Glaxo, SmithKline in merger talks

Shares in SmithKline rose seven per cent and Glaxo four per cent by 1050 GMT as investors relished the prospect of a deal that would strip out costs and boost the combined group8217;s research and development and sales clout in a consolidating industry.

Glaxo8217;s market capitalisation was 63.3 billion pound at Thursday8217;s close, while SmithKline stood at 44.4 billion, suggesting the combined group will vie with BP Amoco Plc, currently valued at around 110 billion pound, for the position as the largest company in Britain.

Paul Diggle, pharmaceutical industry analyst at SG Securities, said cost savings meant a combined group could deliver earnings growth of around 20 per cent, against the mid-teens expected from the two firms independently.

Other analysts also applauded the industrial logic of the proposed tie-up. quot;If this is consumated it will send a chill down the spine of every other industry executive because this creates a very different beast, a super company with true competitive advantage,quot; added Steve Plag at Credit Suisse First Boston.

quot;These super companies 8211; of which Pfizer-Warner-Lambert will be another if it goes through, which looks likely 8211; will have market share well in excess of five per cent and Ramp;D expenditure approaching 4 billion.quot;

The two groups have an annual research and development budget of more than two billion pound and complementary technologies 8211; Glaxo being strong in combinatorial chemistry and SmithKline in genomics.

In February 1998, a planned merger between Glaxo and SmithKline floundered because of a clash between Glaxo executive chairman Richard Sykes and SmithKline chief executive Jan Leschly over who should run the group.

Since then, Leschly has announced plans to retire in April 2000, while Sykes is contemplating a role in academia after he reaches 60 in 2002. quot;The management issues which caused the breakdown of the talks before are now mostly resolved with Leschly going and Sykes nearer retirement,quot; said a second industry analyst who asked not to be identified said.

quot;And the rationale is stronger than it was back then with the prospect of a much bigger, stronger US competitor if Pfizer succeeds in its bid for Warner-Lambert.quot; The global drugs industry, facing rising costs as the search for new medicines becomes ever more complex, is under pressure to merge.

The link-up of Glaxo and SmithKline would create the world8217;s biggest producer of prescription drugs with a market share of around 7.5 per cent. This would dwarf the current leaders, Novartis AG of Switzerland and Merck amp; Co Inc of the U.S, Both on 4.2 per cent in 1998, and put a merged SmithKline-Glaxo on a par with Warner-Lambert-Pfizer.

On the basis of their respective market values, the split between the two companies would be roughly 60:40 in favour of Glaxo.

Analysts expect Sykes to retain the position of executive chairman of the merged company but he is likely hand day-to-day running of the company to Jean-Pierre Garnier, SmithKline8217;s No. 2, who is expected to become Chief Executive.

John Coombe and James Niedel, both of Glaxo, are expected to keep the key positions as heads of finance and research respectively.

SG Securities8217;s Diggle said the combined group would be able to cut its costs by around eight per cent, or 1.2 billion pounds, as duplications in management, manufacturing and Ramp;D are stripped out.

The price of achieving those savings is likely to be heavy job losses in Britain and the United States, and a rationalisation charge of about 1.5 billion pounds over the next three years, most of it in 2001.

quot;At the earnings level, that would mean for the period between now and 2004, instead of Glaxo growing by 12-13 per cent and SmithKline by 15, the two together would grow by around 20 per cent,quot; Diggle said.

No major regulatory hurdles are expected from the planned merger, given the limited product overlap between the companies. Glaxo is strong in asthma and anti-virals, while SmithKline is focused on antibiotics, vaccines, central nervous system products and diabetes.

quot;The last time we were in talks there weren8217;t major regulatory problems and we would assume a similar situation now. The markets we operate in are mostly complementary rather than overlapping,quot; said one person close to the companies.

However, there are some areas where regulators may fret that the new group is too powerful. These include herpes treatments, where SmithKline8217;s Famvir competes with Glaxo8217;s Valtrex, and cancer, where SmithKline8217;s Kytril clashes with Glaxo8217;s Zofran.

There is also some overlap in anti-depressants 8212; SmithKline has Paxil and Glaxo Welbutrin 8212; while products in Glaxo8217;s development pipeline could compete with SmithKline8217;s Avandia diabetes treatment.

The talks between two firms come amid unprecedentedconsolidation within the global drug industry and follow recently announced merger plans between Pharmacia amp; Upjohn Inc. and Monsanto Co. and Pfizer Inc.8217;s attempt to take over Warner-Lambert Co..

Lazards Brothers is advising Glaxo and Morgan Stanley is advising SmithKline, industry sources said.