The Destruction of Innovation? On Pfizer’s Proposed AstraZeneca Acquisition

I worked at Pfizer for two summers during college, and although I no longer have any connections with the company, I’ve followed its corporate development with a distant fondness over the last couple of years.  My last summer corresponded with a changing of the guard and a shift in direction for the world’s self-proclaimed largest research-based pharmaceutical company.  Jeff Kindler, erstwhile CEO, was dismissed by the Pfizer board and replaced by current CEO Ian Read after a series of disappointing quarters and a bizarre case of senior-staff palace intrigue.  Check out this outstanding Forbes piece for a full rundown of the mutiny that occurred.  (Seriously, it’s worth the read.  You’d never imagine so much drama could be manufactured by a drugmaker.  Bickering over helicopters is involved.)

Read’s appointment as CEO heralded a new focus on investing in smaller, case-specific drugs instead of “blockbuster” drugs like Lipitor.  Pfizer’s revenue throughout the 1990s and 2000s was buffeted by a small cluster of huge sellers, but many of these products began to lose patent protection as the decade came to a close, leading to generic competition and significantly lower profits.  Attempts to invest in new blockbuster drugs were largely unsuccessful; multiple late-stage drugs, each bolstered with hundreds of millions of dollars of research funding, were cancelled due to poor late-stage trial results.

Beginning in the late 1990s, a series of company acquisitions (and their product portfolios) was used to shore up revenue streams in the absence of innovative drug creation.  Pharmacia, Wyeth, and Warner-Lambert were all purchased and integrated into Pfizer within the span of a decade.  The company’s revenue streams and size grew but its share price did not.  Read’s focus as CEO was to pare Pfizer’s organizational bloat and alter its boom-or-bust funding framework.  The new goal was investing in a broader cohort of smaller, targeted drugs that had better chances of success.

At least it seemed like Pfizer planned to chart this path over the next decade.  Instead, Pfizer’s recent attempts to acquire British drugmaker AstraZeneca suggest a new course has been abruptly plotted.  Pfizer is interested in purchasing AstraZeneca for the same reason it acquired Pharmacia, Wyeth, and Warner-Lambert: to obtain a new slate of prospective drugs in order to shore up its own pipeline.  The additional driving force that makes this deal unique is the tax incentives Pfizer could unlock by “reincorporating” and shifting its corporate headquarters to the U.K.  In doing so, it could take advantage of British rates and cut its corporate tax from the U.S. rate of 35% to 20%.

Talks between the two companies recently came to a standstill, but a number of major AstraZeneca shareholders are pushing the company to re-enter negotiations with Pfizer.  The last offer Pfizer made was £55 per share and AstraZeneca’s board was looking for £59 per share, which analysts think may be a palatable amount for Pfizer in the end.  This translates to a total purchase price for Pfizer that’s well north of $100 billion.

AstraZeneca, for its part, has been strongly resistant to Pfizer’s takeover attempts.  Since CEO Pascal Soriot took over about two years ago, AstraZeneca has posted strong fiscal results and has developed a promising pipeline that could drive significant growth in the near future.  Soriot’s position throughout negotiations with Pfizer is that his company’s potential for high-quality products will be subsumed by the hassles of integrating into Pfizer’s corporate structure.

He’s not alone.  Bill George had the following to say in an op-ed for Dealbook:

Does anyone believe pharmaceutical companies can create long-term shareholder value by chasing lower tax venues and cutting research and development spending?

AstraZeneca’s board would do well to evaluate whether the company’s progress will continue under Pfizer’s management. If history is any guide, the Pfizer acquisition would lead to a mass exodus of Astra executives and scientists, the closing of more research labs and lost momentum on vital research projects. Mr. Soriot’s scientific leadership could become a casualty, with Pfizer’s financially minded executives dominating the decision-making.

Who benefits from this merger? In the long term, it is doubtful that there will be any winners. AstraZeneca and Pfizer employees will lose jobs, patients may lose innovative new therapies and American taxpayers will lose as Pfizer legally avoids higher taxes in the United States. If history is any guide, Pfizer shareholders will be losers as well, along with AstraZeneca shareholders who retain converted shares.

There has been much grumbling of late regarding corporate acquisitions that seem to prioritize short-term profits or narrow brand assimilation over long-term innovation.  Facebook’s recent purchase of Oculus, arguably the most promising manufacturer of virtual reality headsets, was heavily criticized on the belief that Oculus’ amazing technology will be absorbed for limited, gimmicky commercial ends.  (Anyone want to dig up some 3D carrots in a virtual-reality Farmville?)  It’s similarly ominous when telecom monoliths like AT&T start gobbling up huge television organizations like DirecTV.  In both cases, customers are suddenly saddled with increasing corporate bureaucracy and a lack of independent market choices.

But these kinds of acquisitions have potential upside.  Facebook could use Oculus to build amazing virtual worlds and AT&T could leverage DirecTV’s content to provide a more robust programming experience for its phones.  With pharmaceutical companies, however, it seems like there are very low chances that any kind of synergy will develop.  Pharmaceutical acquisitions involve real disruption to research and laboratory testing and even moderate delays could result in lost trials or benchmarks.  Restructuring inevitably leads to a shakeup of teams and groups as assets are reorganized and paired down.  Jobs will be lost and employees will probably look to leave if they can.

It seems the primary (and perhaps only) beneficiaries of Pfizer’s acquisition of AstraZeneca would be (corporate) shareholders.  Shareholders like BlackRock are the reason AstraZeneca is even considering returning to the negotiating table, since a sale would yield enormous premiums for all parties with a stake in the company.  Bill George is right: this is a short-term boost for investors, and it hurts employees, scientists, doctors, and customers across the board.

Regulators have a responsibility to balance the right of businesses to conduct private deals and the benefits of the public who live with the consequences of those deals.  Most large-scale acquisitions have significant ramifications for communal well-being, but those in the health sector are arguably the most important since their impact is directly tied to life and death.  Pfizer’s purchase of AstraZeneca would signify corporate and legal prioritization of short-term moneymaking for a select number of shareholders over the potential health benefits of continued research.  If Pfizer could guarantee that this deal would result in additional funding for drug development, it’s doubtful there would be so much concern.  But this promise can’t be made, and Pfizer’s history with acquisitions (as George describes in his piece) is not promising.

I hope U.S. and U.K. antitrust commissions address these public benefit questions if an agreement comes to pass between Pfizer and AstraZeneca.  Megamergers and acquisitions are not inherently bad, but deals like this reek of corporatism instead of healthy capitalist expansion that will benefit the majority of parties involved.   This is even more emphatically true in this case given Pfizer’s lackluster history of sparking new innovation with its purchases.  Acquisitions should build on existing structural gaps to yield new value and innovation instead of just padding investor coffers.   At what point will regulators declare that enough is enough?

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