Waters' Back-Up Plan

Lower research and development spending by drugmakers involved in high-profile mergers will hit the pharmaceutical business of analytical tools maker Waters, but it may yet find comfort in the food safety testing market.

If Eli Lilly closes its $6.5bn takeover of Imclone Systems, and Roche succeeds in its bid to buy Genentech, the newly merged firms may lay off overlapping research programmes, combine facilities and outsource drug discovery work.

"Into 2009, pressure on those research and development budgets increase as these companies get swallowed up," Leerink Swann analyst Isaac Ro says.

This could hurt companies such as Waters, which makes instruments used in drug research. "Most believe that the environment will continue to be difficult in terms of trying to sell instruments to pharmaceutical companies," Cowen and Co analyst Doug Schenkel says.

Big Pharma is increasingly turning to mergers to bolster weak drug pipelines that are unable to replace blockuster drugs that go off patent in the next few years.

Lipitor, Pfizer's biggest-selling product, loses its US patent protection in 2011, and Eli Lilly's main cancer drug, Gemzar, loses patent protection in 2012.

Historically, demand slows in the immediate aftermath of a merger, but a reasonable growth rate returns within a couple of quarters, Gene Cassis, Waters' corporate vice president of worldwide business development, says.

Large drugmakers used to contribute about a quarter of Waters' sales in prior years, but their share has since reduced to about 15%, Schenkel says.

Rivals such as Thermo Fisher Scientific and Applied Biosystems are not as exposed to big drug companies as Waters.

Safety in food

One way that Waters – a bellwether of the research-tools industry -– is trying to offset some of this lost pharmaceutical potential is by increasing its market share in the food safety market.

Apart from their use in drug discovery and development, Waters' liquid-chromatography and mass-spectrometry devices are used to identify, separate and measure the composition of chemicals during food-safety and quality-control testing.

This market uses about half of the company's installed mass-spectrometry devices, according to Schenkel.

"They are certainly still exposed to the slowdown in pharmaceutical companies but I would say that they are less exposed than they have been in the past," he says.

Waters' Cassis says while growth from large pharmaceutical companies was flat last year, the company recorded overall growth of 8%.

During the first quarter, Waters' industrial and food safety sales grew 28%, while global sales to pharmaceutical customers grew just 4%.

Emerging markets such as Asia also seem to help. Waters' first-quarter sales in Asia rose 18%.

Strong demand from developing markets, continued expansion of the industrial businesses and sales in the instruments division were cited as key second-quarter growth drivers by CFO John Ornell in a July conference call.

Barclays Capital analyst Anthony Butler says, "As long as standards in emerging markets are moving towards western standards, those markets are growing at the highest rates."