By Ben Hirschler, European Pharmaceuticals Correspondent
LONDON (Reuters) - Is the "Big Pharma" model broken? An increasing number of people seem to think so.
Institutional investors with more than $1 trillion (500 billion pounds) of assets under management were the latest to call on drugmakers to offer better value to both customers and shareholders in a report on Tuesday.
The critical analysis -- sponsored by Dutch, U.S. and British pension funds and prepared by London consultancy SustainAbility -- follows a report from PricewaterhouseCoopers last week arguing the current business model was unsustainable.
Investors, meanwhile, have been voting with their wallets by dumping shares in a sector that has stumbled badly in recent months after a series of high-profile product setbacks.
Stocks in Europe's two biggest drugmakers -- GlaxoSmithKline Plc (GSK.L: Quote, Profile, Research) and Sanofi-Aventis SA (SASY.PA: Quote, Profile, Research) -- have both fallen 10 percent in the past month following body blows to key drugs that have exposed the innate risks in pharmaceuticals.
Glaxo shares have underperformed the UK market as a whole (.FTAS: Quote, Profile, Research) by 25 percent through the past 12 months, Reuters data shows. The stock trades on around 13 times this year's forecast earnings, in line with the overall market and confounding expectations of the sector's traditional premium rating.
Glaxo's diabetes drug Avandia was linked to increased heart-attack risk in an influential but controversial analysis on May 21, while Sanofi's key obesity drug Acomplia, or Zimulti, was rejected by a U.S. advisory panel on June 13.
Both pieces of news lopped billions of dollars off expected revenues at the two drug giants.
SAFETY SCARES
Worryingly, such upsets are all to familiar. Pfizer Inc. (PFE.N: Quote, Profile, Research) was another big casualty last December, when it lost an all-important successor to top-selling cholesterol drug Lipitor after a clinical trial showed the new pill to be dangerous.
Such safety scares have damaged confidence among the general public and investors, who fear companies have not got the risk-reward balance right within their research labs.
"No company can single-handedly overcome the distrust that many feel toward the pharma sector, and redefining the value of medicine today is incredibly complex," said Scott Streator, director of healthcare at the Ohio Public Employees Retirement System, one of the backers of the new report.
"But balancing pressing health needs and return on investment demands nothing less from all of us."
The "Pharma Futures" report from SustainAbility, which was also sponsored by Dutch-based ABP Investments and Britain's Universities Superannuation Scheme, paints a stark picture of an industry struggling to adjust.
The key challenge is research productivity. In the past 10 years, the amount spent on pharmaceutical R&D has almost doubled, yet the number of new molecules approved by the U.S. Food and Drug Administration each year has gone down.
There needs to be a restructuring of R&D to improve productivity, drive out redundant projects earlier and give a better balance of risks, according to SustainAbility.
At the same time, firms will have to provide evidence of the economic value of more specialised and tailored drugs -- a view echoed by PricewaterhouseCoopers, which predicts the demise of the current strategy of placing big bets on a handful of "blockbusters".
CASH CALLS
Some investors have simply got tired of waiting for company pipelines to deliver and are calling on drugmakers to adopt the strategies of private equity to improve sluggish returns.
Many would like firms to take on more debt or else spin off non-core units -- such as Glaxo's Lucozade, Ribena and Horlicks nutritional drinks business -- as a way to accelerate cash returns to shareholders.
An analysis by Citigroup suggests European drugmakers do have capacity to take on more debt to repurchase shares, but the scope varies widely from company to company.
Citigroup believes Sanofi has the largest opportunity and could buy back shares worth 19 percent of the group's market capitalisation, in a move that would be a significant catalyst for the stock.
But Glaxo already gives back the majority of free cash flow to its investors and could probably return only an incremental 6 percent of its market value."