Stock Values

Whoever has forgotten Murphy’s Law, please allow me to remind you that “whatever can go wrong, will go wrong,” and wrong it has gone plenty for Pfizer, Inc. (PFE) over the past decade. As a result, share prices continually slipped recently broaching 12 year lows.

But Pfizer, with the staying power of Viagra, cared not about Murphy and all the market noise he brought with him, instead concentrating on becoming the world’s leading pharmaceutical powerhouse. (Johnson and Johnson (JNJ) is larger in both revenue and market capitalization, but attributes much of both to their non-pharmaceutical businesses.) Two very large and strategic acquisitions helped Pfizer get there - Warner-Lambert Co. in 2000 and Pharmacia Corp. in 2003. Revenue generation was also fueled by heavy R&D investments (pegged at over 16% of 2008 revenue) and by leveraging Pfizer’s mighty distribution channel with licensed in products.

Despite all the efforts, revenue growth stalled 4 years ago. Old chemistry-based methods for discovering meaningful new drugs are becoming ever less effective and the company is facing near-term patent expirations of some of its most profitable drugs. The situation sounds dire, doesn’t it? Add to that: the just announced huge acquisition of Wyeth (WYE), which is expected to gobble up all of Pfizer’s cash, the halved dividend, the legal settlement costs… And that’s not to mention the backdrop of the current economic conditions worldwide, with millions of people expected to loose their jobs (and with them their health care benefits) this year and you are looking down a deep abyss for Pfizer. Ah, if only things were so simple…

On the subject of drug patent expirations: of course Lipitor’s patent protection will surely be missed once it does go away, but everybody knows that already and this (along with a couple of other upcoming blockbuster drug patent expirations) has long been factored into Pfizer’s stock valuation. There are also multiple ways to extend profits from expiring drugs. Reformulations, patent extensions and generic licensing are often used to milk successful products beyond their initial expected lives. For one reason or another, most analysts tend to ignore this simple fact.

People are also seemingly forgetting that Pfizer’s current strategy involves developing a more diversified drug revenue base. Instead of gambling on the next blockbuster to drive revenues, Pfizer is now developing over 100 promising new drugs, with almost a quarter of them in the final stages of development – just about ready to be submitted for approval. Pfizer has also expanded its drug development efforts to new areas, like Alzheimer's and cancer. The current strategy has been in the works for several years already and should start bearing fruits by 2011. This alone would not only make up for loss of revenues from the blockbusters, but also insure more consistent top-line growth.

But how about Pfizer’s seemingly absurd plan to acquire Wyeth, spending all their cash, loosing their top-tier bond rating, taking on debt and cutting dividend in the process? If it was only the newer biotech research methods and mentality that they were after, they could have picked up any of a number of smaller biotech firms on the cheap – a great many of these companies are now in desperate need for financing. Almost certainly Pfizer could have done an all stock deal and saved their precious cash, rating and dividend. Doesn’t the Wyeth deal serve as proof that Pfizer is desperate to regain revenue that they are destined to loose with Lipitor in 2011?

On the contrary, I see Pfizer's acquisition of Wyeth as super smart. To buy Wyeth is not a gamble, as it would be with a purchase of a small biotech. What Pfizer is getting with Wyeth is a rock-solid solid profitable business with a nice product mix that complements their own. They are also getting a proven biotech R&D team, expertise in diabetes, breast cancer, multiple sclerosis, Alzheimer’s and schizophrenia, several great over the counter drug brands and they are getting all this at a very reasonable price.

But they are using up all of their cash and borrowing more. Wouldn’t it be more prudent to conserve cash in such difficult economic times? It would be, if Pfizer’s goal was to wait out the current economic storm on the sidelines and deal with consequences later, but it is exactly this storm that is delivering the opportunity that they have been waiting and accumulating cash for. Pfizer knows that the current low interest rate environment induced by the Fed to stimulate the economy can not and will not last too long, so why not use the opportunity to borrow easy TARP money from the banks, which are only too eager to lend it at very attractive rates? Pfizer also knows that once inflation hits, their big stash of cash will be worth less, so why not use it now?

Cutting the dividend in half to bring stock yield down to a very reasonable 4% is also smart. This move will have immediate positive effect on Pfizer’s post acquisition financial position by improving dividend coverage and quick ratios. This will in turn serve to quickly restore Pfizer’s credit ratings to the highest available. In the short term, a notch lower credit ratings are unlikely to significantly influence new issue bond yields that investors will be willing to accept when Pfizer refinances the TARP funded bridge loan. Most importantly, it will certainly not impact availability of funds to refinance the bridge loan.

What about those previous acquisitions that Pfizer engaged in? They didn’t quite live up to their expectations, did they? There is no denial that there were some problems and culture clashes, which hurt morale and productivity as a result of past acquisitions. Even though Pfizer's CEO, Jeffrey Kindler, is probably correct that Pfizer is now "in a much better position to bring on board the scientists and programs and projects that Wyeth has," I am sure that there will be problems this time around, as well. We can hope that problems will be minimal, but given the large layoffs already announced, there will surely be some issues. The question, however, is not whether the acquisition will go precisely as planned, but rather whether Pfizer is going to be better of acquiring, despite the potential problems. I think the answer to that question, just like it was for the previous acquisitions, is a most definite “yes!”

By now it should be rather obvious that I generally like Pfizer and expect great things from it over the next several years. The only question that remains is, “when would be a good time to jump in?” My answer to this question is, “now.” The recent barrage of negatively perceived news surrounding Pfizer has been immense. Acquisition news, restructuring charges, planned layoffs, legal settlement charges, credit downgrades, a dividend cut, analyst comments and etc. have hit Pfizer shares hard. In light of all this “bad news,” Pfizer shares held up very well, trading above their November 20th, 2008 low.

With bad news behind us, underappreciated good news ahead and Pfizer trading dirt cheap by any and all traditional measures of value, chances are good that Murphy will finally let Pfizer shares appreciate. I purchased my PFE shares on Tuesday, January 27th at $15.93.