Drug giant looking for another gold mine

Cash tills are ringing at GlaxoSmithKline thanks to soaring demand for its swine flu vaccine Pandemrix, and Relenza, which treats the symptoms of the illness that has led to thousands of deaths worldwide.

Analysts predict a £1 billion ($2.17 billion) revenue windfall this year as governments stockpile medicines to combat a possible pandemic.

GSK has landed 22 government contracts since last summer, with 440 million doses ordered.

The company makes the vaccine in Dresden, Germany, and Quebec, Canada, but demand is so great - about 60 per cent higher than for usual seasonal vaccines - that it is outsourcing production to third-party manufacturers.

In the UK, there are plans to vaccinate the entire population if necessary, and the Government has given the go-ahead for vulnerable people, such as pregnant women, frontline health workers and young children, to be inoculated.

Andrew Witty, GSK's chief executive for the past 18 months, stresses the company has worked hard to come up with a vaccine and that "it would be foolish to deny that events like these aren't good for business".

GSK has been planning for a pandemic for 3 years and has spent more than £1 billion to ensure its factories could crank up production at short notice.

"We don't know how big this deal is going to be, but no one can say we aren't ready," says Witty.

But the boost to revenue is a drop in the ocean when you consider group sales for the year are estimated at £28 billion. The headline-grabbing stories about swine flu also mask the quiet revolution Witty has been executing since he took over from Jean-Pierre Garnier, his controversial predecessor who provoked storms over the size of his pay package.

Witty's strategy is to cut reliance on a few blockbuster medicines in developed countries and diversify into emerging markets, which he portrays as a potential El Dorado.

With patents having expired on some of its best-selling medicines in the past three years, GSK has concluded that expansion in Latin America, the Middle East and Asia can plug the gap in revenues as competition from cheap generic drugs threatens to blow a gaping hole in finances. Income from a medicine that loses its patent can drop by up to 80 per cent in two years.

Abbas Hussein, head of GSK's emerging markets business, says the sector's value stands at £50 billion but will double by 2015, and by 2020 will be worth as much as today's US market.

"We have grown our emerging-markets business quite dramatically; it now accounts for 13 per cent of group sales and is expanding at 19 per cent a year. This should be no surprise when you consider that a new middle class as big as the UK's population is created in developing regions each year."

Navid Malik, analyst at Matrix Corporate Capital, says GSK's strategy is all about "changing the business model to deliver sustainable earnings growth by trying to iron out the peaks and troughs that flow from being over-reliant on a handful of products in the US and Europe".

The approach is also about broadening its range. Last year it agreed a US$3.6 billion deal to buy skincare group Stiefel Laboratories in the US.

With other companies, GSK is to cut the prices it charges for medicines in developing countries as part of a drive to exploit demand in faster-growing economies. The industry, which stands accused of cherry-picking rich patients in poor countries who can pay Western prices, has been forced by healthcare authorities in the Philippines to reduce prices or risk exclusion. Turkey is also poised to demand substantial cuts.

To ensure continued unfettered access to emerging markets, and to curry goodwill, it is perhaps no surprise that pharmaceutical companies have made donations, or offered deep discounts on some drugs, notably antiretrovirals for HIV.

But there are clouds on the horizon for Advair, one of GSK's best-selling drugs, which is used to treat asthma; it will lose its US patent next year. Although analysts say that Advair, which is taken as an inhalant, is difficult to copy, it accounts for about 20 per cent of sales and is a key part of its portfolio.

So, despite all the talk about reducing the company's reliance on traditional "white pills and Western markets", GSK is still beavering away in the background to come up with an old-fashioned blockbuster - such as a vaccine for lung cancer or a treatment for the immune system disorder lupus.

But what better way to manage expectations than by downplaying the importance of breakthrough medicines, some of which will take years before they come to the market - if they get regulatory approval?

As Malik says: "It is better to under-promise and then over-deliver if you want to avoid the danger of upsetting your shareholders." GSK is sensitive to opinion in London's financial district. Its share price has dived since the company was formed after the merger of Glaxo Wellcome and SmithKline Beecham in 2000, falling from £21 to £13 because of a range of problems being encountered by big pharmaceuticals in general.

The prices of prescription drugs are falling as governments and health insurers demand bigger discounts. Research and development has become more complex, and consequently more expensive.

Regulators are demanding higher standards after a number of high-profile health scares.

Drugs multinationals must also grapple with the harsh truth that "there are fewer unmet clinical needs than 20 years ago", according to Alan Shepherd of IMS, the healthcare consultancy.

His point is illustrated by the huge growth of "me-too" drugs: medicines that are only slightly different from market leaders, launched with the aim of grabbing a share of an already lucrative market. In The Truth about the Drug Companies, Marcia Angell notes that we now have six branded medicines to lower cholesterol, "all variants of the first".

And now stormy waters are rising in the US, where President Barack Obama wants Medicare to bulk-buy drugs for the elderly and sick to drive down prices that are on average twice as expensive as in Britain.

As things stand, doctors order drugs on a case-by-case basis from individual companies that "charge the Earth", said one analyst.

Big pharma is also under pressure from public opinion, with polls showing Americans are more concerned about healthcare costs than the war in Afghanistan.

At such times, who can blame Witty and his competitors for talking up the prospects for emerging markets? In the developed world, life has rarely been as tough.

THE NUMBERS

$2.2b Windfall expected for GlaxoSmithKline as a result of swine flu.
440m Number of vaccine doses ordered.
$60b Estimated full-year sales for GlaxoSmithKline.
$108b Value of emerging markets sector, expected to double by 2015.

- OBSERVER