Who is high on drugs?

• Author: Scheer, Lisa
• Position: Drug companies' stock prices

The big drug companies came down with a bad case of anemic stock prices at the beginning of last year, back when the health-care-reform movement was fit and robust. Now, after a hefty dose of big-bucks lobbying, some people are predicting government will forget about imposing price controls, and this could give pharmaceuticals a real shot in the arm.

"I'm more optimistic about not getting price controls than I have been for some time," says Dr. Charles Sanders, chairman of Glaxo Inc., the Research Triangle Park-based subsidiary of London's Glaxo Holdings PLC (GLX-NYSE-traded American Depositary Receipts). So is it time to start buying drug stocks again?

Not just yet, analysts say. Although the patient is recovering, the prognosis is still pretty grim. For one thing, the days of 70% gross-profit margins could be gone forever. Health-maintenance organizations have been cutting deals, and that cuts into profits. "The HMOs and PPOs have tremendous clout because of the volumes they deal in," says Winston Way of Buckhorn Capital Management in Charlotte. "They can get these drug companies to cut their margins to the bone."

In response, huge companies such as New York City-based American Home Products Corp. and New Jersey-based American Cyanamid Co. have been merging, hoping fatter sales will compensate for thinner profits. Rumor has it Glaxo is shopping for Indianapolis-based Eli Lilly & Co.

The extra competition for cut-price sales comes on top of Medicare drug rebates and patent expirations. All of which could mean lower earnings for Glaxo and its British neighbor, Wellcome PLC (WEL-NYSE-traded ADRs), whose U.S. operation, Burroughs Wellcome, is also headquartered in RTP. Glaxo is extremely vulnerable to price pressures, analysts say, because nearly half its sales come from one product, the ulcer medicine Zantac. Way calls Glaxo "pretty much a one-horse company." Zantac, which brought in 43% of the company's $8.5 billion in sales last year, is threatened by discount generic versions of SmithKline Beecham PLC's Tagamet, which went off patent earlier this year.

This worries John Harloe, a health-care industry analyst with Sterling Capital Management in Charlotte. Rival pharmaceutical companies are gobbling up pharmaceutical benefits managers -- the middlemen who sell drugs to large employers at a discount. New Jersey-based Merck & Co.'s acquisition of Medco Containment Services, based in Montvale, N.J., is one example. "Merck, SmithKline and Eli...