My word, the pharmaceutical sector is high on adrenaline. Alas, I am just a little doubtful whether this is good for my long term financial health.
It is certainly wise to have a pharma in your portfolio. Although there are risks – long, expensive trials littered with failure are required before any drug gets to market and the lifetime of a hard earned patent is comparatively short – this is a solid, long-term sector. And it’s set to continue to thrive whatever the economic cycle because of the ageing population in wealthier countries.
This week we have had a three-way deal between 
GlaxoSmithKline (GSK), Novartis (NOVN) of Switzerland and Eli Lilly (LLY) from the US, plus a takeover approach from Canadian group Valeant Pharmaceuticals (VRX) for Botox maker Allergan (AGN). Meanwhile there have been reports that Pfizer (PFE) is considering a bid for AstraZeneca (AZN), which has inevitably led to renewed speculation that some American company with more cash than sense will pay over the odds for Shire(SHP).
As a shareholder in Glaxo I am reasonably content with developments. Glaxo is selling more than it is buying, so it is not overstretching itself on the deal. Glaxo and Novartis will both have greater scale in the businesses they retain, which should boost earnings.
On the other hand, I don’t invest in companies that shrink and hand cash back to shareholders in lump sums that have to be invested elsewhere. I’ve already had Vodafone (VOD) pull this stunt on me and I didn’t want lightning to strike twice. I also feel that for Glaxo to sell its developed cancer medicines while hanging onto its early stage cancer pipeline increases risk.
I view the joint venture in consumer products formed by Glaxo and Novartis with suspicion. Joint ventures between international giants are always likely to end in tears, with no-one properly in control, but such is the spirit of cooperation at the moment we can hope that such tears will be some way into the future. Some day this joint venture will unravel and I hope that when it does we will see Novartis overpaying for control.
Morningstar analyst Damien Conover is more sanguine, however. “Overall, the transactions strengthen Glaxo's position in vaccines, Novartis' platform in oncology, and both firms' consumer health entrenchment,” he wrote in this week’s analyst report. Conover believes that while the firms lose some diversification of cash flows, both companies gain more back in cost savings and pricing power in the therapeutic areas improved by the deal.
Glaxo in London and Novartis on the Swiss stock exchange both saw their shares shoot up so investors also clearly see this as a win-win deal. With Glaxo still on a decent yield I am staying in for the long term.
I would never buy shares on bid hopes, especially after they have already gained strongly, but I would certainly not encourage Astra shareholders to take profits. If a bid does go through it will be at a higher level than the current share price, while if Astra stays independent the yield is still attractive and the price/earnings ratio is undemanding.
If anything, there is a case for buying into Astra for the long term, particularly on any weakness in the share price.
Shire is a little more problematic. The takeover rumour is far more speculative, the dividend is tiny and the rating is very demanding. I can’t make a case for buying in, and existing shareholders of a nervous nature could see the latest surge as a chance to take profits. Otherwise this is a sector where you should keep taking the tablets.
Rodney Hobson is a long-term investor commenting on his own portfolio; his comments are for informational purposes only and should not be construed as investment advice.
