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Wednesday, December 9, 1998 Published at 12:49 GMT

Business: The Company File

Europe's giant drug merger explained

The deal could be good for consumers

The merger between drug giants Zeneca and Astra is the latest in a string of high profile deals which are set to transform the pharmaceutical industry.

But what is prompting the sudden rush to do deals, what will it mean for consumers and what are the potential pitfalls?

Why the deal was done

  • Research and development costs
    The cost of getting a drug to market has risen sharply in recent years as competition has intensified and companies are forced to rush out remedies as soon as possible. The average bill for producing a product is now $500m. By pooling resources the two companies hope to create a research and development powerhouse.

  • Patent problems
    The patent on Astra's main money maker, anti-ulcer drug Losec, expires in 2001. Similarly Zeneca stands to lose the exclusive rights over some of its main pharmaceutical products over the next few years.
    When drugs come off patent, competitors usually come into the market, pushing down prices and taking a big chunk of sales.
    Concerns have been raised about the future prosperity of both companies. By combining forces they hope to cover over cracks in product pipelines.

  • Cost savings
    By merging the two companies hope to save $1.1bn. Most of the savings will come from slashing 6,000 workers, including up to 1,000 in the UK, and combining their marketing and research and development arms.

  • Intense competition
    Analysts have criticised Zeneca and Astra for having unambitious management teams, slow to grasp the changes sweeping across the industry. While other group's have joined forces and grown much stronger Zeneca and Astra have been left behind.

    Pressure from shareholders for action and a desire to compete more effectively in the crucial US pharmaceutical market helped prompt the move. The new group will have nearly half its sales in the US, and half in Europe.

  • Good fit
    The companies appear to be a good fit. They have complementary drugs, with few remedies in direct competition with each other. The similar size of the two companies also helped facilitate a merger.

What is means for consumers

[ image: Zeneca has found itself falling behind rivals]
Zeneca has found itself falling behind rivals
Governments around the world are looking to reduce the cost of the pharmaceuticals they purchase.

They are putting pressure on companies to cut prices, which in turn has helped fuel mergers.

The marriage of Astra and Zeneca could therefore lead to lower pharmaceutical prices, with the combined company passing on some cost savings to consumers.

The two drug companies are also under pressure to produce new products, and a merger should lead to more pharmaceutical breakthroughs and speed up the introduction of new remedies on the market.

Doubts remain

Not withstanding the clear advantages of the merger, doubts remain about the deal and the future of the combined group.

[ image: Astra's earnings will be hit by patent expiries]
Astra's earnings will be hit by patent expiries
There are still concerns about the earnings potential of the merged entity. Analysts predict that the expiry of patents will still have a significant effect on profits and there is no guarantee that the combined group can come up with new blockbuster drugs to counter the problem.

Teething problems

Drug mergers have not had a successful history. There is no better example than Pharmacia of Sweden and Upjohn of the US whose own union got off to a terrible start, where the combined management had a major culture clash.

The market has also reacted warily to the creation of the pharmaceutical and life sciences merger between Rhone-Poulenc of France and Germany's Hoechst.

In fact even getting some mergers off the ground has proved difficult.

Management clashes at UK pharmaceutical groups Glaxo Wellcome and SmithKline Beecham prevented their merger and US groups American Home Products and Monsanto recently called off talks.

Shareholders short changed?

Zeneca shares have stormed ahead in recent years as bid speculation has circled the group.

However a merger with Astra will leave some shareholders disappointed that the UK group has not been taken over at a significant premium to the current share price.

Merger pitfalls

When large mergers are announced in a blaze of publicity, share prices usually soar as companies extol the virtues of their new union.

However in the long term, the real benefits of merger are far from clear.

Indeed large mergers could turn out to be bad news for shareholders.

A recent study of 100 large deals taking place between 1994 and 1997, showed that two thirds result in immediate losses for shareholders and, in the long term, the resulting companies underperformed their industry peers.

Mark Sirower, professor of mergers and acquisitions at the New York University's Stern School of Business, who conducted the research, reported a similar trend in the 1980s.

Financial markets have soared over the past few years, putting many stocks on heady ratings.

High valuations mean that companies have to run hard just to stand still, delivering every higher profit growth for their shareholders.

Bitter pill

Astra's deal with Zeneca looks like a step in the right direction for both groups.

However it could still prove to be bitter pill to swallow for shareholders.

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