Man in a Hurry

November 1, 2006

Pharmaceutical Executive

Volume 0, Issue 0

When Arthur Higgins first announced that he was about to take the reins of the healthcare group at Bayer, in 2004, colleagues were surprised.

When Arthur Higgins first announced that he was about to take the reins of the healthcare group at Bayer, in 2004, colleagues were surprised. Here he was, chairman and CEO of Enzon Pharmaceuticals, a small but rapidly growing company, about to move to a firm battered by dropping stock prices and the wave of lawsuits that followed the withdrawal of its ill-fated statin, Baycol (cervastatin). And though many people might regard that as a challenge and opportunity, there was also Bayer's reputation as a classic dyed-in-the-wool German corporation—straitlaced, slow moving, and utterly averse to making decisions. Higgins recalls, "They said, 'How can you live with the bureaucracy?'"

Quite easily, it turns out. Bayer, since 2001, had been remaking itself, partly with an eye toward making itself quicker and more responsive to the marketplace. The company moved to a holding-company structure, setting up its operating units as legally independent entities, and in a startling move for a relatively conservative company, spun off its chemical business—long a cornerstone of Bayer's identity—as a separate company.

For Higgins, Bayer's reputation for bureaucracy proved either exaggerated or out of date. "My observation is that it's actually quite easy to get decisions made in Bayer," he says. "In fact, it can be somewhat easier than at an American company. Basically what I've got to do is win over the CEO and it can get done very quickly in a German company."

DEAL MAKER CEO Higgins welcomes potential partners to his table. "The economics are such that I believe that's still a more profitable model than trying to do it yourself."

For proof, he points to the changes he has brought about in the pharmaceutical business since his arrival in July 2004:

  • Within weeks of Higgins' arrival, Bayer HealthCare announced that it would acquire Roche's consumer products division, making it one of the top-three companies worldwide in over-the-counter drugs. The deal closed in January 2005

  • It divested an underperforming plasma business, but in keeping with a plan to make cardiac care and hematology a key focus, it retained anti-hemophilic Kogenate, the latest in its long line of products for hemophilia

  • It won FDA approval for and launched Nexavar (sorafenib), a first-in-class cancer drug that targets multiple kinases

  • In March, it launched a successful takeover bid for Schering AG, consolidating its position as a specialty drug company and acquiring a high-quality US sales force

  • This past June, it announced the planned sale of its diagnostics division to Siemens, freeing up resources to focus on its diabetes care business, which was formerly linked to diagnostics.

Not bad for a supposedly slow-moving bureaucracy.

"When I think about what we have achieved, it stuns me," says Higgins. "I'm thinking, are we moving that fast? And the answer is yes, we are moving that fast. We've seen our revenues increase from just a little over 8 billion euros [about $10 billion] to a little over 13 billion euros [$16 billion] on a pro forma basis, and we've seen the contribution of healthcare to Bayer grow to more than 50 percent of revenues and income. The Bayer HealthCare stock has doubled in that two-and-a half-year period. Our momentum and confidence in our company are second to none. When I meet with my fellow CEOs, you know, I get a sense I'm having fun and they're struggling."

'We don't need this'

In the 1980s, Bayer was a top-five pharma. By the turn of the century, it was decidedly second-tier. The reason was a familiar one.

"If you think of Bayer in the eighties, the pharmaceutical business was the engine," says Higgins. "Bayer, like a lot of companies, believed that you could achieve sustainability through internal innovation. So they significantly increased their research and development and believed that the pipeline was always going to be their savior."

As a result, when the industry began to consolidate, Bayer passed up on some opportunities to participate.

"Bayer's view was, 'We don't need this,'" says Higgins. "Of course, this was not unique to Bayer. And, of course, a decade later, if you're a company that took this attitude, you probably find yourself no longer competitive from a scale perspective. You probably haven't focused enough on your other businesses, and you get a pretty unbalanced portfolio, and then finally, you overlay that with some misfortune, which can happen to the best of companies. For us, it was Baycol. If Baycol had fulfilled its potential, it would have been a $4 billion to $5 billion asset. And we would have been proven right."

But that didn't happen. Instead, in August 2001, Bayer withdrew the cholesterol-lowering agent from the market, after reports of an elevated incidence of rhabdomyolysis, a breakdown in muscle tissue that can lead to kidney damage—including 31 fatalities in the United States. Over the next two years, Bayer's stock plunged to just over nine dollars.

To cope with the situation, Higgins has been pursuing a strategy that bears many of the hallmarks of Bayer's traditional diversified, multi-market approach. At the same time, it puts the company more in line with today's pharma market, with its focus on high-margin specialty products, efficient use of sales force, and deal-making as a source of new products. And it is working fast, pushing for quick execution—and quick return on its efforts.

Here are some highlights of Bayer's high-speed makeover.

Deeper into Consumer Health

Bayer has long been one of the best-recognized brands in pharma—to a great extent because of its presence in the nonprescription market, where Bayer has played a major role for more than 100 years, arguably dating to the synthesis of Aspirin (acetyl salicylic acid) in 1898.

Consumer health is traditionally a lower-margin business than brand-name prescription drugs. But the category has been growing rapidly in the past few years, and it offers some often overlooked advantages, says Higgins. "There are limits on the synergies you can realize on the commercial end of pharma. A pharma field force can at maximum promote two products. So, when you merge, you still need those selling organizations unless you dramatically reduce the number of products you're promoting—which defeats the whole purpose of the acquisition. A consumer business is almost like a catalog business. We can add product to existing sales and marketing organizations, and get the maximum level of synergies."

Driven by that logic, Bayer HealthCare acquired Roche Consumer Health in a $3 billion deal in August 2004. (Roche Consumer Health had sales of $1.4 billion in 2003.) The deal gave Bayer such products as pain relievers Aleve and Flanax (both based on naproxen); Bepanthen antiseptic cream; the multi-vitamins Berocca and Supradyn; Redoxon (artificially synthesized vitamin C); and Rennie (an antacid). They joined Bayer's lineup of consumer products, which includes such well-known brands as Aspirin, Alka-Seltzer, and One-a-Day. Bayer also acquired five overseas production sites and Roche's 50 percent share of the 1997 Bayer–Roche US joint venture, which makes Aleve.

The acquisition made Bayer the third-largest provider of nonprescription medicines. "At the time people felt we had significantly overpaid. If you see some recent acquisitions, we look like very smart people. We got in at the start of the OTC consolidation, and we got a bargain."

Out of the US Primary Care Business

One particularly hard decision Bayer made was to exit a market that has been one of the richest in healthcare for decades: primary care in the United States.

"At the time," says Higgins, "a lot of people, including people in Bayer, thought this was a highly risky strategy and one we would come back to regret. In fact, eighteen months later, just like with the Roche acquisition, we looked smart, we moved ahead of the count, and now are getting the benefit of that." Higgins says letting go of US primary care not only improved Bayer's profitability, but also served as the catalyst that allowed for a closer focus on specialty products.

To shed its US primary care operation, Bayer took a relatively new tack. The company actively pursued partnerships—and knew it had to be selective.

"We had to make sure that the company taking responsibility for our primary care products was really committed to ensuring they maximized their value, because this led to short-term profitability. If our two assets—Avelox and Levitra—were not properly developed, then over a five-year period of time we may have not achieved as much value as we could have done under a different strategic approach."

The search led them ultimately to Schering-Plough. "We were very careful in selecting a company that had a need to significantly strengthen its primary-care organization and had the resources to do so. If you bring products like this into an organization that's already got a pretty filled portfolio, you're probably going to lose out, because their own products make them more money than in-licensed products. But Schering had a gap. They had also a good strategic fit. Avelox was highly complementary to the Clarinex franchise; Clarinex gets promoted in the summer months, Avelox [an antibiotic used to treat respiratory infections] in the winter."

The deal with Schering-Plough is performance-based. Bayer is granting a license on the products for the term of their patents. Schering makes the bulk of its profit by ensuring that the products sell more than when they were transferred. "We get the early gains, but they get the majority of the benefit of the up side," says Higgins. "If they execute with Avelox and Levitra, over time it should be a very good deal for them. But it was clearly a deal where we were looking for short-term benefit and were prepared to trade off some of the longer-term benefit."

For many at Bayer, the hard part about moving out of primary care was leaving behind Bayer's real heritage business—anti-infectives.

"That was not a very popular decision within Bayer, but the right decision," says Higgins. "Exiting any of these businesses is emotional. You have people who come and tell you with great belief—and there's maybe some reality in it—they've been working on something for five, seven, ten years and they're just a week away from something really significant, and you're worried about throwing the baby out with the bathwater."

It's not unusual for pharmaceutical companies to simply walk away from rather than sell or license out products they have decided not to market. "We have a history of that at Bayer," he says. "It's a clean-hands approach, and I understand why people do it, but it's not smart."

Fund Investment With Non-US Primary Care

Bayer may be moving away from primary care products in the United States, but it is sticking with them elsewhere in the world. For example, in January 2005, it bought back from GlaxoSmithKline (GSK) co-promotion rights to the erectile dysfunction drug Levitra in a number of non-US markets. More recently it purchased from GSK the European rights to Boehringer-Ingelheim's blood-pressure drug Pritor (telmisartan).

Higgins, however, makes an important distinction between Bayer's old and new approach to primary care. In the past, at many companies, constantly rising sales and prices for primary care drugs meant that tight financial controls often went by the wayside. Today, Higgins is looking for quick profits and financial discipline from the primary care side of the business.

"The payback we're looking for is 12 to 24 months," he says. "In our specialty business we would be prepared to take a longer horizon, because we're building a business for the future.

"I think a lot of companies are going to try to find a way to treat primary care as a basic business, where the goal is to ensure pretty ruthless fiscal discipline, so you only make the necessary investments to achieve a level of profitability. Then you reinvest that in specialty. I think that's going to be the business model for the bulk of companies. And that'll be a challenge for some of them—you have to be disciplined, aggressive, and understand the business you're in. We've already seen the benefit of it. Our pharma business, which had single-digit profitability 24 months ago, will be double-digit this year. We've turned this business around in the space of 24 months."

In part, that fast turnaround can be attributed to Bayer's relatively small size. "We can actually transform our pharma business with just our cancer compound sorafenib fulfilling its potential. If sorafenib [Nexavar] and Factor X [Rivaroxaban] fulfill their potential, we'll be one of the real success stories of the next five to seven years, because we can double our pharma business. How many other companies can look at doubling their pharma business in the next five to seven years? That's the Pfizer problem. The laws of big numbers hurt [large companies], and the laws of small numbers give us a competitive advantage."

Build on What You Already Have

For Higgins, the future is in specialty drugs—a conclusion many other companies have come to in the past few years. The company has selected cardiac risk and oncology as its target areas. Why those two? "In this industry, you're really determined by what you have in development," says Higgins. "I could tell you it was after exhaustive deliberation, but in reality it's about recognizing the cards you've been dealt and making the best of that.

"If you look at the size of our discovery groups, in both instances, they're very, very, comparable to a Pfizer or a J&J or an AstraZeneca in numbers. It would have been easy to stay with three [therapeutic focus areas]—and to have been suboptimal in all three. Instead we went for two, and we're very competitive in those two areas."

Several products stand out as key building-block drugs:

Nexavar is the first in a new class of anticancer agents, multikinase inhibitors. It works by blocking kinases—specialized signaling proteins—that control development of renal cell tumors, which has the effect of both blocking the development of blood supply for the tumor (antiangiogenisis) and decreasing the proliferation of tumor cells. Developed in partnership with Onyx Pharmaceuticals, sorafenib was approved in the United States in 2005 and in Europe in 2006 for use in advanced renal cell carcinoma. It is currently in Phase III clinical trials for liver cancer and melanoma, and it is being evaluated for other tumor types in early-phase trials. Higgins says Nexavar is the "cornerstone" on which Bayer will build an oncology franchise.

Rivaroxaban (also known as BAY 59-7939) is an oral anticoagulant that works by inhibiting coagulation Factor Xa. The drug is being investigated for use in thromboembolic diseases. Phase III trials for prevention of venous thromboembolism after major orthopedic surgery began in December 2005, and Bayer expects to file for approval in that indication late in 2007. Rivaroxaban is also being tested for use in treating acute VTE and stroke prevention in atrial fibrillation.

Kogenate Since the 1970s, Bayer has marketed formulations of coagulation Factor VIII for the treatment of hemophilia. The earliest versions were derived from human blood. The most recent is a recombinant product, produced through bioprocessing. Kogenate was Bayer HealthCare's second-best-selling product in 2005, with sales of 663 million euros [about $795 million]. (In first place was the Ascensia diabetes care product line, with sales of 701 million euros.) The company continues to develop Kogenate. It currently markets a version that comes packaged with a needle-free injection system. And the next generations of Kogenate are already in the works. Bayer has identified five new protein variants that might be part of the new formulation. And it has signed an agreement with Dutch-based Zilip-Pharma to license the company's pegylated liposome technology to develop a new longer-acting formulation of Kogenate.

Trasylol (aprotinin), first approved in 1993, is a broad-spectrum proteinase inhibitor used to control the systematic inflammatory response (SIR) associated with cardiopulmonary bypass surgery. Its sales hit 178 million euros in 2005—up 34 percent from the preceding year, and it contributed to Bayer's push to be seen as a force in cardiology/hematology. But in September, controversy over the drug arose when it was revealed that safety data were withheld from FDA. On the plus side, FDA continued to recommend the drug for some subgroups of patients. Bayer has announced an investigation into why the data were withheld. At this point, Trasylol's future has to be seen as uncertain.

"If you take a Kogenate, a Trasylol, and then a Factor X, and maybe some other things that we're pretty optimistic we can achieve, we're starting to build a pretty nice cardiovascular risk business," says Higgins. "I see them as being the kind of exciting assets that send a clear signal to the market that these people can be innovative, that they have real value-transforming assets. From a specialty perspective, we will continue to look at partnering when it comes to the primary care elements of those assets. The economics are such that I believe that's still a more profitable model than trying to do it yourself. You can get as much profitability through your partner without the risk."

Make Diversification Work

Bayer HealthCare is not just a pharmaceutical company. It also has units devoted to animal health, diabetes care, and OTC and biological products. And Higgins' fast-paced transformation has touched all of them as well. OTC, of course, is being transformed by the Roche acquisition. But smaller, yet still decisive, developments are taking place in the other units as well.

Diabetes The diabetes unit was formerly part of a unified diabetes and diagnostics division. That may have made sense years ago, before the advent of simple patient-oriented blood testing devices and the transformation of diabetes care into something resembling a consumer products business. In the 21st century, it left both businesses struggling to find where the resources should be directed. Bayer split the division into its component parts, and in June it announced its intention to sell the diagnostic unit to Siemens.

Animal Health "In that marketplace, it's important to stay in both farm animal products and companion animal products," says Higgins. "The real growth driver is companion animals, particularly in the US. We see that as a very attractive business. We already have an animal health business with above-industry-average profitability. And this year we've seen close to double-digit growth in our companion animal business in the US."

Biological Products "I see that business as an artificial distinction," says Higgins. "To me, the only thing that distinguishes pharma from biotech is that pharma makes money and biotech loses money. Once they become profitable, biotech companies are basically pharma companies. We're going to bring our biological business back into pharma, so it'll actually disappear in the sense of reporting it separately. Because I think the biotech/pharma distinction is wrong. It's wrong because the business drivers are the same. It's also wrong because when we're looking at a therapeutic problem, we shouldn't again be saying this is a problem we solve with a small molecule or a large molecule."

Use Acquisitions Strategically—Not for Scale

Perhaps the biggest change at Bayer in Higgins' tenure is the acquisition of Schering AG, a $20 billion deal—the largest in Bayer's history—which was approved by Schering's stockholders last month.

The deal was one Bayer had in mind for a number of years, Higgins explains. The main attraction was Schering's success in specialty drugs. "There are very few companies that had a higher percentage of their business coming from specialty," he says. "Most companies of that size are primarily driven by primary care products. That wasn't the case with Schering. If people were to look at companies with revenue between three and six billion—a number where Bayer could consider making an acquisition—Schering was far and away the best opportunity available."

Schering brings to the prospective Bayer-Schering Pharma its strengths in gynecology and andrology (its Yasmin is the top selling birth control pill), oncology, diagnostic imaging, and multiple sclerosis (led by its best-selling product, Betaferon/Betaseron [interferon beta-1b]).

"We were looking for a company that would significantly improve the percentage of our business coming from specialty pharmaceuticals," says Higgins. "With this transactions we will have over 70 percent of our revenues coming from specialty products, which is one of the highest percentages in the industry. The combined company will have nine specialty products with annual sales of over $200 million, and those products last year grew at a very impressive 20 percent, when the pharmaceutical industry as a whole was growing at 7 to 8 percent. We have put in place a strong foundation for building one of the world's premiere specialty companies.

Look to the Future

Early in his career, Higgins was put through the exercise of looking into the future—not just short term, but mid- and long-term as well. It became a habit with him, and as he copes with today's market forces (many of which were part of the picture he and his colleagues created close to 20 years ago), he's looking forward. Here's what he sees:

"In the short term, one to two years," he says, "I think you'll still see a lot of concern about the sustainability of the business model. I think that that is going to increase. You're going to see significant pressure here in the US to bring in measures that are not industry friendly. Medium-term I see further consolidation despite the fact that no one really believes that it is the answer.

"And then in ten to fifteen years you will see people spinning out their businesses, and obtaining value by spinning out their cardiovascular business, their oncology business. They're just no longer able to deal with the complexity.

"I believe you'll see smarter healthcare delivery in ten to fifteen years. There will be better examples of personalized medicine and a phenomenal increase in information as a value driver in healthcare delivery. A lot of us will have a situation where you can do your glucose testing or blood pressure with your portable phone, and results will go into a data management system.

"Information technology will play a tremendous role. The technology's already here. It's just the players don't have the financial incentive to make it work. It's a little bit like the car industry. We could have had a more efficient engine, but what was the financial incentive to do that?

"What will make change inevitable is just the same issue we saw twenty years ago. The appetite for health is insatiable, and the number of people growing older will consume more and more. It means we're just going to have to come up with a different business model."