Markets

Why Bristol-Myers Squibb Could Be Acquired by Lilly or Bayer

By Jim Edwards

Updated on: September 26, 2011 / 12:30 PM EDT / MoneyWatch

Bristol-Myers Squibb (BMY) was again fingered as a takeover target yesterday after a Wall Street analyst upgraded the stock. But who might buy the drug company? There are two obvious candidates: Bayer (BAYRY) and Eli Lilly (LLY).

It's instructive to know why BMS is suddenly a hot stock. The company conducted a round of layoffs after the diabetes drug Onglyza failed to materialize into the blockbuster the company had hoped. At the same time, it acquired and launched a skin cancer drug, Yervoy, that has had a stellar launch: $95 million in its first quarter alone.

Since 2007, BMS CEOs James Cornelius and then Lamberto Andreotti* have been trimming their costs and goosing their revenues, with the result that the company is 32 percent more efficient at creating sales today than it was four years ago. This chart shows the number of dollars generated in revenue for every $1 spent on sales, general and administrative costs, the company's biggest operating expense:

That upward sloping line is a rare thing in the pharmaceutical world. Where once BMS generated $3 for every $1 invested, it now gets more than $4. Most drug companies have tried and failed to generate such improvements:

In drug companies, diseconomies of scale tend to kick in -- once a company reaches a certain size there are built-in inefficiencies it simply cannot shed. Of the bunch of companies suffering from that phenomenon, Bayer and Lilly look like the ones most in need of a transaction that might move the needle.

In May, Bayer CEO Marijn Dekkers said he was open to a "merger of equals." His company is so horribly inefficient -- producing only $2 in sales for every $1 invested -- that if he bought BMS and didn't merge any duplicate operations his company's overall average productivity would still rise.

And then there is Lilly. The company has most to lose in revenues from drugs going off patent, with up to half its prescription drug revenues at risk from generic competition. If it wanted to, a combination with BMS would give Lilly Yervoy and the blood-thinner Eliquis (apixaban), which analysts have high hopes for. More importantly, while Lilly's efficiency at generating its own revenues has trended up over time, it's still been less successful than BMS. It's still at the $3 level. A combination would increase the average leverage of its operating costs.

That, however, would require an abrupt U-turn from CEO John Lechleiter, who has adopted an official kamikaze strategy of going it alone, with 7,500 job losses so far.

*Correction: Originally this item said Cornelius was BMS' CEO. Cornelius was of course succeeded by Andreotti in 2010. Apologies for the error.
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Image by e53, CC.