Pfizer-AstraZeneca: Most Takeovers Destroy Value

Despite the generally approving commentary by the British Tory press (especially the Daily Telegraph: “Pfizer’s bid should be governed by the market (sic)”, the plain fact is that multimillion takeovers or mergers rarely accomplish their stated objectives – synergies, more efficient management, cost savings with no loss of output, etc.)  The three red hot certainties are that:

(1) the bidder overbids as hubris or vanity by the CEO kicks in;

(2)  jobs, especially R&D and factories, are slashed in the acquired company to offset the huge borrowing costs incurred by the acquirer;

(3)  brands and patents are transferred out of the acquired company to the acquiring company’s existing production lines or new lines set up in cheap labour countries.

All of these features are likely to be present in the proposed Pfizer takeover of AstraZeneca, the Anglo-Swedish drugs company headquartered in Britain, paying taxes in Britain, with major research facilities in Britain and Sweden, which is responsible for about 9% of Britain’s business enterprise, research and development (BERD), is Britain’s second biggest drug company by sales after Glaxo Smith Kline (GSK), and the seventh largest in the world.

Track-record of Takeovers in the UK

There is now a very considerable literature on takeovers in the UK starting with the seminal studies (1971-75) by Ajit Singh relating to takeovers, their relevance to the Stock Market and the theory of the firm[1].  These and around 50 later studies have been reviewed (2008) by Cosh and Hughes[2].

The overall conclusion is that corporate takeovers basically destroy value, and they particularly destroy value in UK firms taken over by foreign-owned and based companies.  Moreover, according to Cosh and Hughes, Singh’s (1975) main conclusion that the idea that “profit maximisation” by the strong companies taking over the weak, a form of natural selection according to neoclassical, free market profit maximisation theory, had no basis in fact, still holds good in 2008 with over 2000 plus studies to prove it.

Why then, in the face of overwhelming evidence do Daily Telegraph guest writers like Alistair Heath (7th May), Katherine Rushton (16th May), as well as the Telegraph leader writers (5th and 9th May) continue to say, in respect of the bid by Pfizer to take over AstraZeneca: “The Market should decide” – i.e. the whole complex 30 year future of science based companies like AstraZeneca and Pfizer should be decided by a handful of fund managers seeking short-term profit maximisation for themselves – not considering the huge nexus of science, manufacturing, marketing, approvals, and medical effects on millions of different people, over the next 30 or more years, in which the US and UK people and many others have a personal interest?

The short answer is a lack of knowledge about what a modern manufacturing business actually is.  It’s just too easy to repeat 19th Century capitalist simplicities as received wisdom about 21st Century industrial complexities, particularly with respect to the 30 year time scales involved in building and growing any technological business worth over a £billion.

What should be the criteria for a National Interest Commission to apply to takeovers in 21st Century Britain?

  • The future capacity of Britain to participate in and exploit emerging technologies in the company’s field must be secured.
  • The taking-over company must have the cash to buy the company without recourse to new debt taking its total of debt to more than 25% of its balance sheet.
  • The taking-over company must undertake to run the UK company as an integral business, add value to it, invest in it, not asset-strip it, by taking its patents, brands and sales networks for itself.
  • Does either company have sufficient scale in the range of its products and the depth of its expertise to compete over the long-term (say ten to 30 years) with other companies in the market place?
  • If the answer to this question is no, would a merger, rather than a takeover, increase the scale of production which could be adequately supported technically and in marketing terms, to create a more competitive business for Britain?

How does the Pfizer-AstraZeneca Bid measure up?

None of these criteria above are implied by the usual “free market” mantra of the overwhelming majority of financial commentators and right-wing politicians, yet they are pretty much what everyone outside this narrow coterie would think sensible.  The bid by Pfizer fails on all counts, while the aforesaid commentators advised, almost to a man and woman, that Pfizer’s bid should be allowed to succeed, saying the “market” should decide.  But what exactly is the market?  In practical terms Pfizer is owned by about 20 mutual and equity funds.  AstraZeneca’s ownership is more widely spread, but neither group of owners has much more than the short-term financial data available in the newspapers to go on.

Even on narrow, short-term financial data, Pfizer looks like a struggling corporation, trying to bolster itself by using bank debt to take over a more profitable creative undertaking.  Thus on May 24th the financial details for the two firms were:

Pfizer Astra-Zeneca
Price/Earnings 18.0 14.2
Yield 3.6% 4.1%
Share price $29 $70
Sales $ billion 52 26
After tax profit $ billion 4.8 2.3
Balance sheet represented by bank debt 60% 30%

The Price/Earnings and Yield figures are significantly in AstraZeneca’s favour.  It is also to be noted that Ian Read, Pfizer’s chief executive, of whom we in Britain have heard a seen a good deal of late[3], sold a large block of shares at $31.99 in February sometime after the formal offer of 5th January.  Whether this constitutes insider trading in the British sense is academic, since this transaction is subject to US law, but it certainly doesn’t indicate much confidence in Pfizer’s trading position, nor could British holders of AstraZeneca stock repose much confidence in Pfizer’s present share price holding up after it had issued new stock to the tune of around $58 billion or 66% of its present current stock ($88 billion), presumably to be financed by yet more bank borrowings, the interest on which alone would reduce pre-tax profits by something like $4.4 billion – not far short of its current after tax profits (see table above).  In fact were the Pfizer bid to go through, it would look like a private equity firm with a pharmaceutical business attached.

The Product Pipeline Issue

As respected fund manager Neil Woodford commented on 21st May in the Daily Telegraph, valuations of the drug companies’ pipeline of new chemical entities (nce) with pharmacological benefits is a matter of judgement based on a close analysis of the science, leadership and people involved.  This will not be done reliably by fund analysts, who have only superficial knowledge of the business and many of whom sold AstraZeneca at £30 only 3 years ago in 2010 when its yield was about 5.2%, and have now offered the same advice to sell at £55 a share.

Costs of R&D

While all companies have to bid for investment cash from funds and private investors, pharmaceutical companies are exceptions in that a very large proportion, e.g. 25% of their operating costs are attributable to Research and Development.  Over 90% of this R&D expenditure is spent on the discovery and trialling of potential drugs and other medical treatments through 3 separate stages.  About 10% of R&D expenditure is spent on improvements to the manufacture and packaging of proven products – about the same (2.5%) of operating costs found with other manufacturers.

In AstraZeneca around 16,000 people are engaged in the R&D function, mostly in laboratories and in staging medical trials.  At a cost of $5,300 million per annum in 2010 – since reduced to about $4,500 million per annum, this represents about $280,000 per person, a very high cost indeed, which must include a large amount of bought-in materials, expertise and written off specialised equipment.

It is imperative that this huge expenditure should work at maximum efficiency.  This efficiency can only be judged by the value of the drugs which make it to approval and then sales.

Returns on R&D

Briefly there are two areas where R&D has an effect:

(1)  Incremental improvements to existing products and manufacturing efficiencies.

(2)  Innovation and Testing of new products (new chemical entities in the pharmaceuticals case).

Returns on expenditure can be calculated as cash benefit over time divided by expenditure over time.  On admittedly small number samples, area (1) returns are about three times as great as area (2) across a range of industries[4].  The total return for area (2) was estimated at about 3 on average over the companies examined.  So for AstraZeneca $5 billion R&D spent on one successful drug should, on average, yield about $15 billion total operating profit over the drug’s patent life which is only about 10-12 years in commercial operation.  This connotes roughly to a blockbuster ($1 billion per annum) every 18 months for about $5 billion per annum expenditure.  Astra Zeneca’s claims for their pipeline are comparable with this.

The Pfizer Bid

The record of foreign takeovers of existing British firms is extremely bad – very few of them meeting the criteria laid down above[5].  Cosh and Hughes[2] have reviewed some 1,300 cases over the 40 year period from 1969-2008 and find that, on profitability grounds alone, takeovers are almost uniformly bad for the long-term shareholders of the taking-over company and those shareholders of the taken-over company who stayed with it.  Only the senior executives of both companies, the lawyers and the City Mergers and Acquisitions Agencies benefit – usually to the tune of around £10 million in fees, as well as those individuals who sold at the top of the share price range.  Pfizer, with a very high proportion of its equity in highly leveraged equity funds anxious to obtain a short-term profit, would come under immense pressure to cut labour costs, of which R&D accounts for much the greater part, subsequent to a takeover.

Pfizer’s R&D record

This is not particularly impressive.  Its best-selling Lipitor anti-cholesterol drug (now out of patent protection) was actually discovered and commercialised by Parke-Davies, which Pfizer acquired via its takeover of Warner-Lambert in 2007.  Pfizer got going as a pharmaceutical company in 1943 when President Roosevelt handed it the job (and the patents[6]) to make 10 million jabs of penicillin (which it did by means of novel sparging[7] technology for the penicillin culture to reproduce millions of times).

Pfizer’s most famous current own-brand drug is Viagra (sildenafil citrate), discovered in the life sciences section of its research laboratory at Sandwich in Kent as a treatment for pulmonary hypertension.  Pfizer has now closed down its life sciences operation in Kent and transferred it to California with a loss of around 2,000 UK jobs.

What to do in the future

1          Many have called for an additional national interest consideration to be added to the present takeover code.  This at present only operates to safeguard defence and media ownership issues.  The competition commission theoretically has a role, but has not so far intervened in the Pfizer takeover bid, although the EU competition authorities are thought likely to take an interest.

2          If a national interest criterion is added to the takeover code, then the criteria spelled out above, plus a competition restriction on any taking-over company not exceeding 25% of the UK market, should offer proper protection to our strategic industries whether established or nascent.

3          There should be no market restriction on foreign companies financing and establishing new UK companies where new (to the UK) production technologies are concerned.

4          AstraZeneca shareholders should reject any future offer from Pfizer which whether as cash or cash plus shares Pfizer will not be able to afford, without evisceration of Astra Zeneca’s research and manufacturing, and taking on ruinous debt.


[1]  Ajit Singh (1971), “Takeovers, Economic Natural Selection and the Theory of the Firm: Post-war UK Experience” Cambridge University Press; and, same title, Economic Journal (1975), 85 pp 495-515.

[2]  A Cosh and A Hughes (2008), “Takeovers after Takeovers”, University of Cambridge Centre for Business Research, Paper No 363, 25 pages.

[3]  Before the Parliamentary Business and Science Committees of the House of Commons, May 12th and 13th 2014.

[4]  G Davidson (2004), “The Competitiveness of UK Manufacturing and the Role of Innovation”, M.Phil Thesis (Ch.9), Centre for Manufacture, University of Manchester.

[5]  An outstanding exception is the Tata company’s takeover of Jaguar and Land Rover from Ford.  The key feature, besides cash investment in new production lines, was the hiring of a first class German Engineer-Manager, a breed almost unknown in the British car industry, outside the Japanese operations.

[6]  From Britain’s Harold Florey & Alexander Fleming, joint winners of the Nobel Prize 1944.  Despite Churchill’s assurances, no royalties were paid to them by Pfizer.

[7]  1 To spray or sprinkle. 2 To introduce air or gas into (a liquid),

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