Section 3 Implications for Investors View of the city of Rio de Janiero, Brazil, from one of the favelas on the surrounding hillsides
<strong>Pharma</strong> <strong>Futures</strong> 3 <strong>Pharma</strong> <strong>Futures</strong> is designed both to analyse the opportunities and challenges facing the pharmaceutical industry and also to support the investment community in its understanding of how pharmaceutical companies manage their complex social contract. To realise the potential of emerging markets requires companies to take a long-term approach. While the opportunities are significant, the investments required to develop necessary delivery infrastructure, cultivate relationships with key partners and stakeholders and shift internal mindsets take time. The case studies presented in this report support this point; most efforts took nearly a decade to gain significant traction. Still, many pharmaceutical companies have already decided that the potential opportunities are important, and have been building up their investments in these markets. This section reviews the implications of this long-term view for investors. What information do investors need to understand if a company’s particular approach will bear fruit? And if emerging markets really do represent a profitable longterm investment opportunity, how can investors play a greater role in encouraging and supporting these investments? At present the information available to investors about company performance in emerging markets is limited. This lack of disclosure is increasingly at odds with company statements that emerging markets are now a strategic priority. PF3 therefore identified a number of key performance indicators which would support the investment community in its evaluation of the risks and opportunities these markets offer. * Analysis by USS in December 2008 using data from Bloomberg finds that originals producers’ Indian subsidiaries earned an average 27% pre-tax margin, versus 22% for their parents, over the preceding five-year period. The dialogue also concluded that simply applying comparable metrics to those used in mature markets is unlikely to be sufficient to support the adaptive business models that would deliver success in these markets. Most existing metrics will struggle to capture the intangible value drivers identified in Section 2. It was also apparent that the investment community itself could play a more significant role to support the development of health systems by directly providing capital to entrepreneurial ventures. New Metrics to Evaluate <strong>Emerging</strong> Markets As highlighted in Section 1, economic and demographic growth combined with epidemiological trends in emerging markets point to strong commercial potential for pharmaceutical companies. At a macro level, Dresdner Kleinwort (DrK) (2008) forecasts that emerging markets could provide over 30% of sales and 50% of sales growth by 2020, and finds that from 2008 to 2015 there is over US$650 billion new sales potential in emerging markets. This compares with US$150 billion sales at risk from patent expiries in the US and EU during this period. 38 <strong>Opportunities</strong> are not limited to patented drugs; sales of branded offpatent drugs and healthcare products are growing rapidly. Despite these attractive fundamentals, investment analysts have little to no guidance from companies on sales or earnings. 39 Those analysts who have looked at the potential are concerned by what emerging market sales will do for average margins and their working assumption is that lower prices will mean lower margins and lower profitability, measured in terms of return on equity (ROE) or return on assets (ROA). There is, however, little empirical information to test this hypothesis and the financial results for the nine listed subsidiaries of large global originals producers (including GSK, Merck, Aventis, Pfizer, Abbot, Wyeth, AstraZeneca, Novartis and Solvay) suggest these concerns may be overblown. Five-year average pre-tax margins for these companies, for instance, are above their parent companies.* 39 And this is despite the fact that the Indian subsidiaries’ product profile tends to be more heavily weighted towards off-patented branded generics and OTC products, and the fact that the Indian market is commonly viewed as the most competitive among emerging markets. 40 Moreover, ROE and ROA depend as much on asset turnover (sales per unit assets) as net income margins. DrK (2008) estimates that when we incorporate potential sales to emerging markets (growing at an estimated 12–15% up to 2010, then falling back to a longer-term 5%), despite an estimated drop in margins, long-term EBIT growth for Big <strong>Pharma</strong> of 4% (Compound Annual Growth Rate 2007–2020) is realistic. This is above the implied consensus for long-term growth of -2% to +2%, and could justify an upward re-rating for the sector. 41 This lack of disclosure is increasingly at odds with company statements that emerging markets are now a strategic priority.
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