AstraZeneca Needs to Set Itself Free
Long-term growth, strength of pipeline should take priority
The U.K. pharmaceuticals company has been bolstering profits with a series of “externalization” deals, designed to keep its earnings per share above $4.20. That is one of the targets baked into management pay plans, which requires earnings per share to be at least 1.5 times dividend payouts.
There are good reasons to ditch the threshold. It leaves AstraZeneca open to the charge of cannibalizing long-term earnings power for short-term gain. It also fuels worries that Astra won’t be able to control its spending, while simultaneously feeding concerns that the company isn’t investing enough.
Astra’s existing business faces near-term patent expiries as well as mounting pressure in areas like diabetes. But the company’s appeal is built on long-term growth and the strength of its pipeline.
Recent deals, like the purchase of ZS Pharma and a stake in blood-cancer specialist Acerta, have underlined that Astra’s real focus is on long-term growth, not short-term earnings. As data next year shore up confidence in new drugs, the stock—which has gone virtually nowhere since Pfizer abandoned its £55 ($81) a share takeover interest in Astra in May 2014—should benefit.
True, the $4.20 marker has forced Astra to prioritize. UBS concedes that the company has raised about $2 billion through licensing, partnerships and other deals this year, without negatively affecting forecast earnings and cash flows.
But it is odd that a business whose value rests on the long-term future of its pipeline is being run to hit such a short-term goal. Astra does have scope to economize: Its cost-to-sales ratio is the highest in the European sector, notes Moody’s, partly thanks to depressed sales. But some investors worry that Astra actually isn’t investing enough.
In immuno-oncology, Astra is going up against Bristol-Myers Squibb, Merck and Roche, rivals with a head-start on the U.K. company. As the science develops, the goal posts for success shift. Astra said in November that its first immuno-oncology trial, designed to speed up getting to market, now likely wouldn’t enable regulatory filings given rival approvals. Getting an edge means finding combinations of drugs that are highly effective, which requires large numbers of expensive trials.
Astra is on track to spend about $4.5 billion in research and development this year on its broad-ranging pipeline. Yet oncology specialist Roche is forecast to spend about 9.3 billion Swiss francs ($9.41 billion). This isn’t too surprising: Roche has roughly double Astra’s overall revenues. But one analyst estimates close to 40% of Roche’s budget may be going into immuno-oncology, where it has about 30 combination trials running across eight new drugs. In other words, Astra faces big-spending opposition.
Ditching the target shouldn’t mean letting management off the hook. By all means, link pay more closely to the ambitious revenues target of $45 billion for 2023, unveiled in the heat of the Pfizer defense. That would be more in tune with investors’ concerns, and Astra’s strategy.