Solve for X

Abbott: Big Pharma has three big problems – its most important drugs are losing patent protection, growth in developed markets is slowing to a crawl, and much of its cash is trapped overseas. Abbott’s purchase of India’s Piramal Healthcare’s generic drugs business for $3.7 billion offers a partial answer to all three variables.

Six of the world’s 10 biggest drugs are likely to lose US patent protection by the end of 2012. Other major markets in Europe and Asia are on similar timetables. The value of many big franchises will be gutted as cheaper versions of these compounds are introduced. As a result, annual growth of drug sales in developed countries is likely to be between 3 and 6 per cent over the next several years, according to IMS.

Of course, big drugs companies can console themselves that their businesses still generate substantial profits and cash flow. The trouble is that much of this comes from foreign subsidiaries, where it remains stashed away. Repatriating the cash to pay investors dividends or buy back stock would generate a large tax bill.

One way to deal with these myriad problems is to move into the generics business, as Novartis, Sanofi-Aventis and Abbott have. Another is to expand into emerging markets. India, for example, is growing about three times as fast as developed markets and given the state of medical care there, it is unlikely to slow any time soon. A third response is for drug makers to put their stashed cash to work overseas buying foreign companies.

So the Piramal generics acquisition neatly encapsulates all these trends in one package. Unfortunately for Abbott, the answer doesn’t come cheap. Piramal’s sales this year should be above $500 million, according to the company. While Abbott’s only paying a chunk of the cash over several years, the net present value is still 6.4 times trailing sales. The typical generic company goes for around 3.5 times, according to Credit Suisse.

Abbott’s deal has other attractions. The return on the investment appears rather low, but is probably better than leaving the funds smouldering in a bank. Moreover, the Piramal business gives Abbott scale in India. With a population greater than a billion, and the proportion that can afford medicine rising rapidly, that’s a pretty good place to be.