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Over the past five years, pharmaceutical giant Pfizer (NYSE: PFE) has been a company in transition. At one time, its flagship cholesterol drug Lipitor was the best-selling drug in the world, and raked in more than $10 billion in annual sales all by itself.
But those days are long gone. Last year, Lipitor sales fell to $1.8 billion, down 10% from the previous year.
After Lipitor lost patent protection, generic competition flooded the market, and sales collapsed. In response, Pfizer has turned to an aggressive acquisition strategy to replace the lost revenue. Pfizer’s most recent deal is a massive $14 billion takeover of Medivation (NASDAQ: MDVN).
This is a great deal for Pfizer. It will diversify its pharmaceutical business by expanding further in a critical area—cancer—and should provide significant growth to the company in the coming years. Investors should be cheering the deal.
If You Can’t Beat Them, Buy Them
Pfizer has conducted a number of huge M&A deals in recent years. It’s understandable why Pfizer would do this. Replacing Lipitor with its own drugs would have taken years and cost billions to develop. Taking drugs all the way from the research and development stage, to bringing products to market, is an extremely time-intensive and costly effort.
As a result, it made much more sense to simply buy growth through acquisition, particularly for a company as deep-pocketed as Pfizer. Last year, Pfizer bought Hospira, an industry leader in injectable drugs and infusion technologies, for $17 billion.
This time around, Pfizer is focusing on an emerging and highly lucrative therapeutic area, oncology. Pfizer’s existing global oncology portfolio grew revenue by 72% in the first half of 2016, compared with the same period last year, and is poised for even more growth once Medivation is in tow.
Specifically, Pfizer wants Medivation’s Xtandi, a leading prostate cancer drug. Sales of Xtandi currently stand at $2 billion. Pfizer believes there is potential for much more. Plus, the deal brings the benefit of diversification. Pfizer’s crown jewel in its existing oncology business is breast cancer drug Ibrance, which is on its way to being a blockbuster.
Not only will the deal immediately add growth to Pfizer’s revenue, but there are significant opportunities for synergies as well.
Since Pfizer and Medivation both have large pharmaceutical units, the two companies have very similar processes in R&D as well as manufacturing and distribution. As a result, it will be fairly easy to cut duplicated costs. This is why Pfizer expects the acquisition will add $0.05 per share to earnings in the first year after the deal closes.
The takeover also makes financial sense because Pfizer can easily afford the price tag. It will acquire Medivation mostly using existing cash on hand. Pfizer ended last quarter with $21 billion in cash and short-term marketable securities, and another $13 billion in long-term investments on its balance sheet.
All this cash is burning a hole in Pfizer’s pocket. With interest rates still stuck near historic lows, Pfizer is earning little to no interest on all this cash, which means it is not creating value for shareholders. It makes complete sense to deploy this cash to acquire a productive asset, which should generate an internal rate of return far in excess of what Pfizer is earning on its cash holdings.
Pfizer Stock: Attractive for Growth and Dividends
Pfizer is a highly profitable company, with $7.7 billion in net profit last year alone. It uses a significant portion of its earnings to reward shareholders with dividends and buybacks. Earlier this year, the company lifted its shareholder payout by 7%. Pfizer has paid more than 300 consecutive quarterly dividends and Pfizer stock currently offers an attractive 3.4% dividend yield. And, it also approved a huge $11 billion share repurchase program this year.
The bottom line is that while Pfizer has had a big job on its hands replacing Lipitor, management is more than up to the task. Pfizer’s aggressive acquisitions should pave the way for significant growth. Pfizer stock has performed well over the past year, thanks to this strategy, and should continue to reward investors going forward.