Healthy Skepticism Library item: 6993

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Publication type: news

Zuckerman G, Hensley S.
Pfizer Drug-Development Flop
The Wall Street Journal 2006 Dec 5

Abstract:

Big-name investors took big hits as Pfizer shares tumbled more than 11% following the pharmaceutical company’s decision to stop development of its potential blockbuster drug torcetrapib.

Some mutual funds held more than 100 million Pfizer shares at the end of the third quarter, meaning that the $2.96 decline in the share price translated into a loss of some $300 million or more. Some skeptics about Pfizer who were hesitant to make bets against the stock in recent weeks now are gnashing their teeth that they weren’t able to cash in on the dour news.

Torcetrapib was supposed to raise so-called good cholesterol and was being tested for use in conjunction with Lipitor, Pfizer’s best-selling drug that lowers bad cholesterol. During a clinical test involving 15,000 patients, more people than expected died while taking the new drug. In the wake of the biggest research failure in its history, Pfizer now must chart a path through a rockier future. The company already was dealing with the loss of patents on drugs with $14 billion in annual sales during the three years through 2007. Lipitor, which had sales of more than $12 billion in 2005, may face generic competition as soon as 2010. Without torcetrapib, Pfizer has no obvious blockbuster to make up the shortfall.

Executives have said revenues for the next two years would be “comparable” to those for this year and wouldn’t resume growing until 2009. Earnings per share will rise, they said, as the result of cost-cutting and share repurchases.

The share-price decline sent the company’s market value to $179.5 billion from more than $200 billion on Friday, making it look cheap relative to many of the company’s peers. As of Monday, Pfizer was trading at 12.3 times its estimated per-share earnings for the coming 12 months, according to Thomson Financial. That’s about half the 23.6 price-to-earnings ratio for Roche Holdings, the Swiss drug maker that’s developing a rival cholesterol drug, and Schering-Plough’s 27.8 times. Merck is trading at about 17.8 times while Abbott Laboratories , which plans to acquire another firm that also has a rival drug, has a forward PE of 19.1 times.

Mutual funds with stakes in Pfizer include Dodge & Cox in San Francisco, which held more than 127 million shares as of Sept. 30, about 3.3% of its stock fund and the firm’s fourth-largest holding at the time, according to data compiled by FactSet Research Inc. AllianceBernstein held more than 150 million shares of Pfizer at the end of the third quarter, including 25 million shares acquired during the three-month period. Fund giant Fidelity Investments held 123.1 million shares.

Pfizer was State Farm Insurance’s third-largest holding at the end of the third quarter, or more than 4% of its investment portfolio. Spokesmen for Dodge & Cox, Fidelity, Alliance and State Farm all declined to comment. In an interview this weekend, David Shedlarz, Pfizer’s vice chairman, said the torcetrapib failure will put a premium on “focused business development,” or smarter, faster deals to bring new drugs into the company’s fold. Still, he emphasized these deals wouldn’t be done for “short-term financial gain” but instead would only fit with Pfizer if the acquisitions or alliances had “strong strategic merit.” Some investors argue, however, that the company may have to pay a large sum for any acquisition that will affect earnings.

Pfizer executives told analysts last week they expect internal research to bring four new drugs to market annually starting in 2011. Partnerships and acquisitions are expected to add two drugs a year starting in 2010.

The New York drug maker last year embarked on a $4 billion cost-cutting campaign. Since Jeffrey Kindler took over as chief executive in July, the company has signaled that slimming down will be an even higher priority. Last week, the company said it would cut 20% of its U.S. sales force, a symbolic break from its past approach of expanding is sales force. The move could save more than $400 million a year, some analysts estimate. Those cuts could continue. “If they can’t replace revenue, then it’s likely to lead to another downsizing event for the sales force,” though probably outside the U.S., says Jaideep Bajaj, managing director for ZS Associates, a sales consulting firm. He declined to say if his firm does work for Pfizer, citing company policy on confidentiality.

By the end of the month, Pfizer expects to have $34 billion in cash, after it closes the sale of its consumer-products unit to Johnson & Johnson for almost $17 billion. That and ample cash flow from operations give Pfizer freedom to increase its dividend, and to buy back more shares. Pfizer management has board approval to purchase $18 billion in company shares through next year.

After Pfizer executives predicted flat revenue for the next two years in their conference call with analysts about third-quarter earnings, some hedge funds and other investors did become more cautious. There also were concerns about reports of high-blood pressure among certain patients taking torcetrapib in trials.

Frank Sustersic, a portfolio manager at Turner Investment Partners in Berwyn, Pa., who oversees Touchstone Healthcare and Biotechnology Fund, is among managers who saved investors from Monday’s double-digit losses. Turner manages $21 billion in assets. Pfizer was the Touchstone fund’s top holding as of Sept. 30, making up about 7.8% of its $64 million health-care fund, according to FactSet. Mr. Sustersic said his fund has since sold out of the stock. A number of hedge funds that deal with health-care stocks have been “avoiding or shorting” Pfizer recently, says Mario Corso, director of research at Summer Street Research, a Boston health-care research firm that has had a “sell” rating on Pfizer for the past year-and-a half due to worries that torcetrapib could increase blood pressure in patients.

As of Nov. 15, short interest in the company’s stock was 44.7 million shares, less than 1% of the total outstanding, meaning that many shares had been borrowed and sold by investors wagering that a fall in the stock’s price would allow them to replace the borrowed shares at a lower price for a profit.

Several health-care oriented hedge funds say they expected discouraging news about torcetrapib to come out slowly and hadn’t yet established big short positions on Pfizer. Others say they trimmed their bets against Pfizer in recent weeks. Some figured the company could raise its dividend or take other steps to help the shares.