Ties Can Bind Generics

Despite a healthy 2006 and anticipation for a strong 2007, generic-drug companies still must be vigilant about managing growth.

Make sure your eyes aren't bigger than your stomach when contemplating acquisitions, or you could gag on debt, say credit-rating firms. Don't make deals just to get bigger, or you'll be stuck with extra costs without extra strategic advantages, equity analysts warn.

Generic-drug makers generally use acquisitions to reach foreign markets, where manufacturing costs are lower and where potential sales growth is faster than in the U.S. Big deals are tempting because the generics industry is consolidating and because companies don't want to be outdone by competitors.

"There's peer pressure," says Arthur Wong, a credit analyst at Standard & Poor's. Although acquisitions can improve manufacturing scale, "size doesn't get you all that much," he says.

To prove his point, Wong says four companies tracked by S&P have credit ratings within one notch of each other, even though their market capitalizations range from $2.7 billion to $29 billion. "It's a commodity business," says Wong, adding that there won't be any "breakaway winners" in the near future.

However, there will always be buying opportunities, and the biggest lure is the generic-drug business of Germany's Merck KGaA. The drug and chemical conglomerate put its generics division up for sale in January, and it's expected to select a bidder this month.