GlaxoSmithKline chief seeks immunity from sector's herd mentality

Mergers and acquisitions may involve vast sums of money but they are as prone to fashion as anything else. Indeed, when it comes to deals, it is often striking how willing corporate bosses are to follow trends rather than step back and risk standing out from the herd.

The pharmaceuticals world is in the grip of two dealmaking crazes. One involves manufacturers of generic and branded, but off-patent, remedies seeking efficiencies through cost-crunching deals with similar businesses.

The other is for big, research-led pharma groups to buy smaller innovative rivals. The idea is to restock pipelines with exciting new biological compounds that treat conditions such as cancer. Bidders hope that if they get the right product and bring it smartly to market, they can make a mint.

Drug companies have completed about $300bn of deals over the past year: a level that exceeds even the merger boom of the 1990s and early 2000s that created many of today's giant pharmaceutical groups.

A good example of a research-led deal is AbbVie's $21bn takeover of the biotech firm Pharmacyclics. The move gives the US drugmaker access to an exciting new blood cancer compound. Ultimately it is a way to fill a gap on the laboratory bench.

As one of the world's biggest, research-led drug companies, GlaxoSmithKline might be expected to be in the thick of the action. Like other representatives of "Big Pharma", it has struggled to justify its vast market cap with a big enough pipeline of drug discoveries. From being the world's biggest drug company at the time of its merger in 2000, it has dipped to number seven.

Its boss, Sir Andrew Witty, is, moreover, under pressure. Since he became chief executive in 2008, GSK's total return to shareholders is less than half that of the Standard & Poor's 500 index. Some investors would quite like to see him go.

But under Sir Andrew's leadership, GSK is pursuing a different path. Instead of supplementing in-house research with bought-in ideas, he has been cutting projects and withdrawn from one of the hottest new areas of drug discovery: anti-cancer therapies.

This is not because he thinks the drugs won't work. Rather it is the economics of healthcare that GSK finds challenging. The industry depends for much of its revenues on markets in Europe and North America, selling to national health systems and private healthcare payers.

These are markets with stagnating populations and increasingly stretched health budgets. Many of the industry's profits come from selling at premium prices to a small number of US consumers. Were this premium to erode, or the cost inflation that supports it to stagnate, the economics of drug discovery could unravel. Many of the deals being concluded at multibillion premiums would make little sense.

Instead Sir Andrew is touting an alternative: this is to grow GSK's non-drug side, which includes vaccines and consumer healthcare. It was this desire, for instance, that led the group to swap its oncology drug business last year for the vaccine operations of Novartis, the Swiss drug giant.

Sir Andrew's bet is that selling vaccines and consumer products into global healthcare markets will offer faster and less risky growth than the crowded and expensive market to sell costly drugs.

It is too soon to tell whether Sir Andrew is right about drug prices. While European buyers have been squeezing pharma companies, and President Barack Obama's reforms have brought a new cost consciousness to the US system, the American premium has yet to crack.

There are however other things to like about his plan. M&A is very risky when targets are trading at stratospheric prices. The BDX index of biotech shares has more than trebled in the past five years, while the FT world pharma index has risen just 116 per cent. Focusing GSK's drug discovery efforts may help to deal with one of the main disappointments of Big Pharma: that larger research departments tend to be less productive, not more. Concentrating on vaccines doesn't look such a bad idea either: discovery costs are lower than drugs and the vaccine market is growing faster - 7 per cent a year.

John Maynard Keynes once observed that in many walks of life, it is "better for reputation to fail conventionally than to succeed unconventionally". Most bosses follow this dictum and it is rare for one to flout it - especially when others are avidly implementing the fashion of the day. Hopefully, GSK's investors will be patient and give Sir Andrew's idiosyncratic strategy time to play out.

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