After China, GlaxoSmithKline faces pressure for change

By Reuters

Sep 22, 2014 09:22 AM EDT

GlaxoSmithKline may have closed one chapter in a saga of corruption allegations by accepting a $489 million fine in China, but the drugmaker has its work cut out to win back skeptical investors.

That means continued pressure on Chief Executive Andrew Witty, seen not so long ago as one of the sector's star managers, who is under fire for allowing the erosion of GSK's all-important U.S. business just as much as for the woes in China.

"I think GSK is a buy when the CEO of that business goes," said John Bennett, a director of European equities at Henderson Global Investors, which has a holding in the drugmaker.

Other disgruntled shareholders believe an accelerated change of chairman would be an important signal that the company is acting to address their concerns and working to improve financial returns.

The current chairman, one-time Vodafone chief Chris Gent, is due to step down by the end of 2015 but some argue the handover should now be brought forward.

"A new chairman must be overdue. Someone needs to look at the strategic direction of the business with a fresh pair of eyes," said one top-50 shareholder.

Commenting on plans to find a successor, a GSK spokesman said: "Succession planning for the chairman is well under way."

Replacing the chairman early rather than ditching CEO Witty, who has been in the job since 2008, is seen as a potential compromise to reassure disenchanted investors.


The root of investor unhappiness is not hard to find. While the European healthcare sector has been a roll so far this year, rising more than 20 percent on optimism over new drugs, GSK shares have lost 10 percent as forecasts for its sales and earnings have fallen.

GSK unveiled a far-reaching asset swap deal with Novartis in April that will refocus its business by building up its strengths in vaccines and consumer health, in exchange for exiting the hot area of cancer medicine.

In the long term, that transaction should deliver sustainable growth from more stable and lower-risk businesses.

But the Novartis deal will not close until next year and will take time to bed down -- and even when it does, the new-look GSK is still likely to grow below its peers, according to Goldman Sachs analysts, who believe further meaningful change is needed.

"A new chairman could potentially kick-start this change process," they wrote in a note on Monday, while upgrading the stock to "buy" from "neutral" on hopes for an overhaul. "We believe that status-quo at GSK is unlikely to continue for long."

Potential actions by GSK to address poor investor returns could include further cost-cutting and allocating more capital to acquisitions of promising new drugs, rather than buying back shares. A longer-term option might be to sell off the vaccines or consumer health operations to unlock value.


Friday's news that 15 months of Chinese investigations had been resolved brought some relief as the fine, while a record for China, was less than some investors had feared. GSK's former China head also escaped without going to jail.

But the episode will have a long tail, with the pledges given by GSK to ensure flexible prices and increase investment in local Chinese production likely to drag on profits in the country.

What's more, the group still faces further probes and potential fines in the United States and Britain, as well as bribery allegations in Poland, SyriaIraq, Jordan and Lebanon.

More fundamentally, investors are fed up that profit growth has been delayed year after year and alarmed at the precipitate fall in sales of its 15-year-old respiratory medicine Advair, particularly in the United States where price pressure is acute.

Witty has been banking on new respiratory drugs Breo and Anoro to make up the slack but sales to date have been slow.

Frustration boiled over when the company cut its 2014 earnings outlook in July, triggering the biggest daily share price fall since 2008.

"People have come full circle and the glass is very much half-empty now," said Deutsche Bank analyst Mark Clark, who believes U.S. sales of GSK's top-seller Advair are likely to fall by more than 20 percent both this year and next.

Adding to anxiety is concern about the firm's fat dividend, which at an expected 81 pence per share in 2014 offers a 5.6 percent yield.

The dividend is already equivalent to approximately 85 percent of earnings and that figure could climb to more than 90 percent in 2015 once GSK divests older drugs with annual sales of around 1 billion pounds ($1.6 billion).

Ditching these so-called established products makes long-term sense, since their sales are declining, but they remain extremely profitable, so a sale looks set to dilute earnings per share, tightening dividend cover further.

While most analysts see GSK scraping by without cutting payouts, yield investors are doing the sums carefully.

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