Why Pfizer Should Pay Close Attention to the Allergan-Teva Deal

Pfizer's second-quarter earnings may have beaten consensus estimates, but they alsoillustrated why the drugmaker needs to do something drastic to restart its growth engine. Specifically, the company's revenues dropped by 7%, and its adjusted diluted EPS by 3% for the three-month period compared to a year ago.

Source: Wikimedia

A deeper look at the report shows that the main culprit is Pfizer's Global Established Pharmaceutical Segment, which saw revenues plummet by 14% on an operational basis year over year. That's why management has been exploring ways to reformulate--or sell-off--this flagging business for some time now.

Unfortunately, the right opportunity has yet to present itself -- but the recentTeva Pharmaceutical Industries Ltd.'spurchase of Allergan'sgeneric drug business may have just provided a road map for Pfizer's next big move. Here's why.

Pfizer's legacy products are weighing it downPfizer's global established products business is on track to generate around $21 billion this year. With some of its main revenue drivers likeCelebrex, Zyvox, and Lyrica getting clobbered by the entry of generic competitors, though, this figure is expected to drop rapidly.

Although the drugmaker snapped up Hospirato even out the descent of its legacy product business, the fact is that this acquisition's real value comes from its biosimilars component -- where Hospira is an early leader in the pack. Even so, the biosimilar market is going to take several years to fully develop, given the onerous regulatory landscape in the U.S. Put simply, the Hospira acquisition won't make much of an impact anytime soon, leaving the door open for another, perhaps much larger, buyout to right the ship.

Instead of immediately "bulking up" via a major acquisition, though, Pfizer may decide to first sell off its legacy products as a means to unlock the strong growth occurring in its innovative products business (second-quarter sales soared by 17% on an operational basis for this unit). Teva Pharmaceutical Industries' $40.5 billion purchase of Allergan's generic drug segment provides a great example of why Pfizer would be wise to do so.

Despite losing about a third of its market cap after jettisoning its generic unit, Allergan is now loaded with cash from this transaction, and it reshaped itself into a specialty pharma company with high double-digit growth prospects at the same time.

As a result, Allergan can now pursue a host of additional value-creating deals, if it chooses to do so, or simply reward shareholders via a dividend increase. The interesting tie-in is that if Pfizer were able to locate a buyer for its legacy business, we would probably see a highly similar scenario play out for the pharma giant.

What's next?Pfizer's almost certainly going to do something big within the next 12 months; it pretty much has to in order to stop the bleeding from its legacy products, and to let newer products like Prevnar 13 and Ibrance begin to shine through.

Per the drugmaker's second-quarter conference call, we learned that CEO Ian Read believes that the edge for a major deal goes to the innovative products side of the company right now, saying:

I believe that a game-changing transaction for Pfizer's innovative products segment nevertheless appears to depend on the fate of its legacy product segment. So investors shouldn't be surprised if the drugmaker starts to explore a sale of this struggling unit.

The article Why Pfizer Should Pay Close Attention to the Allergan-Teva Deal originally appeared on Fool.com.

George Budwell has no position in any stocks mentioned. The Motley Fool recommends Teva Pharmaceutical Industries. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.