Experts comment on recent US downgrade in credit markets: Part 3

  By Maureen Aylward

We asked our Zintro experts to comment on the recent S&P downgrade and its impact on the global markets. Clearly the markets are still reeling and shaking. Here is the first in a three part series on the issue as seen from a multitude of perspectives.

Mahesh Kotecha, a capital markets expert and an executive who once ran S&P’s sovereign ratings group, provides the following analysis:

• US Treasury securities have tightened today by five to ten bps, not widened and borrowing costs thus may fall for the US. They may of course rise in the longer term.
• The S&P rating is unsolicited and thus not paid for by the US. “I have a proposal to fix the conflict of interest in the current issuer pay rating agency model that may have contributed to the ratings debacle in the structured finance markets. It is published in Journal of Structured Finance and is on SEC website,” he says.
• Whereas it is true that rating agencies rely largely on public information for sovereign ratings, the value addition is in using public information to reach credit conclusions based on an analysis of the ability and the willingness to pay a particular borrower, taking into account appropriate peer group comparisons.
• The agencies have some access to confidential information as they do hold discussion with policy makers on plans and options. The value of this can vary from country to country and over time. In the US, it may be less valuable than in other countries as the policy makers in the current administration have clearly been unable to make policy due to the gridlock in Congress.
• It is a pity that S&P flubbed it on the $2 trillion issue. “I used to run the sovereign ratings group at S&P and would not necessarily have used such projections in the rating analysis/rationale as the main point is that US has no plan to cut the deficit long term, not that debt will be $2 trillion lower or higher,” Kotecha says
• It is debatable whether S&P is right or Moody’s and Fitch are right on the US rating.

Joshua Feldstein, a market data analyst, thinks the downgrade will adversely affect the US credit market. “Although the downgrade is unprecedented for US securities, these securities still represent the safest haven amidst uncertainties in the European markets, with the European Central Bank printing additional money to cover the debts for Italy and Spain in the near term,” he says. “Theoretically, the Federal Reserve could do the same. The difficulty is not whether we would default, but that buyers of our debt would be paid back with depreciated dollars. S&P put themselves in a box, having announced that the grand bargain in the debt ceiling deal had to be $4 trillion. When the deal fell well short of that figure, they had no choice but to downgrade or suffer the indignity of losing further credibility than they already from their errors in rating structured products that led the financial debacle in 2008.”

Chris Toney, a money market manager, reports that prior to the S&P downgrade there were articles on the major news outlets such as Reuters, Bloomberg, and the Wall Street Journal says that the Bank of New York was telling large clients that it would be charging them a fee to hold their cash. “This was in conjunction with the Dow drop of about 500 points and around the time that the one month Treasury bill during intra-day trading fell into negative territory,” he says. “It was the first time in a few months that people were willing to pay or take zero returns just to leave it in a place and not invest it.”

Toney says that actions like this speak a great deal to what banks and investors fear these days. “The bottom line is that banks are a business. They are meant to churn out profits. The good news is that banks are showing strength in that they can walk away from this type of financing, as unstable or less sticky as it might seem,” he says. “The really bad news is that this type of action is indicative of current liquidity fears and the dangers of a painfully low rate environment.” He points out that S&P’s assessment and eventual downgrade, rightly or wrongly, is its opinion. “It is S&P’s analysis. If one believes the rating is flawed, that calls into question the value of S&P as a research source.”

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Is Pfizer’s sale of Capsugel a sign of future divestitures in the pharmaceutical industry?

Pfizer announced that it is selling its Capsugel business for $2.38 billion in cash to a private equity firm. Is this a sign of potential future divestitures? Is this type of divestiture a trend for the industry?

Kaustubh Dharkar, an international pharmaceutical consultant who has worked with the UN Development Programme in Africa, thinks it makes sense for Pfizer to divest Capsugel, a company in a low technology sector, in order to concentrate on its drug development that can provide much higher returns. “The revenue generated by manufacturing 180 billion capsules is just $750 million, which as a percentage of Pfizer’s annual sales of $68 billion is just one percent. Imagine the resources that need to be deployed in terms of personnel, capital, and, most importantly, time, to generate that one percent,” notes Dharkar.

In terms of market share, Asian companies have a higher share at a lower cost of production. Asian companies, such as Associated Capsules and Universal Capsules, are regarded as the number one producers of high quality capsules at a lower cost. Dharkar feels that it would have been a misjudgment on Pfizer’s part to continue competing with these Asian companies.

Dharkar says that it seems as if this action could be a trend for global pharma giants: to withdraw from low technology, low margin, and high resources segments. “If this is a trend, it could release the capital locked up in these segments, which could be deployed in more profitable areas,” he says. “This is what Pfizer is doing, plowing the funds generated from this sale into buying back its shares.”

The pharmaceutical industry also seems to be rebranding itself as biopharma. According to Dharkar the term biopharma seems to be the latest buzz word for the pharmaceutical sector. “I believe that the term is really being overused by most of the industry. Pharma companies would like to re-invent their businesses, either for the stock market or for stakeholders, and by coining biopharma, it might be trying to do just that,” he says. But, he wonders how many of these companies will actually do the necessary research in the true biopharma sphere.

Slaveyko Djambazov, a healthcare CEO in Bulgaria who specializes in pharmaceutical market evaluation and research, makes the patent case, saying that as the patent cliff approaches, the big pharmaceutical companies are headed towards divestitures. “Really big pharma started to invest in biotech in recent years: Roche, Novartis, Eli Lilly, Sanofi-Aventis, Pfizer,” says Djambazov. Biopharmaceuticals are less prone to copying, and he thinks that pharma companies are trying to avoid the patent issues that come with generics (bigger quantities, lower quality, and constantly dropping prices). Djambazov says that rebranding as biopharma may lead toward stronger IP rights and longer business cycles.

Thomas Argentieri, PhD, and a highly accomplished pharmaceutical executive, says there is no question that Pfizer is maneuvering to minimize the impact of the Lipitor patent expiration later this year, a drug that in 2010 represented over $10 billion in sales and 42% of Pfizer’s pharmaceutical revenue. “Many had hoped that Pfizer’s mega acquisition of Wyeth would strengthen its pipeline, but for a variety of reasons, Wall Street is still quite nervous,” says Argentieri.

Not everyone is ecstatic about Pfizer’s recent decision to divest of its Capsugel business, explains Argentieri. “One obvious reason is the lost revenue, but there is no doubt that $2.38 billion will go a long way towards increasing the company’s bottom line,” he says. “I believe the company will look toward divesting other assets, which could include animal health, consumer health, and/or nutrition divisions, each with 2010 revenues of $3.6 billion, $2.8 billion and $1.9 billion, respectively.”

The bigger question, says Argentieri, is if dismantling the business will truly serve to break the cycle of Pfizer’s underperformance or is this latest maneuver by Pfizer simply an attempt to cut its way to short-time profitability.

Jorge Alessandri, an expert in the biotech and pharmaceutical fields, notes that there is a clear trend in pharma companies divesting from assets that are no longer part of the core business. “Last year I worked for a big pharma company that wanted to sell its pharmaceutical factories to concentrate on biopharmaceutical products,” Alessandri says. “Because drug blockbusters are not in the pipeline for any pharma company right now, the trend is to downsize.”

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