I N V E S T M E N T D E A L E R S ’ D I G E S T
APRIL 15, 2002
r e ho
By Laura Santini
xecutives at Bristol, Tenn.-based King Pharmaceuticals Inc. are in the pink these days. From
King’s beginnings in 1994 as a family concern with $14 million in sales making pills for the big
pharmaceuticals, it has morphed into a publicly traded company with an $8.18 billion market cap
by selling brand-name drugs it buys from Big Pharma.
Turning the castoffs of the big guns into gold may seem an unlikely strategy, but so far it is work-
ing. These days the bulk of King’s revenues, which totaled $872.3 million in 2001, come from the sale of 40
different drugs it has purchased from companies including Warner-Lambert (now part of Pfizer Inc.), Eli
Lilly and Co. and Bristol-Myers Squibb Co. King’s roster of products treat hypertension and hormone defi-
ciencies, among other ailments.
King’s pioneering transformation from manufacturer to marketer—with 500 salespeople—coincided with a
shift among the major drug makers toward so-called blockbuster drugs, or those racking up at least $1 bil-
lion in sales annually. With large-cap drug companies and biotech companies focused on the development
of blockbusters, King seized the opportunity to buy drugs with sales ranging between $50 million and $100
million. Its strategy, in a nutshell, has been to snap up these products from the major drug makers and then
boost sales by marketing them more aggressively.
Now droves of so-called specialty pharmaceuticals companies are chasing King’s prescription for success.
Wall Street is hyper over the possibilities, and no wonder. The strategy of these companies is perfect for
investment bankers. Because these companies primarily buy drugs from others, they are constantly in the
market raising capital, which they quickly deploy in M&A activity.
Like King, these specialty pharmaceutical companies aim to buy lesser-selling products from major drug
makers and double or triple sales by applying their own highly focused sales teams. The companies tend to
concentrate on smaller-market treatments in areas such as dermatology, ophthalmology, women’s health
But can King and its followers sustain the type of heady growth that investors have come to expect from
them? Notwithstanding the King success story, and Wall Street’s enthusiasm for the burgeoning financing
opportunities in this area, some doubt lingers as to whether many of these enterprises will be able to survive
long-term in the drug business without in-house research and development teams to create new products.
“It’s easy to do the first couple deals, but then it gets harder for a company to sustain growth,” says one
investment banker, requesting he not be quoted so as not to turn off potential clients. “These companies are
marketing machines. They do modest development, but most have not been successful as developers.”
Adds Peter Crowley, head of by Xcel Pharmaceuticals Inc. has been held up part-
healthcare at CIBC World ly due to the flap over Elan, as Elan’s sale of two
Markets, “There are a lot neurology products to Xcel is part of an accounting
of specialty pharmaceuti- investigation of the company, bankers say.
cal wannabes that
aren’t of critical mass Blockbuster mania
to grow their business The big-cap drug companies’ fixation on block-
in the future.” busters, which took hold following the mega-merg-
In addition to ers of 2000, has certainly given the specialty phar-
murky growth maceuticals industry a lot of room to maneuver.
prospects, specialty In 2000, when Pfizer Inc. moved to acquire
pharmaceuticals have Warner-Lambert Co. in a $91.5 billion hostile
been tarnished recently by takeover, edging out a lesser bid by drug rival
the high-profile woes of American Home Products Corp., the landscape
Shire Pharmaceuticals Plc began to change. That same year, Glaxo Wellcome
and Ireland’s Elan Corp. In Plc merged with SmithKline Beecham Plc in a $78
late February, Shire warned billion deal.
that generic competi- Pfizer’s market capitalization today stands at
tion for Adderall, $244.9 billion; Glaxo SmithKline’s is $146.4 billion.
its treatment for Merck & Co. Inc. is valued at $126.8 billion. Eli
attention deficit Lilly and Company and Bristol-Myers Squibb Co.
disorder, would are valued at $85.43 billion and $62.42 billion,
force the compa- respectively. And more mega-mergers are expected;
ny to hike spend- weeks ago, Bristol became the subject of takeover
CIBC’s Crowley: ing on marketing; rumors among investors.
‘There are a lot of specialty the pre-earnings As the big-cap pharmaceuticals business gets big-
release caused ger, opportunities abound for companies that want
Shire’s shares to to concentrate on niche drugs. “For Merck, a $100
sink by nearly million product represents less than 1% of sales.
one-third. At Elan, the company’s off-balance-sheet Yet, it is expensive to maintain drugs,” says Paul
financing has come under regulatory and investor Donofrio, an investment banker focusing on spe-
scrutiny, in the wake of Enron Corp.’s collapse. Since cialty pharmaceuticals for Banc of America
A s the big-cap pharmaceuticals business
gets bigger, opportunities abound for
companies concentrating on niches.
uncertainty about Elan’s accounting practices sur-
faced, its shares have plunged by more than 70%.
Securities. Even if no further R&D is conducted for
a particular drug, there are marketing, manufactur-
Uncertainty over Elan’s financing threw a spot- ing and compliance costs associated with maintain-
light on accounting practices at other specialty phar- ing these drugs, Donofrio explains.
maceutical companies, namely Biovail Corp. and “A couple of years ago, a large-cap drug company
Galen Holdings Plc, based in Northern Ireland. might have held onto these products, but now there
“When one company stumbles, it puts a negative are other companies eager to get their hands on
cast on the entire sector,” says Thomas DeRosa, co- them,” Deutsche Bank’s DeRosa says.
head of global healthcare at Deutsche Bank. And Such drugs—with annual sales between $50 mil-
there have been other ramifications in the capital lion and $100 million—are becoming the raw materi-
markets. For instance, an initial public offering filed als for a new crop of specialty pharmaceutical com-
panies. By applying a sales force focused on only one IPO led by Credit Suisse First Boston. “I
field, say dermatology, the companies seek to boost give credit to King Pharmaceuticals for
sales, sometimes doubling or tripling the revenue. starting the product acquisition
A look at the strategies of Bristol-Myers and King trend,” says John Hudson, head of
illustrates the point. Desperate to fend off the threat healthcare at Wachovia Corp.
to its bottom line posed by generic drug companies, In 1998 alone, the company
Bristol-Myers signed a landmark $2 billion agree- acquired 15 branded pharma-
ment with biotech company ImClone Systems Inc., ceuticals from Warner-Lambert,
whose prostate cancer drug, Erbitux, promised to in addition to buying Altace,
rise to blockbuster status once regulatory approval from Hoechst Marion Roussel
was granted. (now Aventis SA). A year
The terms of the Bristol/ImClone deal grabbed the later, King acquired the antibi-
attention of Wall Street and investors and under- otic Lorabid from Eli Lilly. In
scored the desperation of Bristol-Myers to secure a 2000, the company bought
future pipeline of billion-dollar products. (When the another specialty pharma concern,
Food and Drug Administration initially rejected Jones Pharmaceuticals, in a stock
ImClone’s Erbitux application, Bristol-Myers stock transaction valued at $3.4 billion,
was roiled, and its future prospects appeared grim, again hiring CSFB as its adviser.
leading to the recent merger speculation.) The purpose of the deal was to
At the same time, the drug behemoth has sought add products to King’s
to shed smaller products, selling four brand-name lineup, bankers say.
drugs to King Pharmaceuticals for $286.5 million. “We’ll acquire any
The drugs—Corzide and Corgard, both beta block- product that we can
ers used to treat heart patients, Delestrogen, an promote into the pri-
estrogen replacement therapy, and Florine, a corti- mary care market,” BofA’s Donofrio:
costeroid for treating patients with Addison’s dis- says a King ‘Earnings are more predictable
ease—complemented King’s roster of cardiology, spokesman.
women’s health and endocrinology treatments. Unlike many spe-
for companies with products
Indeed, King’s biggest product, Altace, is an ACE cialty pharma com- because development is risky.’
inhibitor used for treating hypertension. panies, King doesn’t
“A $100 million product is considered tiny by a shy away from competing with big drug companies
large-cap company, but it probably generates 80% in a major market. King’s biggest seller, a hyperten-
gross margins: probably $40 million in pretax sion drug, falls within cardiovascular treatments, a
profit and $25 million in earnings,” esti- major market. But King applied a unique sales
mates Ben Lorello, head of healthcare strategy—make the pitch to primary care
at UBS Warburg. In this particular physicians, not just cardiologists.
deal, Bristol-Myers approached Today, most prescriptions for King’s
King, and the two companies nego- hypertension medication,
tiated terms without the help of an Altace, are written by primary
investment bank. care physicians. The com-
Meanwhile, to continue its promotion pany follows the same
of Altace, King launched a direct-marketing strategy for all its drugs.
campaign last month featuring golfer Jack King’s growth has
Nicklaus and is projecting sales of between $400 spurred other specialty pharma-
million and $500 million (a 40% to 75% increase) ceutical companies, which previously
for 2002. may have concentrated exclusively on generic drugs
or drug delivery mechanisms, to replicate the com-
Acquisition Frenzy pany’s product acquisition model. “People have
King’s aggressive acquisition strategy was aided looked at King and said, ‘Why can’t I do that?”
by the cash it earned from its 1998 $87.5 million Wachovia’s Hudson says.
Because R&D is minimal at $52.5 million in cash to purchase the Prenate line
specialty pharmaceutical com- of prescription prenatal vitamins from Sanofi-
panies, their most important Synthelabo Inc., which reported at the time that
resource, bankers say, is a the products generated $16.6 million in 2000. A
management team that is few months prior to the acquisition, First Horizon
well connected to the large- raised $77.2 million in a follow-on equity offering
cap drug industry. Contacts underwritten by Banc of America, J.P. Morgan and
become even more important Thomas Weisel.
as competition for products Enormous increases in drug consumption are
heightens. CIBC’s Crowley notes also contributing to hikes in acquisition prices
that when Dura Pharmaceuticals demanded by big-cap pharmaceutical companies.
Inc. (acquired by Elan in 2000) In 2001, the pharmaceuticals industry in the U.S.
bought the dermatology business generated between $125 billion and $185 billion
from Glaxo, it was bidding against in sales, according to estimates by Wachovia.
35 contenders. Compare that with approximately $80 billion in
Prices for products are also on the sales raked in by the industry in 1998. Brand-
rise, a result, some bankers say, of name products continue to drive spending, despite
more recent deals, such as inroads by generic companies and prescription
King’s acquisition of Jones. benefit managers to coax doctors and pharmacies
Bankers say big-cap to switch to generic versions. For instance,
pharmaceutical com- although 42% of overall prescriptions were for
Essex Woodland’s Currie: panies these days generic drugs in 2001, they represented only 8% of
total sales last year, according to Wachovia’s data.
‘There is so much money; the have an edge in ham-
mering out product For some clue as to the wealth of products avail-
shortage is not capital but acquisition terms. able for possible acquisitions by specialty pharma-
good management.’ “Large-cap pharma ceutical companies, consider that of the top 1,200
has a lot of cash. That drugs on the market in the U.S., only 200 bring in
gives them an edge sales over $100 million. According to Banc of
because they aren’t as desperate, plus there is now America, those 200 products constitute around 70%
more capital chasing after opportunities to acquire of overall drug sales. If big-cap drug companies
products,” says Stan Blaylock, co-head of global intend to focus primarily on the upper echelon of
healthcare banking at Deutsche Bank. the drug market, specialty pharmaceuticals could
As competition for these products heats up, potentially capture anywhere from $41.25 billion to
investment banks are called upon not only as $61.05 billion in drug sales, bankers estimate.
M&A advisers, but also as lenders and underwrit- Greater demand by consumers is not the only
ers. Take Roswell, Ga.-based First Horizon element driving up acquisition costs for specialty
Pharmaceutical Corp., another aggressive acquirer pharmaceutical companies. A product’s patent life
of drug company products. In May, the company also factors into the size of a deal, Banc of
will launch hypertension drug Sular, for which it America’s Donofrio says. The longer the patent,
paid AstraZeneca $185 million. The deal was the higher the asking price. Development poten-
funded by a bridge loan from First Horizon’s tial can also jack up the price. If a specialty phar-
investment banker, Deutsche Bank. maceutical company has the capability to refor-
First Horizon, with 13 branded products for mulate a product or change how it is delivered to
treating hypertension, gynecological conditions the patient, the owner of the drug may negotiate
and gastroenterological disorders, also has a shelf more aggressively. Finally, existing sales figures
registration for a follow-on offering of 6.5 million play a role. “If you’re going to take a product that
shares. Deutsche Bank, Banc of America, J.P. wasn’t selling before, you need a good sales force
Morgan Chase and Thomas Weisel Partners are to convince doctors to think differently now,”
named as underwriters on the deal. Donofrio says, explaining that many drugs target-
In 2001, First Horizon was similarly aggressive ed by specialty pharma are not promoted by exist-
on the financing and acquisition front. It paid ing big-cap drug parents. Their sales reflect doctors’
willingness to prescribe the product without a for- maceuticals analyst at Wachovia Corp.
mal pitch or marketing material. Although 50 mg and 100 mg capsules
Enter private equity already existed, Medicis sold 75 milligram
Even though costs may be going up, there’s no Dynacin by arming its sales reps with
shortage of money available. A healthy portion of it data showing greater effectiveness with
is coming from private equity funds. “Specialty the changed dose, Tong says.
pharmaceuticals is very significant for us,” says Jim
Currie, senior partner at Essex Woodlands Health Development Conundrum
Ventures. Investing around $30 million in the sec- Oddly, specialty pharmaceutical com-
tor, Currie’s fund has provided financing to several panies not involved in heavy product
specialty pharmaceutical companies, including development are currently valued higher
Richwood Pharmaceuticals Inc. (now part of by the market than companies with sig-
Shire), PediaMed Pharmaceuticals Inc. and nificant product development in their
Integrity Pharmaceuticals. budgets. Bankers agree that most
“There is so much money in the area, the short- specialty pharmaceutical com-
age is not capital but good management,” Currie panies will insist they
says. “Most business plans are the same old thing: engage in product devel-
an oncology team from some big company wants to opment to avoid being
start up a specialty pharma company and contract a perceived as primarily
sales force,” he adds.
Currie says he is presented with a greater number
“drug marketing firms.”
Differences abound among
UBS Warburg’s Lorello:
of business plans for specialty pharmaceutical start- these companies in terms ‘A $100 million product is
ups today than ever before. Because prices on prod- of the resources they are considered tiny by a large-
ucts have risen, he says, it is crucial that manage- willing to commit to prod- cap company, but it proba-
ment possess accurate projections about how much uct development. A typical
sales might be increased under a company’s steward- big-cap pharmaceutical
bly generates 80% gross
ship. For his part, Currie says he looks for an ability company will plow 10% to margins.’
to triple sales within 18 months of an acquisition. 20% of total sales into
Product development is also key, Currie believes. research and development,
Rather than invest in companies whose sole mis- analysts say, so specialty pharmaceutical compa-
sion is to acquire products and then lift sales nies with significantly less than that on their bal-
through a more aggressive marketing ance sheets are considered light on product devel-
campaign, Essex seeks to invest in opment.
companies that rely on a combina- The lower valuations are partly explained by
tion strategy of acquiring and realizing that development costs represent
developing products. a drain on a drug company’s earn-
“I just don’t see the benefit of ings. “Investors tend to be short-
spending $300 million to buy term, and earnings are more
products without developing predictable for companies
one’s own products,” he says. with products because
After awhile, the acquisition well development is risky,”
dries up as a source of future earn- explains Donofrio.
ings, he explains. “People think, ‘What
In certain instances, specialty pharmaceutical does a specialty pharma
companies also develop a drug further to make it company know about
more “patient-friendly,” lowering the dosage or cre- research?’” CIBC’s Crowley says.
ating a patch to be used instead of tablets. Medicis Biotech, with its emphasis on break-
Pharmaceutical Corp., for instance, boosted sales of through drugs that eventually will become blockbuster
acne medication Dynacin by creating a 75 milligram sellers, represents a completely different type of invest-
capsule in 1999, cites Michael Tong, specialty phar- ment, bankers in specialty pharmaceuticals maintain.
Bankers are reluctant to discuss Reliant, so the decision to merge the companies
which companies are more driven was anything but impulsive, he suggests.
by product acquisitions than For the moment, financing deals and product
development, for fear of turn- acquisition deals with big-cap pharmaceutical com-
ing off potential underwriting panies is plentiful. Salix Pharmaceuticals Ltd., a
business. specialty pharmaceutical company focusing on gas-
One recent merger of two troenterology, just raised $50 million in equity in a
specialty pharmaceutical deal done jointly by UBS Warburg and Wachovia.
companies has grabbed the Despite the market’s apparent preference for sales
attention of bankers in the initiatives over development, development repre-
sector, particularly because of sents an important component of a company’s long-
the $1 billion price tag for the term growth prospects, Currie insists. Development
target company. Last month of acquired products often helps boost sales, for
Alkermes Inc., a drug delivery instance. In addition, developing new products
company, purchased Reliant lends credibility to a company’s pursuit of market
Pharmaceuticals in a stock share in a particular medical specialty.
deal valued at $1 bil- Finally, some bankers expect that in a few years
lion. The market specialty pharmaceutical companies and biotech
hasn’t greeted the companies will start collaborating. In such a sce-
merger warmly. nario, biotechs would look to specialty pharma
Alkermes’ stock, companies for two things: sales and marketing
trading in the $28 expertise plus the development potential to convert
to $30 range before biotech’s often injectible products into more
Wachovia’s Hudson: the March 21
How all this affects the average consumer is yet
‘People have looked at King lost around 25% of to be played out. Bankers cheer that the marketing
and said, ‘Why can’t I do that?’ its value, trading at muscle provided by specialty pharmaceutical com-
$22.46 April 11. panies helps meet the needs of patients suffering
Peter Reikes, head of healthcare at SG Cowen from relatively rare diseases and disorders. And
Securities Corp., which advised Alkermes, defends some doctors agree. Adds Dr. Dan Dubin, health-
the deal by saying it will bring long-term benefits to care strategist of Leerink Swann & Co. and presi-
Alkermes’ product development initiatives, provid- dent of MEDACorp., a consultant for institutional
S ome bankers expect that in a few years
specialty pharmaceuticals and biotech
companies will start collaborating.
ing the company with Reliant’s existing products investors: “From a doctor’s perspective, it’s a good
and sales force. “The strategic rationale is exceed- thing if specialty pharma companies are focusing
ingly clear-cut,” Reikes says. In December, on underpromoted products that help patients get
Alkermes made a $100 million investment in better.” Wall Street feels the same. IDD
Reprinted with permission of Thomson Media
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