6.25.16 | Forbes.com
By Steve Brozak
To read the entire article on Forbes, please click here.
In medicine they talk about triage in making quick decisions to save lives. Central bankers and politicians across Europe will be performing financial triage this weekend on the UK and EU. But big Pharma execs and their financial staffs will also be working overtime to monitor their cash reserves and scrutinize their corporate financial structures.
Blame it on Brexit
Corporations like predictability and Brexit represents the antithesis to that order. Pharmaceutical entities will react to this dislocation in a fairly predictable manner. These issues do not just specifically apply to UK entities like AstraZeneca and Glaxo Smith Kline, which both depended on the EU-UK in FY 2014 for more than 25% of their revenues. The realities of newly uncertain markets will shake every major pharmaco. Based on what I’ve seen before, one of the first casualties becomes R&D. Next less profitable operations are quick to be shuttered. Finally when even more severe actions occur it will be easy to “Blame it on Brexit” for everything that goes bad or any type of corporate reshuffling. That won’t be pretty.
Portfolio Managers were not prepared for this. But no amount of financial modeling can tell us where Europe and the world will go because the ramifications and repercussions are so far reaching. How will the markets deal with a financial crisis that could put parts of Europe into recession, and impact key industries that bolster their economies?
Here are four areas that have to be considered:
1. Big Pharma’s balance sheets just took a hit
Between the UK and the EU most large pharmaceuticals have more than 20% of their sales in the region, as a result these companies will be working the numbers this weekend to see how their performance will be affected by Brexit and the ensuing financial chaos. As an example let’s use Pfizer. You had $9.714B in revenue in FY2015 from “Developed Europe” (that’s the U.K., Western Europe, Finland and Scandinavia). What number is Pfizer now managing, planning to report for this quarter, and what’s the breakdown in estimated sales for those countries as the market becomes destabilized and currencies swing wildly? Wait, there’s more. Pfizer, like other big pharmacos, has debt. In this case Pfizer holds 2.2B £ debt, maturing in 2038 (as of December 31, 2015). The debt and their revenues are inter-related here. How their sales may be affected are the least of their worries. Remember that many U.S. companies have vast sums of money locked up in Europe in order to avoid paying taxes. All of these holdings have been affected by Brexit and the volatility in the FOREX markets. This is almost an un-hedgeable event for most of these companies. If you thought they were conserving cash before wait till you see them hoard it now.
2. The healthcare capital markets have now come to a screeching halt
Despite some glimmers of hope in the last few weeks, the healthcare capital markets were barely creaking before Brexit as IPO levels hit their lowest levels since the financial crisis in 2008-2009. People must understand they will be completely shutdown, so don’t be surprised if you call your investment banker next week only to find that he/she decided to take a holiday. Spinning capital markets make everything else go round, both in the public and private domains. With a decompensating banking system, the UK’s financial chaos will certainly have a domino effect across the rest of the continent. Management teams will be distracted, layoffs will certainly ensue, and once that happens, meaningful R&D will slow down as workers begin to worry about their jobs
3. Even the EMA is a question mark
The European Medicines Agency (EMA) is the pharmaceutical regulatory agency for Europe. Right now, the word is: “Don’t panic. No changes soon.” Nice to know, since EMA Headquarters is in Canary Wharf, London.
4. The downsides of inversions
Like any good divorce, it always comes down to money– or in this case, taxes. A case in point is pharma giant Allergan AGN -3.34% Plc, which, having combined with an Irish entity, was able to obtain a favorable tax rate compared to the U.S. corporate schedule through an “inversion” into the European Union. As EU cohesion and European financial instability becomes an issue, tax laws as well as trading relationships are in play.
Yes, taxes on those cozy inversions could be changed or even nullified. Trade and tax agreements between the EU and the rest of the world dictate and help to make trade more predictable, establishing trade routes, tariffs, customs processes, etc. What happens when they are put at risk?
Central banks will be issuing new policies next week to reassure panicked markets. But they can’t do that overnight and the markets know that. This is an incredibly complex time, which could transform geo-politics and the way global economies interact. Investors should be analyzing their holdings very closely for total exposure.
Remember: Pharmaceutical and medical device companies aren’t just service providers. They are among the largest industries in the world. They require stability. And suddenly, we don’t have it.