Morningstar Advisor - August/September 2010 - 43

Acker: I would say it’s two things. One is the

fact that I mentioned: We’re getting the pressures from the taxes and fees now. For example, the bill was passed in late March. 16000 Pharma companies had already given their guidance for 2010 earnings, and then 13000 some aspects of the bill were made retroactive. So, we had earnings revisions as these taxes 10000 came into effect. Everyone saw earnings going down. Then on top of that, you’ve had 7000 the cuts in Europe. Pricing pressure is usually higher in Europe than in the United States. Companies see, on average, 2% to 3% price cuts per year in Europe; in the United States, we generally see price increases in the low-to-mid-single digits. This year, however, with the austerity measures and the budget deficits in Europe, we’re seeing price cuts in places like Greece, Spain, and Germany that are higher than we’ve ever seen before. I think there’s a worry that this is going to become the norm. We’ve got 10% budget deficits. Are we going to see 5% price cuts every year? Longer term, people realize that the health-care costs in the United States are going to be much higher than expected, and that will be an issue.
Jenner: Yes, I agree. It’s much easier to

more difficult to get new drugs approved; and the generic patent wave—which some people call the patent cliff, which peaks in 2012 when a lot of old drugs lose their patents. All of these factors are making pharma companies figure out how they can grow. One way is to look for sustainable franchises. Pharma companies want to get off of this treadmill of having a drug on the market for 10 years, getting a lot of sales, but then seeing it go generic. There’s new focus on things like vaccines, which generally persist even after patents expire; consumer products, which tend to have higher multiples because you establish a brand; and emerging markets. So, when Pfizer buys Wyeth and Merck buys Schering-Plough, they’re getting access to products that have longer lifecycles, but they’re also taking out significant cost, above what we’ve ever seen before in the pharma industry. Pfizer and Wyeth combined had an $11 billion to $12 billion R&D budget. We expect that to come down to about $8 billion for the combined entity. Everyone’s cutting back. They’re not developing me-too drugs anymore. They’re really pushing for more innovative therapies. We always focus on innovative companies, companies that are addressing unmet medical needs. If you have a company that has a new therapy for cancer, a new therapy for diabetes, a new therapy for Alzheimer’s— these are unmet medical needs. Even in a tougher reimbursement environment, people are going to pay for these drugs. So, they are attractive assets, and they tend to get taken out from time to time.
Jenner: That’s right. Damien, you asked, how

T. Rowe Price Health Sciences PRHSX
$16K

13 S&P 500 TR 10

05

06

07

08

09

10

Category Health	 Morningstar Rating

Expense Ratio (%) 0.87 5-Yr Anl Total Rtn (%) 6.41 5-Yr Anl TR % Rank Cat 4

QQQQ	
Minimum Investment $2,500 Data as of June 30, 2010

see a stunning example of value destruction. That is not to say that one of these can’t work. I’m just saying caveat emptor, because statistically these have not been opportunities for investors.
Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Feb-05Aug-05Feb-06Aug-06Feb-07Aug-07Feb-08Aug-08Feb-09Aug-09Feb-10 Mar-05Sep-05Mar-06Sep-06Mar-07Sep-07Mar-08Sep-08Mar-09Sep-09Mar-10 Apr-05Oct-05Apr-06Oct-06Apr-07Oct-07Apr-08Oct-08Apr-09Oct-09Apr-10 May-05Nov-05May-06Nov-06May-07Nov-07May-08Nov-08May-09Nov-09May-10 Jun-05Dec-05Jun-06Dec-06Jun-07Dec-07Jun-08Dec-08Jun-09Dec-09Jun-10

Conover: That’s a great point. I think the most

dangerous words in the investing community are, “This time it’s different.” But is this time different? The purchase prices on some of those acquisitions were lower and the cost synergies appear to be higher. Jenner: I’m hopeful that it can be different, but

whack an industry and say you’re going to get 10% less today than you did yesterday than see pensioners riot in the streets and have it on CNN.

M&A: A Path to Growth
Conover: Let’s talk about mergers and acquisitions. In 2009, we saw some massive acquisitions. Pfizer PFE took over Wyeth. Merck MRK took over Schering-Plough. Why did these mergers happen? How can investors benefit from them? Acker: A lot of the mergers were a response to

pressures in the pharmaceutical industry. We’ve seen global pricing pressure; R&D productivity that has been declining for years; very high regulatory barriers, where it’s

can investors benefit? Statistically, large mergers have not created value. Pfizer, for example, bought Warner-Lambert in 2000 and then bought Pharmacia in 2004, and now they have bought Wyeth. If you go back and march through time and ask what was Pfizer’s market cap, what did they pay for these companies, and what is it now, you will

I’m skeptical. I’m hopeful that Merck and Schering-Plough will be more valuable than they were individually. But I’m not making a large bet that it will be different. What generally happens with these mergers is that both companies have substantial cost infrastructures that get reduced because they eliminate duplicative efforts, and there is some value in that, but it’s a one-time thing. Then, on the back end, what happens is that you have dysfunction in the pipeline, and the core essence of these companies is to bring important new medicines to the market. Dysfunction in the pipeline, in my opinion, is why these mergers haven’t added value.

MorningstarAdvisor.com 43


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Morningstar Advisor - August/September 2010

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2010

Morningstar Advisor - August/September 2010
Contents
New on MorningstarAdvisor.com
Contributors
Letter From the Editor
What Aspects of Health-Care Reform Will Most Affect Your Clients?
Bonds, Chicago Style
Investment Briefs
Which Risk Are You Managing?
Eye on the Prize
Advisors Can’t Rely on Fidelity Alone
Health Care Gets Back to Business
An Opportune Time to Bet the Pharm
Reform’s Impact on Other Health-Care Industries
Top Takeover Targets in Biotech
After Reform, Narrow-Moat Firms Have Strong Prospects in Diagnostics
Health-Care Investing Alive and Well
Quest for Knowledge
Four Picks for the Present
How to Make Your Bond Portfolio Inflation-Resistant
Weeding Through the Energy Patch
Uncertainty and Value in Basic Materials
Stock Market Doom-Busters
Hunting Down European Debt-Dodgers
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks With Wide Moats
VA Sales Slip a Bit in First Quarter
New at Morningstar
Star Wars, the Sequel
Morningstar Advisor - August/September 2010 - Morningstar Advisor - August/September 2010
Morningstar Advisor - August/September 2010 - Cover2
Morningstar Advisor - August/September 2010 - 1
Morningstar Advisor - August/September 2010 - 2
Morningstar Advisor - August/September 2010 - Contents
Morningstar Advisor - August/September 2010 - 4
Morningstar Advisor - August/September 2010 - 5
Morningstar Advisor - August/September 2010 - New on MorningstarAdvisor.com
Morningstar Advisor - August/September 2010 - 7
Morningstar Advisor - August/September 2010 - Contributors
Morningstar Advisor - August/September 2010 - Letter From the Editor
Morningstar Advisor - August/September 2010 - What Aspects of Health-Care Reform Will Most Affect Your Clients?
Morningstar Advisor - August/September 2010 - 11
Morningstar Advisor - August/September 2010 - Bonds, Chicago Style
Morningstar Advisor - August/September 2010 - 13
Morningstar Advisor - August/September 2010 - Investment Briefs
Morningstar Advisor - August/September 2010 - 15
Morningstar Advisor - August/September 2010 - Which Risk Are You Managing?
Morningstar Advisor - August/September 2010 - 17
Morningstar Advisor - August/September 2010 - 18
Morningstar Advisor - August/September 2010 - Eye on the Prize
Morningstar Advisor - August/September 2010 - 20
Morningstar Advisor - August/September 2010 - 21
Morningstar Advisor - August/September 2010 - Advisors Can’t Rely on Fidelity Alone
Morningstar Advisor - August/September 2010 - 23
Morningstar Advisor - August/September 2010 - 24
Morningstar Advisor - August/September 2010 - 25
Morningstar Advisor - August/September 2010 - 26
Morningstar Advisor - August/September 2010 - Health Care Gets Back to Business
Morningstar Advisor - August/September 2010 - An Opportune Time to Bet the Pharm
Morningstar Advisor - August/September 2010 - 29
Morningstar Advisor - August/September 2010 - Reform’s Impact on Other Health-Care Industries
Morningstar Advisor - August/September 2010 - 31
Morningstar Advisor - August/September 2010 - 32
Morningstar Advisor - August/September 2010 - Top Takeover Targets in Biotech
Morningstar Advisor - August/September 2010 - 34
Morningstar Advisor - August/September 2010 - 35
Morningstar Advisor - August/September 2010 - After Reform, Narrow-Moat Firms Have Strong Prospects in Diagnostics
Morningstar Advisor - August/September 2010 - 37
Morningstar Advisor - August/September 2010 - 38
Morningstar Advisor - August/September 2010 - 39
Morningstar Advisor - August/September 2010 - 40
Morningstar Advisor - August/September 2010 - Health-Care Investing Alive and Well
Morningstar Advisor - August/September 2010 - 42
Morningstar Advisor - August/September 2010 - 43
Morningstar Advisor - August/September 2010 - 44
Morningstar Advisor - August/September 2010 - 45
Morningstar Advisor - August/September 2010 - 46
Morningstar Advisor - August/September 2010 - 47
Morningstar Advisor - August/September 2010 - 48
Morningstar Advisor - August/September 2010 - Quest for Knowledge
Morningstar Advisor - August/September 2010 - 50
Morningstar Advisor - August/September 2010 - 51
Morningstar Advisor - August/September 2010 - Four Picks for the Present
Morningstar Advisor - August/September 2010 - 53
Morningstar Advisor - August/September 2010 - How to Make Your Bond Portfolio Inflation-Resistant
Morningstar Advisor - August/September 2010 - 55
Morningstar Advisor - August/September 2010 - 56
Morningstar Advisor - August/September 2010 - 57
Morningstar Advisor - August/September 2010 - Weeding Through the Energy Patch
Morningstar Advisor - August/September 2010 - 59
Morningstar Advisor - August/September 2010 - 60
Morningstar Advisor - August/September 2010 - Uncertainty and Value in Basic Materials
Morningstar Advisor - August/September 2010 - 62
Morningstar Advisor - August/September 2010 - 63
Morningstar Advisor - August/September 2010 - Stock Market Doom-Busters
Morningstar Advisor - August/September 2010 - 65
Morningstar Advisor - August/September 2010 - Hunting Down European Debt-Dodgers
Morningstar Advisor - August/September 2010 - 67
Morningstar Advisor - August/September 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - August/September 2010 - 69
Morningstar Advisor - August/September 2010 - 70
Morningstar Advisor - August/September 2010 - 71
Morningstar Advisor - August/September 2010 - 50 Most Popular Equity ETFs
Morningstar Advisor - August/September 2010 - 73
Morningstar Advisor - August/September 2010 - Undervalued Stocks With Wide Moats
Morningstar Advisor - August/September 2010 - 75
Morningstar Advisor - August/September 2010 - VA Sales Slip a Bit in First Quarter
Morningstar Advisor - August/September 2010 - 77
Morningstar Advisor - August/September 2010 - 78
Morningstar Advisor - August/September 2010 - New at Morningstar
Morningstar Advisor - August/September 2010 - Star Wars, the Sequel
Morningstar Advisor - August/September 2010 - Cover3
Morningstar Advisor - August/September 2010 - Cover4
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