing the untapped areas. "There is too large a market on a global basis to see price wars or marketshare wars having an impact on corporations if you look [at results] on a consolidated basis," Friedman said. While the cutthroat competition may "happen in particular market inches," Friedman said, "I do not believe that we will see it on a global basis." Friedman emphasized the international nature of possible mergers. He recounted working with a would-be acquirer of Pennwalt against the eventually successful Fisons bid. "One has to ask why did Fisons pay up significantly from our perspective," Friedman said. "I would suggest that it was because they saw a platform and they had OTC brands." Riccardo was pressed to name the U.S. "middle market" companies that might become available based on a lack of balance in their business. He suggested Lederle Labs, Upjohn and Syntex. "Look at a company like Lederle Labs of American Cyanamid," Riccardo said. "I would suggest that it could not compete long-term against Bristol-Myers Squibb, Merck, Lilly, Pfizer. That would be my opinion." He noted that was probably the reason behind the recent mergers by the dominant management at Marion and Squibb and the reason for the sale of Sterling to Kodak. "Upjohn has two major products with patent expirations in 1993: Halcion and Xanax," Riccardo noted. Those products are "big, big profit contributors." He pointed out that it would "be nice for Upjohn with those products coming off patent to have a Listerine, or Seldane, or more help to offset that situation." Similarly, at Syntex Riccardo noted a lack of balance and dependence on one product. "Syntex has a product that has sales in 1990 of $800 mil. Naprosyn is Syntex," Riccardo declared. He estimated that it probably will contribute about "$350 mil. after taxes" this year.
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