Takeover Fever in the Pharma Industry

There's renewed enthusiasm in the pharmaceutical industry and this is good for the marketplace. The first big story this year was Pfizer's (NYSE/PFE) takeover bid for Wyeth (NYSE/WYE) -- and the fever is beginning to spread to other names in the industry.

Bristol-Myers Squibb (NYSE/BMY) is often referred to by industry insiders as one of the most desirable pharmaceutical companies for a takeover. The rumor is now that the French company Sanofi-Aventis (NYSE/SNY) is gearing up to buy some more U.S. assets. Both of these companies already have a strong working relationship with each other, as they split revenues from the well-known blood thinner "Plavix," which is the world's second best selling drug.

I wrote before that the pharmaceutical industry is ripe for consolidation in the current economic environment, because so many brand name drugs are coming off of patent over the next few years. Competition from generic drug makers is going to be fierce and it will be very difficult for the large industry players to grow revenues and earnings. So, with this reality, there isn't much else they can do but merge with each other. It's the old adage: if you can't beat them, then you might as well join them.

Investor enthusiasm for large-cap pharmaceutical companies tends to occur in waves. The only thing that keeps investors interested throughout the volatile product development cycle is fairly strong dividends among most companies. Currently, Bristol-Myers Squibb is yielding over five percent and Pfizer is now yielding just over eight percent (the stock is down because of its takeover bid for Wyeth).

You can easily make compelling arguments that the outlook for large-cap pharmaceutical companies is either great or lousy. The aging population is a solid demographic argument for the industry, but the product development and marketing costs are so large that earnings growth is a real challenge.

I'd have one or two large-cap pharmaceutical companies as part of a well-balanced equity portfolio. Investor enthusiasm for the industry is turning around right now. Merck (NYSE/MRK) just reported earnings that beat consensus estimates and so did Schering-Plough(NYSE/SGP). Without the dividends, however, these companies would be significantly less attractive as an investment.

Profit Confidential

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