GSK And Life After The Patent Cliff

Published in Investing on 10 April 2012

This pharma giant is showing how innovation should be done.

Many would say that the pharmaceutical sector is one whose best days are behind it. In the past, drugs companies boomed as their R&D departments churned out blockbuster after blockbuster. But now Big Pharma has to deal with the looming patent cliff, where many of the largest money spinners are soon to go off patent, and increasingly returns on their research are poor.

So does the pharmaceutical industry face a future of slow decline? Not necessarily. If you want to see what the healthcare sector could be like in the future, I think you should take a look at British pharma stalwart GlaxoSmithKline (LSE: GSK).

Drugs companies are not all alike. GSK, unlike other pharma giants such as AstraZeneca (LSE: AZN), has already passed the worst of the patent cliff and, impressively, through this period the business' sales have held up well. But what really excites me about GlaxoSmithKline is its pipeline of new drugs.

The best pipeline in the business

Drugs firms have been finding it increasingly difficult to innovate. It seems that a lot of the low-hanging fruit have already been picked, and companies are having to go to extraordinary lengths to find new treatments.

Other drugs makers, notably Roche and AstraZeneca, have resorted to acquisitions to bulk up their pipelines. But GSK seems to be the one pharma business to have cracked the art of innovation.

GSK Chief Executive Sir Andrew Witty has been raving about his company's pipeline: " of the big, big focus points for us over the last four years has really been to re-energise our R&D organisation, and we saw some very, very good progress on that front."

GSK now has around 30 drugs in late stage development. Many of these medicines are producing strong data, and over the next few years the firm can expect a flurry of drugs which will gain regulatory approval. In 2012 alone around 10 new medicines are expected to file for approval.

A step change in research productivity

In Witty's words, this is a 'step change in R&D productivity'. While the R&D spend over recent years has been largely static, the number of new drugs which have been produced has rocketed.

So what is it about GlaxoSmithKline's research that has made it so successful? Well I can identify several strands.

Firstly, the firm has been placing more emphasis on biologics, i.e. biological rather than chemical drugs, which I have described previously as being key to the future of the pharma industry.

Secondly, GSK is clever in the way it exploits partnerships. It has a tendency to enter into alliances rather than take over companies. For instance, it recently invested $212 million in Theravance (NASDAQ: THRX.US) as the two firms work together to develop asthma treatment Relovair, and it has developed an Aids drug in partnership with Japan's Shionogi.

And thirdly, GSK is ruthless in incentivising success. The days when you were assured of a job for life at the company are long gone. Nowadays, the harsh reality is that to stay in your job you have to produce results. And it works. GSK's labs today are buzzing with energy, creativity and invention.

What's more, GSK is not only innovating better, it is directing more of its energies away from 'white pills in Western markets' to consumer products and emerging markets. This is also likely to boost growth.

Foolish bottom line

Glaxo's shares have had a great run since August of last year, but it still stands on a forward P/E ratio of just 12, with a prospective dividend yield of 5%.

Admittedly the business is no longer dirt cheap, but I still took the opportunity to buy some shares last month, as I expect the company to do well over the next few years, as a series of new drugs hits the market and the business expands its consumer healthcare and emerging markets businesses.

For me, this is one to buy and tuck away in your high-yield portfolio.

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> Prabhat owns shares in GlaxoSmithKline.

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The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Hannibalis 10 Apr 2012 , 12:41pm

Thanks Prabhat - good pharma overview. Although I sold some GSK recently (for the capital gain), it does still look like a good 'income' share, as you say.

Sotograndeman 10 Apr 2012 , 2:10pm

"But GSK seems to be the one pharma business to have cracked the art of innovation."

That comment tells me you are merely repeating what the Company is saying, and do not have any real knowledge of your own. That's dangerous - not only for yourself, but for others who may read your recommendation and believe, and for whom it's also outside their circle of competence.

Being in the business, it's extremely difficult to know what promise a pipeline holds. GSK has absolutely NOT been a paragon of innovation - at least not since the pioneering days of research at Ware a couple of decades ago. Their failures have been the major reason for their acquisition spree to diworsification and for the ensuing and more recent huge layoffs. Research staff have been frustrated by the short termism. R&D does not work on a short term basis, however much management and shareholders would like it otherwise.

In fact, Roche has been a far more successful research organization than GSK. And continues to be. And Pfizer UK was so much more innovative and successful than GSK also.

As an investment, GSK will continue to be a good bet for dividends. More than that is speculation in my opinion. The partnership with Theravance is taking an age to produce anything, and as a matter of fact, is not certain to do so.

Caveat emptor!

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