The Missing Synergy That's Killing Life Sciences


When biotechnology and agriculture expert Sano Shimoda explains the much-touted life-sciences strategy of chemical companies, the native New Yorker wants you to imagine a well synchronized baseball team playing at Yankee Stadium. Shimoda, the president of BioScience Securities, a San Francisco Bay-area brokerage/investment bank that focuses on industrial and agricultural biotechnology, explains: In right field, you have the health and drug guys, in left field, food and agriculture. The game plan: Take advantage of synergies in intersecting operations of agriculture, biotechnology, and pharmaceuticals.

One hypothetical synergy, for example: Creating industrial-strength genetically altered plants with derivatives that could be used to create blockbuster drugs. It's beautiful in theory. Unfortunately, the concept hasn't produced any grand slams. And disappointment over the lack of success has led to an industrywide trend of backing off the life-sciences strategy.

WHITE FLAG. The latest example came in mid-December, when the board of DuPont (DD) approved a plan to divest its pharmaceuticals unit and focus on its core chemicals business. The drug business, which includes its HIV/AIDS drug Sustiva and blood-thinner Coumadin, could fetch around $7 billion, analysts estimate. Company officials are still mulling a sale or spin-off through an initial public offering, most likely sometime in 2002. The move essentially ends the efforts of DuPont CEO Charles O. Holliday to transform the chemicals giant into a life-sciences powerhouse.

DuPont has plenty of company. In the last 18 months, other chemical companies have abandoned their drug businesses, and vice versa. The excitement about potential "horizontal synergies" has fizzled. Stocks of drug companies with exposure to life sciences are no longer trading at 24 times earnings or higher. Chemical stocks once again are trading like chemical stocks -- not biotech holdings. "Things have not gone the way of the playbook," says BioScience Securities' Shimoda. The reasons for the strategy shift vary, including lack of profits, the inability to get new products to market, consolidation in the drug business, and consumer uneasiness with genetically modified foods.

The trend has a wealth of examples. In December, German chemical giant BASF agreed to sell its Knoll Pharmaceutical unit to Abbott Laboratories (ABT), a Chicago-based health-care-products maker with well-known brands including infant formula Similac and nutrition supplement Ensure. Earlier last year, life-sciences company Monsanto and drugmaker Pharmacia & Upjohn merged. The new company, called Pharmacia (PHA), kept the drugs and on Dec. 18 spun off Monsanto's agricultural-biotechnology business. The new Monsanto (MON) is an autonomous subsidiary of Pharmacia.

UNSTABLE COMBINATIONS. Meanwhile, European drug giants Novartis and AstraZeneca spun off and merged their respective agribusiness and agrochemicals business to create Syngenta. The transaction was completed in November. Dow Chemical (DOW), based in Midland, Mich., may have been ahead of its time when it sold its drug businesses in 1995. "The list is endless," says John Moten, a Deutsche Bank Securities chemicals analyst.

A key factor in this movement has been the major consolidation in the drug business, which has made it very difficult to be a small drug player in a pond full of big outfits. Richard U. DeSchutter, who will oversee DuPont's divestiture of its pharmaceuticals business, says the company shelled out roughly $500 million annually for its drug unit's research and development. While that was money well spent, DeSchutter notes, the figure was expected to climb to $800 million in a few years. DuPont spends about $1.8 billion annually on R&D in total. "It was best to separate," DeSchutter says. A first-hand witness to the changing tide of life sciences, DeSchutter is the former chief executive of the old Monsanto drug unit, G.D. Searle & Co., which was sold to the recently created giant Pharmacia.

Consolidation aside, selling the life-sciences concept grew more difficult as consumers became wary -- and in some countries, fearful and angry -- about bioengineered foods. Environmentalists and other opponents of bioengineered foods were gaining leverage from the StarLink corn episode in late 2000. StarLink, a variety of genetically modified corn developed by Franco-German group Aventis and approved only for animal consumption in the U.S., was discovered in various products including taco shells in U.S. stores. The public was outraged. While life-science advocates believed the new research's achievements would speak for itself and gain acceptance with time, the public-relations backlash against bioengineered foods has only escalated.

"OFF THE CLIFF." Stagnant earnings growth -- particularly at DuPont -- have also pushed chemical companies and investors alike to rethink the life-sciences strategy. According to Moten of Deutsche Bank, DuPont's drug-divestiture decision was probably brought to the forefront after it disclosed in the third quarter that pharmaceuticals sales would be down $300 million the next three quarters.

BioScience Securities' Shimoda also points to faltering earnings as a driver of the drug divestiture. DuPont's agricultural-chemicals business, including crop protection, which provided a reliable stream of earnings, "fell off the cliff," says Shimoda. Indeed, competitor Monsanto's Roundup herbicide franchise has cornered the market. And with agricultural chemicals' profits off, DuPont had to be very selective about where to spend money. Life sciences' results suddenly seemed too expensive and very far off in the future. "That was the trigger for people to step away," Shimoda notes.

But ever the sports fan, Shimoda says it's easy to play Monday-morning quarterback and wonder what DuPont and other companies were thinking when they started to gobble up pharmaceutical investments about a decade ago.

SELLING THE STORY. Still, you really can't blame the chemical companies for trying: The life-sciences concept gave them higher valuations. Traditionally measured by hard assets such as manufacturing facilities, analysts began assessing chemical outfits on variables usually associated with pharmaceutical companies, such as product pipelines. Wall Street pitched the enticing life-sciences story, and investors bit. More than a year ago, DuPont was trading in the $70 range. It's now trading under $50, closer in valuation to its peers.

So, is this the end for life sciences and bioengineered foods? No, analysts say. It's just shelved for a couple of years, perhaps until after the economy regains momentum. Shimoda predicts: "Life sciences will come back from the dead." By Heesun Wee in New York


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