Why the Sanofi-Pfizer rumor makes sense

An outright merger is unlikely, but a transatlantic partnership could benefit both firms, argues Fortune's John Simons.

By John Simons, Fortune writer

(Fortune) -- In the last week of trading, shares of French drugmaker Sanofi-Aventis have jumped 5.5% on rumors that U.S. pharma giant Pfizer (Charts, Fortune 500) is pondering the purchase of a significant share of its business. There are two hypothetical scenarios now circulating the markets. One of them makes sense for Pfizer. The other? Not so much.

First, a bit of backrgound: Two of France's industrial champions - oil and gas company Total S.A., and cosmetics maker L'Oreal - own a 13% and 10% stake in Sanofi-Aventis (Charts), respectively. Each company has said publicly over the last few years that its investment in Sanofi is no longer important to its core business. And, as a result, both have expressed interest in selling their combined 23% stake.

A limited Pfizer investment in Sanofi-Aventis might make sense.

For its part, Pfizer is in a fix. As early as 2010, the company's top-selling cholesterol medicine, Lipitor, will lose patent protection and face competition from cheaper generics. Lipitor is a hard act to follow. It is history's best-selling medicine. Generating sales of $12.8 billion in 2006, it represented roughly a quarter of Pfizer's $48.3 billion revenue.

The company's only hope for a follow-on to Lipitor, another cholesterol-lowering agent called torcetrapib, was cancelled in lab testing last winter due to safety concerns. Pfizer's scientists are hard at work on a number of significant medicines due to be on the market by 2010, but the combined projected revenue of the drugs is unlikely to reach the heights Lipitor achieved.

With a significant amount of cash on hand, Pfizer is looking outside of its own laboratories for a solution to the inevitable revenue falloff. The company is combing the pharma landscape, looking to engage in joint ventures and make outright acquisitions of companies with potentially top-selling drugs and healthy pipelines.

Under one scenario Pfizer would purchase L'Oreal and Total's portion of Sanofi and be a partner in the business. According to another version of the rumor, Pfizer would purchase the 23% share as a precursor to an outright acquisition.

Trouble is, a large-scale merger would be the wrong thing to do. In the beginning of the decade, Pfizer went on a major acquisition binge. The company is still right-sizing and integrating two of its biggest acquisitions: Pharmacia, acquired in 2002, and Warner-Lambert, purchased in 2000. Last January, in fact, incoming CEO Jeff Kindler unveiled a number of cost-cutting measures, including plans to layoff some 10,000 employees. The cuts, incidentally, included the shutdown of the Ann-Arbor, Michigan labs where former Warner-Lambert researchers discovered Lipitor.

However, if Pfizer purchased just a portion of Sanofi, the deal could benefit both companies. Pfizer would share in the revenues of future medicines in treatment areas where it is currently weak, such as cancer. And it would effectively be placing a small bet on the possibility that Sanofi scientists discover the world's next top-selling drug. For its part, Sanofi would gain from Pfizer's considerable U.S. salesforce, and marketing prowess.

Robert Hazlett, an analyst with BMO Capital Markets, who won't comment on the specific Pfizer-Sanofi rumors, believes Pfizer should generally "put their cash to work in every way possible for the next several years," he says. "They've got the biggest issue to surmount. So, from that perspective nothing is off the table. But they shouldn't do a large transaction that would create a problem."

And there could be problems. Although Sanofi stock is rather cheap, with a current price-earnings ratio of nine, the drugmaker has encountered several regulatory setbacks in the U.S. Most notably, last summer, the company failed to gain FDA approval for its much-anticipated weight-loss drug, sold in Europe under the name, Acomplia. Meanwhile, Sanofi, like Pfizer faces a problem of hunting for a replacement for its current top-selling drug. Sanofi's blood-thinning treatment, Plavix (which it jointly markets with Bristol-Myers (Charts, Fortune 500)), is set to face generic competition in 2011. It is currently the world's fourth-best seller, with sales of nearly $6 billion in 2006.

Eking out synergies while trying to discover and develop replacements for two of the world's top-selling drugs is a tall task. Not to mention possibly the biggest deal-breaking factor in the full takeover scenario: French nationalism. Sanofi-Aventis is the product of a 2004 pairing of two French drug companies. During the period when Aventis was in play, several foreign companies were reportedly interested in purchasing the company. The French government, including then-finance minister and current president Nicolas Sarkozy, actively discouraged bids from foreign firms, including Swiss drugmaker Novartis, which had expressed an interest.

Similarly, a full takeover bid for Sanofi from Pfizer "would be difficult politically," says Philippe Lanone, an analyst with Natixis Securities in Paris. The French government could have a say in approving such a deal under its laws that guard "strategic state interests," according to Lanone.

Even if the French government opposes the takeover of one of its industrial champions and does nothing to stop it, it could create regulatory nightmares for Pfizer, especially as it relates to downsizing the company and firing French workers. "This undermines the likelihood of a full acquisition," Lanone says.

As of this morning, neither company has commented on the rumor. But if they handle a deal carefully, it could end up benefting both. Top of page