Assistant Managing Editor

The long-predicted wave of consolidation in the drug development industry could finally come rolling in this year, if the last two months are any indication, with Pfizer Inc. offering $68 billion for Wyeth, Merck & Co. Inc. merging with Schering-Plough Corp. in a $41.1 billion deal and Roche Holdings AG's $46.8 billion offer for the remaining minority stake of Genentech Inc.

"Every year, we hear that we can expect a bunch of these mergers," said Leerink Swann & Co. analyst John Sullivan, though he said more consolidation this year is likely, especially if the credit markets remain open for big pharma.

Last year saw some notable consolidations - Eli Lilly and Co.'s $6.5 billion bid for New York-based ImClone Systems Inc. and Takeda Pharmaceutical Ltd.'s $8.8 billion buyout of Cambridge, Mass.-based Millennium Pharmaceuticals Inc. - though none came close in dollar amounts to the recent mega-mergers. But this year has brought some changes that have caused a bit of a shift in pharma's outlook.

Part of that is due to the economic environment. The recently declared recession has prompted severe cutbacks across all industries, including big pharma. Pfizer, Merck and Wyeth, as well as other pharma firms such as GlaxoSmithKline plc, all slashed jobs last year, and, if the recent mergers go through, more positions likely will be cut from the combined firms to continue reducing costs.

At the same time, pharma is inching ever closer to the so-called "patent cliff" of 2011, when some of the industry's top-selling drugs, such as Pfizer's blockbuster cholesterol drug Lipitor (atorvastatin) will face generic competition. And it's becoming clear that the pharma R&D engines of old just aren't capable of generating enough new drugs to offset those upcoming patent expirations.

But the one asset big pharma does have in abundance is cash. About $100 billion, in fact.

Pharma has "a lot of liquid cash and firms have been able to raise debt money relatively easily," despite the state of the current markets, said Damien Conover, equity strategist for investment research firm Morningstar Inc., which held a conference call earlier this month to look at potential acquisition targets.

For instance, he said, "Lilly was able to raise $2 billion to $3 billion easily" ahead of last year's ImClone buy. Meanwhile, Amgen Inc. secured $2 million in debt in January and Roche managed to pull in more than $30 billion in debt financing to help cover the cost if it succeeds in buying out the minority stake of Genentech.

And, as the year progresses, large pharma firms should see their cash flows "remain fairly stable," Conover added.

But that does not mean those dollars will be funneling into the small biotech arena right away. Despite the fact that depressed capital markets have brought stock prices down to bargain basement prices - not to mention the willingness, even desperation, of cash-strapped small and medium-sized biotech firms to score M&A deals - the looming patent pressures could force big pharmas to spend a significant chunk of their cash on acquisitions that bring immediate returns.

'The Right Transaction at the Right Time'

Merck's merger agreement with fellow pharma firm Schering-Plough marked a shift in the Whitehouse Station, N.J.-based company's strategy, which previously focused efforts on growing its internal pipeline and in-licensing or partnering on biotech products to build up its portfolio.

But as Merck gets "close to that patent cliff," management is "doing what's necessary to be able to maintain" the bottom line and deliver to shareholders, Leerink's Sullivan said.

Merck's osteoporosis drug Fosamax (alendronate) went off patent last year, and two other top-selling drugs Singulair (montelukast), for asthma and allergy, and hypertension drug Cozaar (losartan), are set to face generic competition in 2010 and 2012, respectively.

For its part, Kenilworth, N.J.-based Schering-Plough is better positioned in terms of patent expiration dates, but the smaller pharma has significantly less cash in the bank than Merck even though it's advancing a late-stage pipeline of 12 compounds. In the companies' conference call last week, Fred Hassan, Schering-Plough's chairman and CEO, said that given "the accelerating challenges of our industry and the attractiveness of [Merck's] offer," it was the "right transaction at the right time."

The need for an immediate, or at least near-term lift could put smaller and earlier stage acquisitions lower on big pharma's priority list.

A recent research report compiled by Morningstar rating 62 companies on their takeout potential ranked "profit-boosting power," defined as the timing and size of an acquisition prospect's profit potential, as the second most important rating factor, behind only drug portfolio strength. Companies scoring high in that category, according to Morningstar, include Biogen Idec Inc. and Celgene Corp., both of which would offer acquirers immediate impacts with profits in the mid-hundreds of millions, as well as Genzyme Corp., which currently is profitable though it has the near-term potential with late-stage programs like mipomersen, an antisense drug for cholesterol partnered with Isis Pharmaceuticals Inc.

Morningstar also rated Thousand Oaks, Calif.-based Amgen Inc. and Foster City, Calif.-based Gilead Sciences Inc. high on the list of profit-boosting takeout targets, though it acknowledged that both of those firms maintained independence, and seem to be better positioned as acquirers, instead.

In fact, Gilead last week made a $20-per-share bid for CV Therapeutics Inc., of Palo Alto, Calif., topping Astellas Pharma Inc.'s earlier $16-per-share offer. Based on the number of outstanding CV shares, that deal could be worth $1.4 billion.

And the good news is that it's doubtful if even the recent spate of mega-mergers will leave smaller development-stage biotechs on the sidelines for long.

The change in administration could affect pricing power and that could direct interest away from follow-on small molecules and toward more innovative products, Conover said. "So I think we'll be seeing more interest in biotech."

Leerink's Sullivan agreed. "There are two types of deals," he said. "Deals like [the Merck and Schering-Plough merger] are out of necessity because [companies] have to become more efficient." But the second type of deal is needed for "the drug industry to achieve growth" and biotech represents the drug industry's "long-term revenue growth."

Cash in Hand and Ready to Shop

Every month that goes by increases the likelihood of more mergers and acquisitions happening in the biotech space, Morningstar's Conover said. The only question seems to be which big pharma firm will make the next move, whether it's another merger among giants, like the Pfizer/Wyeth or Merck/Schering-Plough deals, or a more modest transaction.

Bristol-Myers Squibb Co., for instance, has a "great cash balance," and is "definitely a company that will make some acquisitions," Conover said.

BMS, which reported cash and equivalents totaling about $8 billion as of Dec. 31, is facing the patent expiration of anti-clotting drug Plavix (clopidogrel, partnered with Sanofi-Aventis Group) around 2011. The pharma firm acquired Kosan Biosciences Inc. last year, but lost out to Lilly in a bidding war for ImClone a few months later.

As for Lilly, the Indianapolis-based firm is "still digesting ImClone," but it already has replaced the cash spent on that deal and likely will be "ready to do more," Conover said.

Pfizer is expected to "have its hands tied with Wyeth, probably for the year," he said, though other firms could easily step up, such as Novartis which has "strong cash" and might seek to take advantage of the depressed stock prices, and Sanofi-Aventis, which has "huge patent problems and [is] definitely looking to get deals."

Conover also expects New Brunswick, N.J.-based Johnson & Johnson "to be in play" this year, armed with a plenty of cash, even after its $1.07 billion buyout of medical supplier Mentor Corp.

There had been speculation that J&J might even make a move for Schering-Plough, its joint venture partner on Remicade (infliximab) and golimumab.

London pharma firms AstraZeneca and GlaxoSmithKline are not in the best positions in terms of cash, Conover said, but both could "easily do anything under a billion." And news of the Merck/Schering-Plough deal even fueled rumors that those two companies might consider joining forces in a mega-merger of their own, though GSK reportedly has said it is not seeking a deal of that size.