I wrote this article for FT in 2005, but after reading news on Pfizer it feels like I could have written it today.
Here are some excerpts from the article:
- Blockbuster success is a double-edged sword. In this litigious society a discovery of side-effects brings an army of tort lawyers to the doorsteps of pharmaceutical companies.
- The demographic trends of ageing baby boomers will push demand for the pharmaceuticals into the stratosphere for a long time. However, investors should add another dimension to their analysis – product diversification. Companies that have a high concentration of sales in just a few blockbuster drugs should either be avoided or have a much smaller place in the portfolio. Also, investors should temper valuation premium expectations for the overall sector as it is unlikely to return to its old levels.
- Medical device/instrument companies are likely to take over the leadership from pharmaceutical companies and inherit the premium valuation. [Zimmer (ZMH), Biomet (BMET) come to mind here]. They will reap the rewards from the baby boomers’ desire for longer and healthier lives. With few exceptions, medical device/instruments companies have a much more diversified product line.
- Companies that provide services to the pharmaceutical industry are a good sidedoor to participate in the industry’s future prosperity without subjecting investors to the all risks. IMS Health (RX), a provider of market intelligence to the pharmaceutical industry, comes to mind as a good side position. It has all the qualities of a pharmaceutical company: strong competitive advantage, terrific return on capital, monopoly-like profit margins, great cash flows, very reasonable valuation and good consistent growth prospects ahead, without all the aforementioned risks. [I no longer own RX, but it maybe a good time revisit the stock.]
Position in ZMH