Wall Street Journal - December 22, 2004
Jeanne Whalen at jeanne.whalen@wsj.com

Thanks to cost-cutting programs and a narrow focus on a few therapeutic areas, companies such as Ireland's Elan Corp., Schering AG of Germany and Shire Pharmaceuticals Group PLC of the U.K. have been bringing new products to market and enjoying some of their best financial results in years.

Not long ago, critics thought these midsize drug makers would get squeezed out of business as the rest of the industry consolidated into a handful of titans with huge research budgets and sales forces.

They have been proved wrong, at least so far. Instead of trying to compete head to head with the likes of Pfizer Inc. or GlaxoSmithKline PLC, midsize companies are mostly concentrating on diseases too small for their bigger rivals to target. Often, that means less competition, less price pressure and better treatment from regulators such as the U.S. Food and Drug Administration, which tend to approve drugs for underserved disease areas more quickly.

"We look at areas big pharma isn't in, where there's high need," says Matt Emmens, chief executive of Shire, which sells Adderall XR, the leading medicine for attention-deficit/hyperactivity disorder and has just won FDA approval for a new drug for kidney failure.

To be sure, the picture with midsize companies is mixed. Some are performing poorly, and others are only beginning to turn around poor sales and profit figures. But at the best-performing companies, revenues are growing in the double digits and profit margins are widening. That compares with a profit squeeze at many big pharmaceutical companies, which have been under pressure to cut their drug prices and spend more on development of new medicines.

And while Merck & Co., Pfizer and AstraZeneca PLC face sharp criticism about the safety of their drugs, some of the most successful product launches in recent months have come from midsize producers, such as multiple sclerosis treatment Tysabri, developed by Elan and Biogen Idec Inc. of Cambridge, Massachusetts.

Investors seem to be taking note. While overall pharmaceutical stocks have fallen by about 8% over the past three months, based on Morgan Stanley data. Schering has risen by 13% and Shire by 4%. Elan, meanwhile, has soared 36% year-to-date thanks to the Tysabri approval, as well as anticipation of it. Elan's shares ended yesterday in Irish trading at Ç19.30 ($25.84), off 30 European cents. Schering's shares closed in Frankfurt at Ç55, off 29 cents. In London, Shire ended at ú5.39 ($10.50 or Ç7.84), up six pence.

For many midsize drug makers, surviving has meant scaling down their grander ambitions of the past. Ten years ago, Schering was a classic German conglomerate, making fertilizers as well as pills. But in recent years it has sold a number of businesses, laid off thousands of employees and narrowed its drug development to four therapeutic areas.

With its new strategy in place, Schering aims to double sales in the crucial U.S. market to $2 billion (Ç1.49 billion) by 2006. To strengthen its lead in oral contraceptives, Schering last year launched consumer advertising for its birth-control pill Yasmin, helping double the product's sales and make it the top-selling oral contraceptive in the U.S. The company is also in the early stages of researching contraceptives for men.

Beyond birth control, Schering is hoping for FDA approval next month of a new treatment for bone metastases in breast-cancer patients, and longer term, for a new cancer drug in development with Novartis AG.

A cost-cutting program is also beginning to boost Schering's historically low operating profit margin, which will grow to about 15% this year from 14% last year. Schering aims to raise it to 18% by 2006.

Elan, too, is boosting its financial performance by narrowing its ambitions. The company nearly collapsed in 2002 after an accounting scandal, failed drug trials and bad acquisitions. Under new management Elan has sold off a number of businesses and focused on drugs to treat nervous-system disorders, autoimmune diseases and chronic pain. In addition to its recent success getting Tysabri approved for sale, Elan is hoping for FDA approval in the coming weeks for Prialt, a medicine for the kind of severe pain suffered by cancer and HIV patients.

Being smaller makes Elan more scientifically innovative, and better able to change course when things go wrong, says Elan Chief Executive Kelly Martin. Midsize pharmaceutical chiefs say their salespeople also have an easier time building relationships with doctors, since they sell only to a few specialists and not to general practitioners.

Some analysts sound a note of caution about midsize investments, saying they can be more easily hit by a product failure or another setback than their bigger rivals. "The advantage of midcap companies is also the disadvantage -- one drug can totally transform the picture," says Denise Anderson, a pharmaceutical analyst at Kepler Equities in Zurich.

That is certainly true at Shire. Sales are booming, thanks to the growing market for treating ADHD, but some investors are worried that could come to a halt when the company's patent for Adderall XR runs out in 2007. "Sales and earnings are growing double digits ... [but] it's not a stock we have big exposure to because of the uncertainties," says John Wilson, an investment director at investment fund firm Standard Life of Edinburgh, Scotland. Shire's Mr. Emmens says the company has enough new products in development to keep growing.

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