Japan's vulnerable pharma companies, by P Reed Maurer Article | 12 September 2012 Once upon a time Japan's pharma companies could be compared to a convoy of ships. The big and small, fast and slow ships all moved at the same pace, comments long-time Japan industry watcher P Reed Maurer, president of International Alliances Limited. Their businesses were largely confined to Japan, and they spoke with one voice to the government in terms of reimbursement prices and regulatory requirements, he notes. This analogy and its consequences is now passé. Five companies depend heavily on overseas markets for sales revenue. As of fiscal year 2010 they were Otsuka 55%, Eisai 54%, Daiichi Sankyo 52%, Takeda 49% and Astellas 43%. Except for Otsuka, these four companies plus two others, ie, Dainippon Sumitomo and Shionogi, increased their foreign sales ratios through acquisitions of foreign companies. From 2007 through April 2012 the six companies spent $42.640 billion to acquire 12 companies, a staggering amount that led many to suggest the acquisition costs were not justified. Companies on the other hand, countered by saying they are making long term investments to access emerging markets and product pipelines, particularly in oncology, that will pay off over time. Whatever the outcome, there is no doubt these companies took aggressive actions to go beyond the Japan market for both growth and access to innovative new therapies. They will be challenged by the difficulties of integrating the acquired assets and the cultural hurdles of globalization. But they took actions, which is more that can be said about Japan's mid-tier companies who continue to be totally dependent on the mature Japan market saturated with off-patent drugs.
Defining vulnerable companies Space does not permit listing all of Japan's vulnerable pharma companies, often less kindly referred to as Zombie companies. Generally these can be identified by looking at one or more of the following three criteria:
1 A high proportion, over 50%, of revenue accounted for by long listed drugs, that is, drugs with generic competition. For example, as of April 2012, 70% of Mochida's revenue was contributed by long listed drugs. Revenue growth of these drugs is threatened by the double whammy of multiple generics and reimbursement price reductions of an extraordinary nature to provide financial resources to increase medical fees as demanded by the Japan Medical Association.
2 A Price Book Ratio (PBR) below 1.0. This measures the book value of the company's assets against the stock market price. Overall Japanese company PBR's are 50% lower than global companies, a perspective by stock market players that many Japanese pharma companies are not growing now and will not grow in the future. Two examples of a low PBR are Aska at 0.4 and Kissei at 0.6. Companies with a deeply discounted share price are vulnerable to take overs by outsiders.
3 A large proportion of generics in the revenue base which is indicative of few new branded drugs, and the company strives for growth by selling generics.An example of a company in this category is Nippon Chemiphar. In 2011 their generic sales were 69% of total sales, branded products were 20% and declining. This so-called hybrid business model is considered not sustainable for two reasons:
a. Competing in the generics business, a cost driven business, is very different from the branded business. Having both under the same umbrella means you do not do well in either space.
b. Gravitating to an all generics business because there is no pipeline of new branded products puts the firm in direct competition with both Japanese and multinational pure play generic companies. Both are hard to beat because of their low cost base and full line of product offerings.
Future options for vulnerable companies
What are possible outcomes for vulnerable companies? There are five options:
1 Evolve into a niche player with a well defined focused therapeutic range of products. Companies in this category who are given good premiums by the stock market include Santen in eye care, Hisamitsu in topical patch products, and Taisho in OTC products.
2 Form an alliance with a multinational company as Chugai did with Roche. Chugai is now ranked 6th in Japan in terms of promoted products, that is, excluding sales of products only distributed on behalf of other companies. Its pipeline and marketed products are loaded with oncology products which compete in Japan's second highest therapeutic area of antineoplastics.
3 Form an alliance with a domestic "outsider" company. An example is Kyowa Hakko Kirin. Pharmaceutical sales of the combined entity are growing rapidly while non-core assets like chemicals were divested. Other examples of local outsiders committed to the pharma industry include Toray, Teijin, Ajinomoto and Asahi Chemical.
4 Consolidation among the vulnerable companies is an option but hard to imagine synergy resulting from these types of mergers that was possible in the mergers that resulted in Astellas and Daiichi Sankyo. This scenario is a case of one plus one will equal one half.
5 Muddle through, or in other words continue to do tomorrow what you did today. The attraction of this option is it preserves the independence of owners and senior executives. Shareholders are not demanding change, and banks are very willing to roll over debt as long as interest is paid. During my 42 years in Japan no public pharma company has gone bankrupt.
Summary We can conclude that vulnerable companies abound in Japan. Most are not taking action to change their future outlook and will inevitably be in trouble if their long listed but still very profitable drugs suffer mandated price reductions in 2014. The silver lining in this cloudy outlook is an opportunity for outsiders to acquire assets in Japan to enhance their competitive positions in the pharma market.
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