Heard On The Street: Drug Stocks Surge On Glaxo Merger
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By Ron Winslow
Staff Reporter of The Wall Street Journal
Is there a pill for hyperventilation?
Drug stocks surged nearly across the board yesterday on prospects
that a possible Glaxo Wellcome and SmithKline Beecham megamerger may
signal a new round of consolidation in the pharmaceutical industry. Just
two weeks ago, reports of a potential American Home Products-SmithKline
union provoked a similar buying spree.
Now, companies in the sector are up as much as 31% just since the
first of the year, pushing price-to-earnings multiples into nosebleed
territory and prompting even some bullish analysts to advise clients to
temper their enthusiasm for some stocks.
Aside from Glaxo, which soared 8 15/16 to 62 3/4, and SmithKline, up
4 3/8 to 67 1/2, the big winners from the merger news were companies
long considered potential targets in any consolidation wave. They were
Zeneca Group, up 8 3/16 to 127 1/4, WarnerLambert, which rose 5 7/16 to
155 15/16, and Schering-Plough, up 2 7/16 to 74 13/16. Bristol-Myers
Squibb gained 2 3/4 to 102 7/16, while other industry giants Merck and
Pfizer were up fractions.
Among major drug companies, only American Home, whose merger
prospects were scuttled when SmithKline opted to deal with Glaxo
instead, fell in the broad market upswing, falling 3 13/16 to 91 5/8.
Mariola Haggar, an analyst at Deutsche Morgan Grenfell, downgraded
Pfizer, Warner-Lambert and Eli Lilly yesterday to "accumulate," saying
their price-earnings ratios have been pushed so high-Pfizer's is about
42-that investors should buy only on weakness. But she considers Merck,
at 26 times 1998 earnings, and American Home, at under 25 times, both
bargains even in the current drugstock feeding frenzy.
In the past year, she noted, the P/E multiple for eight major U.S.
drug companies has risen to 31 times her 1998 earnings estimates from
21.4 times projected 1997 net income a year ago. "At today's price, you
have to be longer-term oriented on some of these companies and willing
to withstand near-term volatility," she said.
Still, she is among a chorus of analysts who argue that based on the
industry's historical performance on Wall Street and on a robust
emerging-product pipeline, the bullish case, especially for a handful of
companies such as Merck and American Home Products, remains strong.
The Glaxo-SmithKline talks amount to "real confirmation that merger
activity is for real," says Steven Gerber, drug analyst at CIBC
Oppenheimer. "That is throwing more fuel on fire" already ignited by
"strong earnings results and high degrees of earnings consistency.
That's a very precious commodity in this market."
But investors who overplay the merger card may be disappointed.
Though the conventional wisdom is that a SmithKlineGlaxo merger will put
pressure on even other giants such as Merck, Pfizer and Novartis to
follow suit, don't expect Merck or Pfizer to join the fray any time
soon.
Raymond Gilmartin, Merck's chief executive officer, continues to
insist the company doesn't see the need for a merger. And people close
to Pfizer say the company's rich pipeline - including its widely
anticipated drug Viagra for impotence - will fuel earnings growth well
into the next decade. Both concerns are said to view mergers as
expensive distractions sought only by companies dealing from weakness.
"The downside [on the merger bet] is much higher than the upside,"
says Hemant Shah, an independent analyst. "I know of no industry
executives who have a big desire to give up their top spots," a
prerequisite for a successful union.
Mr. Shah says hostile bids are out of the question because they would
require cash. Pharmacia & Upjohn, considered one of the weakest
companies in the sector, still carries a stock-market value of about $22
billion, he notes, adding, "No one has $22 billion in cash." Mr. Shah
doesn't dispute that consolidation pressure is mounting, but he believes
a new wave of mergers will take three or four years to play out.
Drug-stock bulls view their current premium prices as moderate on a
historical basis. Over the past 20 years, Oppenheimer's Mr. Gerber says
drug P/E ratios have averaged 33% above the market as a whole; in the
current run-up they have risen to about 40%. "With the slow growth in
the economy, poor predictability of earnings elsewhere and the
increasingly powerful consolidation story, earnings multiples are likely
to work their way higher," he predicts.
Larry Feinberg at Oracle Partners doesn't disagree. But he has
another idea. He is betting that continuing enthusiasm for the drug
group will soon spill over into the long-term laggard biotechnology
stocks. For one, he likes Idec Pharmaceuticals, which just launched a
new treatment for lymphoma he says is racking up larger-than-expected
sales.
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