Fire Sale! What Pfizer's Plan to Sell 40% of Itself Means in Practice

Pfizer (PFE) CEO Ian Read is considering breaking the company into little bits through sales and spin-offs, reducing the size of the company by up to 40 percent, according to an investors' note from Bernstein Research analyst Tim Anderson. Such a plan could produce a smaller, more profitable drug company in the short-term, but the plan is fraught with long-term danger. Observers are agog at the scale of change that Read is proposing. Anderson wrote:

If we hadn't been there ourselves to hear it firsthand we would not have believed it.

The plan, which could start in 2012, could reduce Pfizer's revenue base from $67 billion to about $35-40 billion a year. It would also be a complete repudiation of more than a decade of acquisitions that have made Pfizer the largest drugs company in the world.

UPDATE: How Pfizer's Breakup Plan May Explain Sudden Exit of Former CEO

Following former CEO Jeff Kindler's acquisition of Wyeth in 2009, it became clear that bigger was not better. Quarter after quarter, promised efficiencies failed to emerge. Anderson suggested that Pfizer was now so big it was facing "diseconomies of scale." That's a theory I floated in June last year when I noted that across the industry, consolidation and M&A have failed to deliver increased margins. It may just be that to run a drug company of a certain scale, there are built-in structural costs that can't be taken out of the system, even if you're trying to.

Everything must go!
Here are the units Read is thinking of either selling outright or spinning off independently with Pfizer retaining an investment stake:

Unit, estimated revenues:
Established Products (generic drugs, etc.): $10.1 billion
Animal Health (vet drugs): $3.6 billion
Consumer Health (Tylenol Advil, etc.): $2.8 billion
Nutritionals (mostly infant formula): $1.9 billion
Capsugel (a pill-making company): $1.1 billion

Absent those units, a leaner-meaner Pfizer 2.0 would consist almost entirely of its prescription drug business. Rx drugs are enormously profitable. At Pfizer, Anderson estimates they bring a 92 percent gross margin and a 35 percent net margin. It's the 40 percent of non-Rx junk in Pfizer that's holding the company back, the argument goes.

In the short term, the new company would look like a very good bet indeed. Pfizer recently announced successful phase 3 trial results for tofacitinib, a rheumatoid arthritis drug that Anderson estimates could add $1.4 billion a year in revenues. But that won't be enough to offset the loss of revenues from Viagra ($2 billion) and Lipitor (13 billion), which both lose their patent protection soon. The loss of Viagra and Lipitor to generic competition is part of a structural trend within the industry -- far more old drugs are losing their exclusivity than there are new drugs gaining exclusivity. Which is why the long term is so much more important for Pfizer than the short term.

A rising tide
Pfizer, however, has a generic drugs unit -- Greenstone. Read may be tempted to get rid of Greenstone because the profit margins on generics are low and cannot be increased, and because in recent quarters Pfizer has demonstrated that it is inept at marketing generic drugs.

He should think twice about such a sale. Greenstone is like a boat sitting in front of a rising tide. It ought to benefit from the wave favoring generic drugs over branded prescriptions. All Read needs is management competent enough not to wreck the boat -- which, of course, is always an open question at Pfizer.

The story with consumer, animals, Capsugel and nutritionals is less compelling: These are all steady-eddie businesses that don't have great margins but do produce reliable revenues year in, year out. Unlike Rx drugs such as Lipitor and Viagra, they don't experience dramatic, sudden declines in revenues due to legal technicalities.

Such constant, reliable cashflows may not excite Wall Street, but they provide a useful hedge against the rollercoaster of the Rx business. Merck (MRK) is considering a similar sale of its consumer products business, which includes Dr. Scholls and Coppertone. Both companies should remind themselves that when Pfizer sold its old consumer business -- Nicorette, Zantac, etc. -- to Johnson & Johnson (JNJ), the latter laughed all the way to the bank while Pfizer's stock continued to plummet.

Who gets the debt?
Lastly, let's not forget that the disintegration of Pfizer could also be driven not by corporate strategy but by accounting tricks. Anderson wrote:

These spin-outs could also be layered with debt, improving the balance sheet of the remaining Innovative Core side of the business.

Uh huh. Shift the debt to the spinoffs and leave Pfizer with no liabilities and lots of high-margin drugs. It's a great story for Pfizer ... not so much for the investors and employees lumbered with the low-margin, indebted spinoffs. Even then, the smaller Pfizer would remain more at risk, not less at risk, from the violent ups and downs of new drug approvals and patent expirations.

Hang on to your hats and keep your limbs inside the car. It will be a bumpy ride.

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Image of generic beer by Flickr user miserloujones, CC.

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