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Neo-classical theories see mergers and acquisitions (M&As) as efficiency improvement measure taken by the organizations in response to industry challenges such as deteriorating profitability, reducing market share, duplication of resources, stringent industry regulation etc. (Jovanovic and Rousseau, 2002). However, neo-classical theory alone cannot describe a wide range of reasons that force the companies to merge together or adopt an acquisition strategy (horizontal or vertical acquisition) to obtain or sustain a competitive advantage by achieving synergy, diversify business portfolio to distribute risk, attain growth, increase bargaining power with buyers and suppliers or to simply eliminate competition (Marks & Mirvis, 2013).
This paper will discuss the case of biggest acquisition in the pharmaceutical industry with the acquisition of Wyeth by Pfizer in January 2009 for $68 billion, the second biggest acquisition in the history of corporate America since AT&T and BellSouth’s US$70 billion deal in March 2006 (Pfizer, 2009). The acquisition of Wyeth was a cash-and-stock transaction valued, based on the closing market price of Pfizer’s common stock on the acquisition date, at $50.19 per share of Wyeth common stock (Pfizer, 2009). At the time of this acquisition Wyeth was generating $22.4 billion in sales with a bottom line of $4.6 billion and Pfizer generated net revenues of $48.3 billion and the net income of $8.1 billion (Pfizer, 2008). The completion of acquisition in October 2009 made Pfizer the largest pharmaceutical company in the world with potential savings of $4 billion from the usage of common resources and elimination of inefficiencies in the supply chain.
However, under this deal Pfizer had to repatriate billions of revenue dollars from foreign subsidiaries to the US, resulting in higher tax costs and waste of value (Pfizer, 2009). This merger was also criticized by Harvard University Professor Gary Pisano, who commented on this news “the record of big mergers and acquisitions in Big Pharma has just not been good. There’s just been an enormous amount of shareholder wealth destroyed” (Karnitschnig & Rockoff, 2009).
A quick comparison of the two companies at the time of announcement of acquisition is shown in figure-1 and various aspects of this acquisition and the benefits reaped by Pfizer are critically analyzed in the following sections.
Figure 1 – Comparison of Pfizer and Wyeth in 2009. Source: Karnitschnig & Rockoff (2009)
The biopharmaceutical industry is a major source of medical innovation, where R&D drives the success of the company and also constitutes almost 17-25% of its expenses (Danzon, 2014). The pharma industry is highly competitive due to stringent regulations and longer times to market their drugs as they seek approval from relevant governmental agencies (for example Food and Drug Administration – FDA in the USA) that set the safety, efficacy and quality of manufacturing as a prerequisite to market the drug to consumers (Danzon, 2014). Other industry challenges include the loss or expiration of intellectual property rights that allow low cost generic brands to enter the market and drive down the prices, the pipeline productivity, pricing and access pressures and increasing competition among branded products (Pfizer, 2009).
So, in response to these challenges in the operating environment Pfizer made an attempt to strengthen its market position by acquiring Wyeth that enabled the company to diversify its product portfolio with the inclusion of vaccines, biologics, small molecules and nutrition across developed and emerging markets. This synergistic effect is shown in figure-2.
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Figure 2 – Synergies from the acquisition of Wyeth by Pfizer. Source: NYTimes (2009)
Despite the criticism surrounding the merger of two pharma giants and the unfavorable economic conditions amid global economic downturn, the Wall Street and the major banks supported this is acquisition because of beneficial market position and lent $26 billion to support the acquisition deal (NYTimes, 2009). With this acquisition, Pfizer has consolidated its position as the market leader by entering previously untouched market segments pertaining to oncology, pain, inflammation, Alzheimer’s disease, psychoses and diabetes, as well as the critical technologies of vaccines and biologics. This acquisition will also help Pfizer to achieve its aim to become the top-tier biotherapeutics company by 2015 and it will also gain growth in emerging markets of Brazil, India, Russia and China (Pfizer, 2009).
The literature points to the fact that horizontal M&As, such as Pfizer-Wyeth, achieve more operating efficiencies and economies of scale than vertical ones (Maksimovic and Phillips, 2001). The operational and economic benefits have also been recognized by the chief executive of Pfizer, Jeffery B. Kindler who commented “Our combined company will be one of the most diversified in the industry and will benefit from complementary patient-centric units that match speed with the benefits of a global company’s scale and resources” (NYTimes, 2009). Firstly, Pfizer expects to save $4 billion annually by combining and streamlining its operations with Wyeth due to lower and more flexible cost base for the combined operations that helped in cutting down the production overhead, R&D, and the number of employees (NY Times, 2009, Pfizer, 2009). Secondly, the infusion of new ideas, perspectives and processes can produce lasting benefits that are broader and deeper than initially expected by the companies (Vermeulen, 2005). In this case, the existing patents and the ongoing research at Wyeth added complementary capabilities to Pfizer, which benefitted from diversified product portfolio of consumer and nutritional drugs (Stempel & Schiffer, 2009). This acquisition will also help the company in depicting higher performance in innovation and technological knowledge generation, resulting in higher quality drugs in future (Makri et al., 2010). The operational and economic benefits of this acquisition can also be shown through the ratio analysis of Pfizer before and after acquisition as shown in figure-3 and figure-4.
Figure 3 – Profit Margins of Pfizer before and after acquisition of Wyeth in 2009. Source: Financial statements of Pfizer from 2008 – 2012
Figure 4 – ROA and ROE of Pfizer before and after acquisition of Wyeth in 2009. Source: Financial statements of Pfizer from 2008 – 2012
It can be seen in both the aforementioned figures that all the performance metrics fell immediately after acquisition, but over next three years the performance measures met or exceeded their initial values before acquisition, thereby pointing to cost savings, reduction in inefficiencies, increase in productivity, enhanced operational performance, better asset utilization and increased profitability.
Stock markets often behave irrationally or inappropriately to the news of acquisition, especially, when it involves large companies, but the evidence shows that if an acquirer makes a cash offer to purchase the company; it ends up earning long–run abnormal returns due to non-dilution of earnings per share (EPS), as compare to stock offerings that earn negative long-run abnormal returns (Loughran & Vijh, 1997). Under the deal of this acquisition the Pfizer paid $50.19 per share of Wyeth using a mixed structure of cash and equity — $33 a share in cash and 0.985 Pfizer shares worth $17.19 a share based on Pfizer’s closing price, and paid almost 29% premium over the actual company valuation per share (Karnitschnig, 2009). This deal was immediately appreciated by the stock market resulting in the shares of Wyeth to increase by 12.96% (by $4.91) and the shares of Pfizer to climb by 1.4% or 24 cents (Karnitschnig, 2009).
The acquisition of Wyeth has highly beneficial to Pfizer financially, because Pfizer was facing a pressing challenge of its patent (or exclusivity) expiration of Lipitor, a cholesterol lowering drug that accounted for almost 25% of its revenue stream as being the best cholesterol control in the world. Although, the loss of exclusivity on this drug in 2011 costed Pfizer a projected loss of $12 billion, not much has been solved with the acquisition of Wyeth as 14 other drug patents are scheduled to expire in 2014 with a projected loss of $35 billion (Pfizer, 2010). However, some of these lost revenues have been compensated by the legacy drug brands of Wyeth as the revenues of Pfizer in 2010 increased by 36% to $67.8 billion, compared to $50.0 billion in 2009. This financial growth was achieved due to the inclusion of revenues from legacy Wyeth products for a full year in 2010 compared to part of the year in 2009, which favorably impacted revenues by $18.1 billion or 37% (Pfizer, 2010). The silver lining in this discussion is that such challenges are not unique to Pfizer and its competitor drug makers – Merck, Bristol Myers Squibb and Eli Lilly are all facing their own patent losses in the next couple of years.
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Despite these financial benefits, Pfizer has faced a major cost of acquisition in the form of added taxes resulting from the repatriating the billions of dollars in the US as a part of acquisition deal and this resulted in the effective tax rate increase from 17% in 2008 to 20.3% in 2009 amounting to $2.1 billion in taxes in 2009 up from $1.6 billion in 2008 (Pfizer, 2009).
In conclusion, the financial performance metrics are an obvious indicator of success of this acquisition as the company has successfully created value for its shareholders and has gained sustained market advantage in prevailing highly competitive operating environment. Although, in doing so the company has destroyed some value due to increased tax burden and the threat of loss of revenue due to expiring patents still looms at large, the company’s increased capability to invest in R&D and develop next breakthrough drug (like Lipitor) will be the sole decider of its future performance.
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