The Pfizer-Mylan deal is not quite as it appears

The early reaction to the pairing of generic drug maker Mylan Laboratories and Pfizer’s generics unit, Upjohn — officially announced Monday — is that it’s great for Mylan but maybe not so amazing for Pfizer. A close look at the deal may lead to a reassessment on both fronts.

For Pfizer, the deal represents the culmination of nearly a decade-long strategy to sell off or spin off non-core units one by one, including its veterinary business, a baby formula business, its consumer products division, and now its generics business. For Mylan, there are big risks, including managing the prospects for aging Pfizer brands such as Lipitor and Viagra in China and other markets and doubling both the company’s annual sales and its debt.

And yet in morning trading, Pfizer shares edged down 1.7% to $42 and Mylan’s share price increased 10.6% to $20.43; the deal was first reported by the Wall Street Journal on Saturday.

It’s easy to see what Mylan investors like about the deal. The new company (which will have a new name, shedding a brand that has been tarnished by the EpiPen scandal) will pay a dividend of 25% of free cash flow. It will also bring some new management, replacing Mylan CEO Heather Bresch with Michael Goettler, a Pfizer executive. (Bresch could get $37.5 million in severance, according to Mylan’s most recent proxy.) Chief Financial Officer Ken Parks will also depart. And Mylan shares are down so much — almost 38% over two years, and underperforming the S&P 500 under a one-, two-, or five-year period — that investors are likely ready to embrace just about any change.

But Robert Coury, Mylan’s chairman and Bresch’s boss, will remain in charge. And Mylan’s president, Rajiv Malik, who has been targeted by states investigating generic price-fixing, will remain, too. On a conference call Monday morning, Coury promised “a 180-degree turn” in the company’s direction, but praised Malik, saying, “There has not been a transaction I have done that he has not been by my side.”

Mylan will take on $12 billion in debt, which will be raised by Upjohn; the proceeds go to Pfizer.

In a note to investors issued after the WSJ’s report Saturday, Ken Cacciatore, an analyst at Cowen, warned that the deal is “slamming bad things together.” While it increases Mylan’s earnings, it doesn’t increase the value of its discounted free cash flow. And while the new business is better than the old one, he wrote, he viewed the old Mylan as “absolutely broken.” David Maris, an analyst at Wells Fargo, said in a note to clients that major deals in generics such as those between Teva and Actavis and Impax and Amneal “have proven to be very beneficial to the sellers, but less so to the buyers who each faced significant integration and business risks as the industry suffered from severe price contraction.”

So what’s to like for Pfizer? Ian Read, Pfizer’s chairman, began floating the idea of splitting Pfizer up back in 2011, shortly after he became CEO. It was an idea Wall Street loved, and it helped get the company through a period when it was losing patent protection on big products but didn’t have a lot of new products to talk about. Since then, the company, previously not known for R&D, has done better, particularly with cancer drugs such as Ibrance for breast cancer, which was approved in 2015 and had annual sales of $4.1 billion last year.

As Pfizer launches more new drugs, those other businesses represent not safety, but a drag on growth. So Pfizer sold baby formula to Nestle in 2012, spun off veterinary business Zoetis in 2013, and in December decided to merge its consumer products business with that of GlaxoSmithKline.

With this deal, Pfizer CEO Albert Bourla is finishing Read’s plan, and setting himself up to bet more substantially on Pfizer’s R&D and business development. The Upjohn division consists largely of Pfizer medicines that are household names but no longer have patent protection such as Viagra and Lipitor. In some countries, particularly in developing markets, these still generate significant sales. Lipitor, for instance, had worldwide sales of $2.06 billion, $1.6 billion of those in “emerging markets” such as those in Asia. But these markets have different risks, too: In the second quarter of 2019, Lipitor sales dropped by $200 million compared to the first.

Pfizer is losing about $4 billion in earnings before taxes, interest, depreciation, and amortization (EBITDA); getting just $12 billion in cash for that will seem like a raw deal to some investors. But for every quarter going forward, Pfizer will get to grow off a smaller base business. It will get to skip the patent expiration of its pain drug Lyrica, giving the brand to the Mylan-Upjohn. Investors who don’t love the deal now may forget that as Pfizer posts better numbers over coming quarters.

A previous version of this story misstated the measure of cash flow.