In a world where you can buy a
30-pound jar of mayonnaise, it seems that bigger is
almost always better. But when it comes to acquisitions in
the health-care space, history says otherwise.
Sure, companies say they'll experience huge synergy
savings to justify their large acquisitions, but the numbers
say otherwise. Just look at the dramatic cuts in return on
equity (ROE) that these companies have experienced after
making major acquisitions.
Company
Target
Three Years Before Acquisition
Two Years Before Acquisition
Year Before Acquisition
Year After Acquisition
Second Year After Acquisition
Third Year After Acquisition
Pfizer (NYSE: PFE)
Pharmacia
41.9%
42.3%
41.9%
3.2%
13.6%
16.5%
Boston Scientific (NYSE: BSX)
Guidant
20.0%
32.2%
13.3%
(37.5%)
(1.9%)
(16.5%)
Mylan (Nasdaq: MYL)
Merck KGaA's generic-drug business
11.6%
29.0%
20.7%
(5.90%)
N/A
N/A
Source: Capital IQ, a division of
Standard & Poor's. N/A = not applicable.
Now, you'd expect ROE to drop the first year after an
acquisition as a bunch of one-time charges work their way
through the income statement. What's disconcerting, though,
is that two and three years after the acquisitions, it hadn't
come back up for Pfizer and Boston Scientific.
One big problem, as I see it, is that research and
development isn't very scalable. A company that increases its
revenue by 50% reasonably needs to push out roughly 50% more
drugs, either in sales of existing drugs or in introducing
new ones, to increase earnings by the same amount.
Unfortunately, researchers at the larger, post-merger company
have less incentive to develop new drugs because their
discoveries have less impact on the company's success.
For a generic-drug company like Mylan, this R&D issue
is not as big, and it shows. As Mylan approaches its second
year after swallowing an acquisition twice its size, Mylan's
return on equity is approaching its pre-acquisition levels at
13.6% over the past four quarters.
Another problem is asset turnover, or how efficiently the
company's assets are being used to generate sales. For
instance, in the year before Pfizer bought Pharmacia, asset
turnover was 0.7. So for every dollar in assets, it was able
to generate roughly $0.70 in sales. Nearly two years after
acquiring Pharmacia, it was only 0.4. That's a big drag on
ROE.
This time it's different. Right?
Both Pfizer and
Merck (NYSE: MRK) think it's not going to be
the same as before after they acquire
Wyeth and
Schering-Plough (NYSE: SGP), respectively.
Both have put their management teams in place well ahead of
the closing of the deals, to try to hit the ground
running.
And they might. Pfizer certainly has a lot of experience
in what not to do with large acquisitions. In addition to
Pharmacia, it also struggled with the integration of
Warner-Lambert. Merck it has familiarity with
Schering-Plough, through its joint venture to sell the
cholesterol drugs Vytorin and Zetia -- a move that itself
should help smooth the transition a little. Continued... |