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Pfizer's M&A Prescription

2/9/2009 --

Drug giant's purchase of Wyeth provides a blueprint for mergers in a tight market, says Ross professor.

ANN ARBOR, Mich.—Pharmaceutical icon Pfizer made more than headlines when it recently announced a $68 billion acquisition of rival drug maker Wyeth. Pulling off a megadeal in such a tight credit market actually offered signs of life in the ailing economy. Richard "Erik" Gordon, clinical assistant professor at the Stephen M. Ross School of Business, says the Pfizer/Wyeth deal can serve as a welcome template for other mergers, even outside the pharmaceutical industry. But the pact also shows that the structure and terms of pulling off a megamerger have changed. As for Pfizer, Gordon sees a good formula at a critical time.

We keep hearing that the credit markets are locked and nobody is lending. How was Pfizer able to pull this deal off?
Gordon: Well, what you're hearing is wrong. Look, if you're a small, innovative, risky business, it's hard to borrow money. But it's a different story in a well-structured, conservative deal with an established, credit-worthy company. Deals will get done, but they won't be done with aggressive financing. They will be deals with conservative financing. In Pfizer's case, about one-third of the deal value is borrowed. About one-third of the purchase price is going to be cash from Pfizer. Not 10 percent, not 15 percent, as in the past. And one-third is going to be done in stock. That's conservative compared with what we saw two years ago. What you're not getting is deals done on the old terms for anybody. Pfizer is a top credit-rated company. But even Pfizer is only borrowing one-third, so the credit crunch is having an effect even on Pfizer. The credit crunch is having larger effects on less credit-worthy companies because they can't borrow anything. But it's not true that there's no money. It's just there's no money for companies below a certain level of credit-worthiness, and no money for deals that are too aggressively financed.

So is this an example of the structure of deals going forward?
Gordon: I think this is a strong signal. I think this tells you what a top credit-rated company can expect to get. Even a top company like Pfizer isn't going to borrow 75 percent or 50 percent. They're going to get less than half. So this deal is a bellwether. Everybody can be calibrated now. Everybody can look out and say that at least for the next few months -- keep in mind credit markets change -- but if you are a top-rated company and you want to do a deal now, don't dial in that you're going to borrow 75 percent of it. Dial in that you're going to borrow less than half.

So if other companies can structure a deal like this, do you think they will move on it?
Gordon: Yes, especially in the pharmaceutical business and in other industries where they need to do some mergers and do some cost savings. I think they are taking this as an encouraging sign. It's a sign that, yes, you can do a deal and now we have some guidance about how to do it. That's opposed to all we hear, which is "forget it, no deals are being done." So this deal is a positive. The fact that they got five banks to line up to loan them the money is a positive, not just for the pharmaceutical business but for other top-rated companies. We know now what the banks will go for.

Even so, investment bankers shouldn't get too excited, correct?
Gordon: The deals are going to be fewer and farther in between. The days where investment bankers had more business than they could handle and couldn't hire people fast enough are gone. Investment bankers used to cook up deals. They would approach CEOs about possible acquisitions and assure them that financing was available. Now, deals will still be done but there will be far fewer and the financing will be tougher to line up. The Pfizer-Wyeth deal includes a $4.5 billion payment from Pfizer to Wyeth if Pfizer's financing falls through. That is way beyond what we saw two years ago. All this means the investment banking firms are changing their cost structure, too.

Why was this deal made now?
Gordon: The motivation to do this came from two sources -- big, industry macro- environment sources and sources particular to Pfizer. The industry as a whole is likely to see a major round of consolidation driven by two industry-wide factors. The first factor is product pipeline problems. Most major, mature companies have run into pipeline problems. They're investing years and hundreds of millions into projects that don't' make it to market. One reason to do a merger is to combine two pipelines, each of which is missing something, into one pipeline that has enough. The second factor that's pushing the industry to consolidation is that mid- to large-size pharmaceutical companies have to move to a new cost structure, a lower cost structure. Virtually every good size pharmaceutical company in the world has, over the last five years, done all it could to get costs out. And that's the problem. For the most part, they've done all they can, but their cost structure is still not right. If you've already done all you can, what can you do? Well, if you merge, you create some redundancies. If your sales force is the smallest sales force that will support your company, when you merge with another company, you may have overlap in the two sales forces that allows you to lay people off and go forward with a sales force that is smaller than the two sales forces had been. So consolidation is one of the few sources left for cost savings.

For Pfizer, it has one of its giant drugs, Lipitor, coming off patent protection in about two years. Lipitor generates an enormous portion of Pfizer's revenue. So Pfizer has to do today what most of the companies have to do between today and next week. Not only does Pfizer have the pressure to do it today, they are one of the few companies that can do it today and not next week. Here's why: To do a deal today you have to have cash. Pfizer is sitting on a pile of cash, enough cash so that they can make a deal happen. So for them, the bad news is they're one of the companies that must act now and not next week. But the good news is they're one of the few companies with the cash to act now.

In the pharmaceutical industry, will there be some reaction, like defensive or strategic mergers?
Gordon: I think there are two things going on. Prior to this, for reasons that have nothing to do with Pfizer and Wyeth merging, companies needed to get bigger. They needed to get their cost structures right and needed to get their pipelines right but they have been on the sidelines because it wasn't clear any deals could be done. Now they can jump in because they see that a deal can be done.

I also think some of them will feel more pressure to do a deal now. You don't want to compete against a Pfizer-Wyeth that has one cost structure if you have a different cost structure. Life is tough enough. The pharmaceutical business is one of the three toughest businesses to be in today. You don't want to be the last guy to get your cost structure right.

What kinds of issues will Pfizer face absorbing Wyeth?
Gordon: If you look at pharmaceutical companies, they have a business side and a science side. For the most part, mergers go well on the business side. People will lose their jobs, but on the business side, the mergers tend to go smoothly for the company. What you often worry about is the science side. The key is to figure out which researchers you want to keep and what it takes to keep them. With researchers, it usually takes more than money. It takes some preservation of a viable research culture that they like. I don't think that's going to be a big problem with Pfizer and Wyeth. Where it gets to be a problem is where you have a large pharmaceutical company that buys a smaller biotech firm. They will have very different cultures: it's a giant, formalized structure versus a small, informal structure. And even the science is a little different. But Pfizer is a big company and Wyeth is a big company. They both have mature, big-company cultures. Pfizer also has done some other mergers -- and didn't do them really well -- and has learned some lessons. So if you learn from your mistakes, Pfizer is smart.

So was Wyeth a good target for Pfizer?
Gordon: There's enough overlap so they can get some cost synergies, but there also are some areas where they don't overlap and something new comes to the table. Wyeth has a good vaccines operation, and the vaccine business is a good one to be in these days. So that's something Pfizer doesn't really have. Wyeth is believed to be a little bit more involved in biologics. So it's a pretty good fit that you have, at the same time, cost-cutting opportunities and synergies but also some new expertise that will get Pfizer into areas much more quickly than if Pfizer develops those areas by doing a lot of little acquisitions. It appears to be a pretty good combination.

—Terry Kosdrosky

For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847,