Challenges Surround GlaxoSmithKline

As Big Pharma companies have stumbled in recent years, GlaxoSmithKline(GSK) has been a virtual fortress for drug industry investors.

Look at stock activity at various intervals -- two years, one year, six months and three months -- and you'll see that GlaxoSmithKline has outperformed the Amex Pharmaceutical Index of Big Pharma stocks at every turn except the three-month period. In all but the two-year time frame, the company has also outpaced the S&P 500 index.

Now, however, a few cracks are appearing: A suspension of testing on a multiple sclerosis drug, a long-running dispute with the Internal Revenue Service and a U.S. investigation into Medicaid pricing are viewed by analysts as probably small chips in the fortress. But the recent seizure by the U.S. government of two products because of manufacturing problems could represent a full-fledged fissure.

Suddenly, GlaxoSmithKline -- the second-largest seller of drugs in the U.S. -- looks a bit less solid: Two investment-banking firms downgraded the stock recently.

"We believe that the story of manufacturing deficiencies ... is far from over," says Kevin Wilson of Citigroup Smith Barney in a March 21 report to clients, as he cut his rating to hold from buy. "We believe FDA will be very tough, given the company's apparent failure to deal with four warning letters."

Although the products accounted for about 3% of corporate sales last year, manufacturing quality disputes with the Food and Drug Administration can be expensive beyond the cost of lost sales. Just ask Schering-Plough (SGP): Its constant failure to improve manufacturing practices at two plants metastasized into a $500 million fine in 2002.

Some Good Signs

The unsettling news comes at a time when GlaxoSmithKline is outshining giant U.S. rivals such as Merck(MRK) and Pfizer (PFE) by offsetting patent expirations on big-revenue drugs with new products and promising experimental products.