The team viewed the video “Cost of Capital” as part of our weekly team discussion. In the video, Amil Singh discussed the cost of capital for Pfizer Inc. Pfizer Inc. is the world’s largest research-based pharmaceutical company that develops its own products in America. Pfizer revenue is about $65 billion with market gap close to $140 billion (John Wiley and Sons, 2012). The cost of capital is the “rate of return that capital could expect to earn in an alternative investment of equivalent risk” (Investopedia LLC, 2015). When the company researches and develops a new product it can take nearly eight to ten years before it hits the market and see a profit. In this paper, we will look at how Pfizer addresses its cost of capital and issues with research and development. Pfizer has experienced challenges in recent years, with more than $2 billion in legal settlement payments over marketing practices for drugs in 2009. Additionally, Pfizer could face tremendous revenue loss as drug patents, which account for 40% of their sales, expire in the coming years.
Pfizer will have to face some corporate finance challenges which include litigation, discontinued projects, focus on blockbusters, loss of revenue, exposure to generic drugs and FDA regulatory oversight. Pfizer has been involved in numerous litigations, which resulted in two things: damaged reputation and enormous payouts. The two biggest litigations concerned the pain killer Bextra and related off-label promotions and illegal drug testing on seriously ill children in Nigeria during a meningitis epidemic. The first was settled in 2008 by paying $2.3 billion in charges and the latter involved paying a fine of $75 million in April 2009. The discontinued projects reflect a loss of resources and also in the perceived inability to complete research projects. From September 2008 until March 2009, Pfizer discontinued over 25 research projects, including projects that were beyond initial stages.
While Pfizer has been focused on blockbusters, it has had some of the most successful products available on the market and has also become riskily complacent and relied too much on them. Without future mergers and acquisitions, it will become increasingly difficult to grow sales while centering their growth model around their blockbusters. Connected to the narrow focus on blockbusters is the trend of Pfizer seeming to lose revenue growth, particularly in the U.S. In 2008 the U.S. fiscal revenues dropped by 13%. This happened mostly due to the loss of exclusive rights on drugs like Norvasc and Zyrtec/Zyrtec D as well as lower sales of Lipitor and Chantix. With many patents expiring, population opting for generic drugs as cheap alternatives and the proposed regulatory approval for generic versions, Pfizer will face uncertainty in this sector. The government is also in favor of generic drugs as they will help to cut health care costs. Pfizer will have to take on retailers such as Target and Walmart, which already offer lower-priced generic drugs to their customers.
In 2011, Pfizer lost the patent for its most widely sold drug, Lipitor, which had a huge impact on their sales once the generic products entered the market. Regulations not only threaten to interfere with Pfizer’s international business, but are also imminent for its business in the United States. With the FDA having increased regulatory power, Pfizer’s costs are expected to rise as it will become more complicated to get new drugs approved and on the market. This will negatively affect the revenue. Pfizer’s position in the market is still strong, despite the weak economy, legislative measures and legal factors. Extant theories suggest that a firm’s greater disclosure should lower its cost of capital, which arise from information asymmetries either between the firm and its shareholders or between buyers and sellers of firm shares (Ly, 2010). Many companies, just like Pfizer, invest a considerable amount of cash balance decisions.The cash balance decision is one of the keys to success in maintaining the value of its intangible assets, which typically comprise of a substantial portion of the total price for the knowledge that companies hope to preserve their assets value. Pfizer’s credentials are good, and their top drugs still sell well. Americans are already looking to cut costs, and taking generics instead of brand names is one way to keep health care spending lower. By keeping up with all the new FDA regulations, Pfizer will have to try to stay ahead of the game by complying with them and not taking too many risks. Pfizer will have to find a balance between creating new medications and lowering costs for consumers by creating their own comparable generics.
Investopedia, LLC, 2015. Cost of Capital. Retrieved from: http://www.investopedia.com/terms/c/costofcapital.asp John Wiley and Sons (2012). Cost of Capital [Video podcast]. Retrieved from http://phoenix.edu Ly, K. (2010). Investor relations level and cost of capital: Evidence from Japanese firms. Asia – Pacific Journal of Business Administration, 2(1), 88-104. doi:http://dx.doi.org/10.1108/17574321011028990 Parrino, R., Kidwell, D., & Bates, T. (2012). Fundamentals of Corporate Finance (2nd ed.). Hoboken, NJ: John Wiley & Sons, Inc.