It is in the nature of mega-deals that they can straddle collapses in the stock market. What fun erstwhile Chancellor Nigel Lawson had back in 1987 when world markets spiralled during the sale of the latest tranche of the Government’s shares in BP.
Last week, the solar-eclipsing $50bn (32.8bn) merger of pharmaceuticals giants Sandoz and Ciba-Geigy preceded bear runs consecutively in Wall Street, Tokyo and London. Stock market collapses appear to be accompanied by acts of God.
In 1987, we had just been visited by hurricanes that blew a hole in the national infrastructure, not to mention Lloyd’s of London. As market-makers slashed quotes last Monday, a Chinese satellite was hurtling towards Britain. In other ways, the gods were kinder to us this time around. Shares in London lost only around one-seventh of what they lost in 1987.
And the Sandoz/Ciba deal appears to be a marriage made in heaven, catapulting the new corporate entity, Novartis, to second place in world market capitalisation rankings behind Merck, as well as second place in world market-share behind Glaxo Wellcome.
The rationale for rationalisation in pharmaceuticals markets is well recorded. There is the global pressure on international pricing – drugs companies have found it increasingly difficult to force through price increases, so they have looked for earnings growth (plus economies of scale) from acquisitions and mergers. Then there is the desire to be represented in the buoyant over-the-counter (otc) market. Finally, the long lead times in pharmaceutical research and development require critical mass – this is no market for niche players.
So the birth of Novartis is to a family that has celebrated a number of significant unions over the past couple of years. From American Home Products’ $9.7bn (6.3bn) takeover of Cyanamid in 1994, through to last year’s $13bn (8.5bn) merger of Upjohn of the US with Sweden’s Pharmacia.The Sandoz/Ciba merger provides an opportunity to take stock – and I believe that it throws up a couple of interesting trends which have implications beyond the drugs markets.
The first relates to what happens competitively within an industry that rationalises to this extent. Cost savings can have a limited beneficial effect on the profit and loss account. But the argument runs that cost-savings can only have an extended value in terms of increased profitability where the merger steals a march on its rivals. Suppose, for purposes of this argument, that Ford were to merge with General Motors. Not withstanding competition issues, it is hard to think what the rest of the industry could do in retaliation.
The rationalisation in the pharmaceuticals industry is of this relative stature, but there are enough drugs companies to ensure that merger can be followed by retaliatory merger and that one conglomerate can meet the competitive threat of another with its own responsive economies of scale. That is why there has been so much merger activity over the past two years and why worldwide regulatory authorities have largely left the competition flag unflown.
My point is that the cost savings that a Sandoz/Ciba generates – said to be of the order of $1.5bn (988m) per year – are likely to be eroded as other groups make similar cost savings and then start to shave margins to win market share. There is, in this sense, nothing magical about economies of scale – the real throat-cutting in the drugs industry will not come as a result of cost savings but of price-cutting.
My second point is that rationalisation activity in pharmaceuticals bucks the trend for demerger. This is fairly obvious, admittedly, but drugs companies are forming ever larger conglomerates just when the fashion – witness Hanson, British Gas, Thorn EMI et al – appears to be to deliver shareholder value through the break-up of conglomerates. Nothing is sacred, of course, and those who do the reverse of what is considered the City consensus very often make the most dosh. In this respect, we will watch Gerry Robinson’s Forte conglomerisation with interest.
Nevertheless, the entire pharmaceuticals industry appears to be the contra-indicator here, not simply one or two maverick companies within it.The answer must be that the high-inflation, high-growth Eighties’ environment has finally given way to the psychology of low growth and low interest rates that encourage investors to look for real industrial synergies between companies, rather than the quick-turn, macho takeover of the old days.
The new era requires a far more grown-up approach to industrial integration. In hostile takeovers, you need a strong nerve, a cash pile or highly leveraged paper and a blood-lust for the incumbent managements of target companies. For mergers, you need a solid strategic case for working together long term in the same markets. It may be that the pharmaceutical giants are the first to show us how to do it.
And one further thought: such mergers rely to a greater extent on the support of a wider constituency of interest within the conglomerate than merely its shareholders. You might say they depend on the support of all the stakeholders. Now, where have I heard that word before?