Pfizer Eyes Wyeth. We Ask "Why?"

This morning the rumors are circulating that Pfizer (PFE - Analyst Report) is in talks to acquire fellow drug maker Wyeth (WYE). In fact, sources close to the two firms say talks have been ongoing for months, but that a potential deal is still far off.

Nevertheless, should Pfizer absorb Wyeth, it would be the largest drug merger combination in years.

Financing seems to be the biggest hurdle to finalizing a deal at this point. Wyeth management could be looking for as much as 50% in cash. Wyeth currently trades with a market value of $55 billion. Assuming a 10-20% premium would mean that Pfizer may need to pony up close to $30 billion in cash to close the deal.

Pfizer held roughly $26 billion in cash at the end of the year, but little is known how much of that cash is held in the U.S. vs. cash overseas that would need to be repatriated and taxed. Pfizer still holds a AAA rating, and Wyeth holds another $14 billion in cash and investments, so a short-term financing option makes sense. If Pfizer can get that done, it will say a lot about potentially easing credit markets. If Pfizer can't get money, we still have a long way to go with this current crisis.

From a product standpoint there's little overlap between Pfizer and Wyeth. Wyeth should deliver around $23 billion in sales in 2008, up around 4% from 2007 levels. Key products include depression drug Effexor, children's vaccine Prevnar, proton pump inhibitor Protonix, and anti-inflammatory drug Enbrel. Pfizer's key products include cholesterol drug Lipitor, pain drug Celebrex, fibromyalgia drug Lyrica, erectile dysfunction drug Viagra, glaucoma drug Xalatan, and cancer drug Sutent.

The only areas where we see significant overlap is in antibiotics -- both firms have several broad-spectrum compounds -- and in animal health -- both divisions are among the largest in the world. On the research front, both firms are making a push into oncology, Alzheimer's disease, and central nervous systems disorders.

Wyeth also has a consumer and nutritional division. Pfizer sold its consumer division to Johnson & Johnson (JNJ - Analyst Report) in 2006, so it will be interesting to see what management does with Wyeth's consumer division should a deal get done. Closing the deal and then selling off parts of the animal health, consumer, and nutritional business could help Pfizer re-coup some of the deal costs.

What the deal does not do for Pfizer, however, is add any significant revenue growth. Our financial model assumes Wyeth's top-line stays roughly flat from 2008 through 2012 at $23-24 billion. Pfizer's top-line is also showing no growth, and will remain flat at $49 billion until 2012 when it drops significantly due to the Lipitor patent expirations.

Pfizer's patent situation is well documented by our work and the impetus for why Pfizer needs to do a deal. However, Wyeth's patent situation is really no better, with expirations on Effexor, Protonix and Zosyn all expected in the next few years. By acquiring Wyeth, Pfizer gets bigger and slower in our opinion. In 2010 the combined Pfizer-Wyeth could have $73 billion in worldwide sales. That number may decline to $68 billion in 2013 due to patent losses.

That being said, Wyeth has $11 billion in operating costs (SG&A + R&D) which seems to offer a significant opportunity for cost cutting. Pfizer should be able to achieve as much as $2 to $3 billion in costs synergies by absorbing Wyeth. This could turn virtually no, or negative, top-line growth into double-digit earnings growth in 2010 and 2011.

But investors have never paid up for this type of "manufactured" earnings growth, so we question why Pfizer should do this deal. It will surely be dilutive for 2009 and 2010. Plus, getting bigger is not something Pfizer needs to do. Pfizer should be looking for small-to-mid sized strategic biotech acquisitions that would offer significant growth opportunities through new innovative products. Wyeth should be doing the same.

Instead, this looks like two large struggling companies coming together to form one enormous struggling company. What does a deal of this size say about Pfizer's confidence to growth organically through its internal pipeline? Not much, obviously.

It's also odd that just last week Pfizer announced layoffs of 2,400 sales positions, and now today they may be looking spend $60 billion on Wyeth. Begin the head-scratching.

Read the full analyst report on PFE

Read the full analyst report on WYE

Read the full analyst report on JNJ