P&G Merger Talks Bring Pharmaceutical-As-Consumer-Brand Idea To Fore

Procter & Gamble's aborted merger discussions with Warner-Lambert and American Home Products may herald the next phase in the evolution of consumer-focused pharmaceutical marketing.

The prospect of a $140 bil.-plus offer to purchase Warner-Lambert and AHP - and of a head-to-head bidding war with Pfizer - proved too much for Wall Street. However, P&G's willingness to consider the deal reflects the growing importance of consumer marketing in making investments in prescription drugs pay off.

The pharmaceutical-as-consumer-brand mentality - a relatively new concept for most pharma companies - is central to P&G's approach to the business.

P&G's $650 mil. in-house pharmaceutical division gives at least symbolic weight to the company's belief that there are important synergies between the broad consumer products market and the specialized prescription drug field.

P&G dates its interest in the pharmaceutical sector to its work on bisphosphonates performed initially by its laundry unit in the 1970s. The research ultimately led to the discovery of applications in bone health and the launch of the Rx drug Didronel.

In a listing of organizational strengths on the P&G Pharmaceuticals Web site, the company cites a "world class ability to communicate effectively with consumers, to persuade them to take action via advertising and other direct-to-consumer means. This skill will become increasingly critical to success in a pharmaceutical environment becoming much more consumer-centric."

"We are cultivated to operate in highly competitive markets where efficiency and marketing advantage are the norm," P&G Pharmaceuticals declared. "The pharma industry does not have this heritage."

P&G maintains its strength in marketing to consumers can help the company grow underdeveloped segments. The company also believes it has an "opportunity to optimize relationships with managed care organizations, similar to the company's Customer Teams we have in place with retailers."

The company acknowledges one area for improvement: "We need to continue to access more classic pharmaceutical experience and capacity to supplement our growing capabilities."

P&G's consumer marketing skills have not to date translated into a blockbuster pharmaceutical product.

The company's interest in investing in the pharma sector is likely to outlive the aborted Warner/AHP talks, provided the firm is able to communicate its enthusiasm for a deal to the investment community.

Under CEO Durk Jager, P&G appears eager to use a major acquisition to re-energize its performance. "A few years from now, P&G will be a very different company than it is today - still based on our core values and principles - but totally different in almost every other aspect," Jager declared during the P&G shareholder meeting in October.

P&G terminated discussions for a three-way merger Jan. 24, but asserted the idea would have resulted in "a blockbuster combination of technology, marketing and scale capabilities." The merger "would have created substantial shareholder value with minimal up-front dilution."

The termination of discussions was an acknowledgement that P&G investors were not ready for the deal. P&G's share price fell almost 20% between when the negotiations were first disclosed and the announcement of the termination.

The decline had the direct effect of making a stock-swap transaction more difficult for P&G by increasing the number of shares (and potential dilution) necessary to counter Pfizer's offer to acquire Warner-Lambert. The loss of valuation meant Pfizer actually commanded a higher market capitalization than P&G by the time the talks broke off.

Assuming Pfizer's bid for Warner-Lambert prevails, AHP could remain a possible acquisition target for P&G, although other pharma companies would presumably consider bids for AHP as well.

P&G's experience with the Warner/AHP talks suggests it will need to prepare Wall Street better for any future acquisition plans in the pharmaceutical sector.

The attractiveness of the high-margin pharmaceutical sector to P&G is clear. The company reported operating margins of 18.5% (excluding the effect of restructuring costs) for the first six months of its fiscal year (through Dec. 31). Pfizer's operating margins for the full-year 1999 were 29.4%.

P&G Pharmaceuticals touts itself as "one of P&G's fastest growing businesses," with a growth rate of 14% per year over the past five years. "We expect growth over the next five years to be at least as robust."

The parent company's top-line growth for the first six months of the fiscal year was 5%. The company's long-term goal is sales growth of 6%-8% annually.

While a decision to expand the pharma business may appear logical to P&G internally, it is easy to see why Wall Street was surprised by the talks given P&G Pharmaceuticals' extremely limited impact on the performance of the parent company.

At $650 mil. in fiscal 1999 revenues, P&G Pharmaceuticals contributed less than 2% of the company's $38.1 bil. in revenues for the period.

In the P&G's quarterly earnings release issued Jan. 25, pharmaceuticals are not mentioned. P&G cited the performance of its health care segment as contributing to growth, but focused on the performance of the recently acquired Iams pet food brand.

In the long run, P&G's efforts to expand its pharmaceutical industry presence may be helped by other companies within the industry making the case to Wall Street about the value of consumer marketing.

If Pfizer succeeds in its bid for Warner-Lambert, the company also will have to consider its plans for the Warner consumer products businesses. Pfizer has so far retained its relatively small OTC business while divesting other "non-core" operations.

However, if Wall Street does not warm up to an expansion of P&G in the pharmaceutical sector, the company may find itself with the daunting prospect of trying to build the business internally with a professional marketing infrastructure that cannot hope to rival the ever larger detailing forces of its competitors.

The P&G Web site downplays the significance of size, maintaining there is no evidence that size alone improves the efficiency of R&D. However, if P&G is unable to grow in the pharmaceutical sector, it may benefit from the enthusiasm of other companies for bulking up by divesting its pharma operations.

Following the end of the P&G talks, Warner-Lambert pledged to "continue to explore strategic alternatives, including discussions with Pfizer." W-L shares continue to trade slightly above the value of Pfizer's two-and-a-half share per share offer for Warner (¹ (Also see "Miza Pharmaceuticals USA" - Pink Sheet, 10 Jan, 2000.)).