Trends Show Wider Regional Divergence
Recent economic data from the developed world have shown divergent trends while growth in the emerging economies appears to be stabilizing. The U.S. economy expanded at a faster than expected pace during the second quarter, more than offsetting the first quarter decline, which revised estimates show was not as severe as thought earlier. The Euro-zone economy came to a standstill during the second quarter as Germany, until now the bulwark of the common currency region, slowed. Economic activity was weaker than expected in France and Italy, while Spain continued to see a moderate recovery. The consumption tax hikes in April led to a sharp decline in Japanese output for the second quarter as expected, but recent data suggest that consumer demand maybe improving. Among the emerging countries, the Chinese economy expanded at a healthy 7.5 percent during the second quarter.
Global manufacturing output expanded further in July, to the fastest pace in more than three years. Sustained gains in the U.S. and the U.K. continue to drive global growth, while the output index for China rose to the highest level in more than a year. Even the Euro-zone saw factory output expansion during July, though the pace of growth remained at the same level as the previous month. Global services activity also expanded at a faster rate in July, again led by the U.S. and the U.K. Export trends from most Asian countries were positive, suggesting that the slower demand in Europe is being offset by the revival in shipments to the U.S. Energy prices remained high on persistent geopolitical risks in Eastern Europe and the Middle East, while prices of most industrial materials remained relatively subdued.
GLOBAL INDUSTRY SPOTLIGHT FOR THE MONTH: PHARMACEUTICALS
The global pharmaceuticals industry has recently seen an increasing number of mergers & acquisitions, partly as companies attempt to shift their domicile to lower tax regimes, but also to achieve scale and enter new market segments. Some companies see acquisitions as a more cost effective way, when compared to proprietary research, to gain access to new molecules and broaden their product offerings.
Helped by the abundant availability of affordable capital and the improved business optimism fueled by signs of improving economic trends, global mergers & acquisition activity has surged over the last year. The aggregate value of all such corporate deals this year is expected to be close to the record witnessed before the financial crisis. The pharmaceuticals sector has seen some of the most intense activity, helping to drive stock prices of several companies higher so far this year.
Most major global pharmaceutical companies, created during earlier industry consolidations, have faced a large number of patent expiries in recent years. Some of them continue to see significant revenue losses as they lose exclusive rights over several blockbuster drugs. While the patent expiries have likely peaked, these global manufacturers are under pressure to replace the lost revenues.
Developing new molecules through primary research requires sustained investments and the results are unpredictable. In this scenario, some companies find it easier to acquire companies that have strong research capabilities or have a pipeline of molecules in various stages of clinical trials. While still costly, acquisitions reduce the uncertainties surrounding product development and regulatory approvals.
Another motive for several recent corporate deals is to shift the domicile of the combined entity to a location with more favorable tax policies, such as Ireland. The corporate income tax rates in some of these countries are significantly lower than most developed countries. In addition, regulatory and compliance costs could also be lower as these countries try to attract more businesses. However, such merger transactions could decline in the future as attractive target companies become fewer. In addition, the U.S. and other countries have already started exploring ways to prevent transactions that are aimed only at tax savings.
Still, mergers among the generic pharmaceutical manufacturers are driven by the growing need to achieve scale. Generic companies witnessed significantly faster growth for the last several years as they took advantage of the patent expiries to launch cheaper variants. However, intense competition among the generic producers has led to lower profit margins across most segments. To protect their earnings, some of the generic companies have started focusing on less popular or niche drugs that attract fewer competitors. The companies that are launching copies of widely used drugs have to achieve scale, across multiple geographies. Larger scale of operations also allows them to build the capability to manage the regulatory approval process more efficiently. Acquiring other companies is likely to remain an attractive option for the larger generic companies even in the future.
Despite the evident strategic benefits of acquisitions, the majority of the pharmaceutical manufacturers continue to focus on primary research. While the cost of research continues to rise and the availability of qualified manpower for research is a limiting factor, the potential payoff from a successful product launch remains lucrative. Even generic manufacturers are expected to significantly increase their research outlays over the next several years, to achieve product differentiation and compete better in the developed markets.
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FORWARD LOOKING STATEMENTS
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