With pharma famine looming, Lilly relying on snack-size deals

Compared with some of his pharmaceutical CEO peers these days, John Lechleiter has his company on a diet.

Instead of using a mega-merger to bulk up before the famine that patent expirations will bring on the industry next year,
Lechleiter has Eli Lilly and Co. burning management fat while looking for smaller companies to munch on.

He’s betting Lilly’s scientists can once again save the company with breakthrough drugs, averting a plunge in profits.

Counting on Lechleiter’s regimen to be right are 12,000 Lilly employees and 3,000 Lilly supplier companies in central Indiana-not
to mention the region’s municipalities, school corporations and charities that benefit from Lilly earnings and donations.

If he’s wrong, Lilly’s stock price could fall so far that other pharma companies might try to gulp down Lilly.

"Right now, we don’t see that size per se conveys unique advantages," Lechleiter said. "We think if we can be innovative,
if we can produce new products from our labs, we can compete at our current scale."

Lechleiter, 55, insists smaller is better for research and development. He’s cut 20 percent of Lilly’s executives in the past
year so that only six to eight layers exist between himself and Lilly’s factory workers—compared with as many as 14 layers
before.

Such cost-cutting moves have helped Lilly put up nice profits recently and pile up nearly $5.5 billion in cash. Since Lilly
has reduced its debt to $4.7 billion, analysts say it now has the financial wherewithal to make a big acquisition—New York-based
Bristol-Myers Squibb Co. has been floated as an idea—if it wanted to.

If it doesn’t, Lilly’s $20 billion in annual revenue will be dwarfed by companies created by a round of mergers proposed this
year.

The combination of two New Jersey-based drugmakers, Merck & Co. Inc. and Schering-Plough Corp., would more than double Lilly’s
sales. New York-based Pfizer Inc.’s acquisition of New Jersey-based Wyeth would create a colossus with revenue topping $71
billion.

Such size yields billions of dollars in savings and, consultants say, could give companies more leverage when negotiating
drug prices with health insurers and government health programs.

But Lechleiter downplays those advantages. He has turned up his nose at indulging in any big-pharma acquisitions. Such deals
have been running at prices north of $40 billion, roughly Lilly’s stock market value. Instead, he’s licking his lips over
companies in the $5 billion to $15 billion range.

"These things just don’t answer the basic question of how does a company become more innovative," he said. Speaking of the
Pfizer-Wyeth deal, he added, "What is it about that combination that’s going to make that merged entity that much more productive
in terms of its research labs and the ability to innovate?"

Faith in history

In a year as Lilly’s CEO, Lechleiter has made several moves to increase Lilly’s productivity. The company now has 61 experimental
drugs in clinical trials and nearly one-third could launch by 2015.

But Lechleiter said one of his biggest fears is Lilly’s pipeline failing to produce. (The other is health care reform, set
for debate in Congress in June. Lechleiter said he has traveled to Washington this year "more often than I ever dreamed.")

Lechleiter takes comfort in Lilly’s history. He counts three other times when the company found new blockbusters right when
its old standbys faded.

In 1982, Lilly had to pull its rising star, Oraflex, off the market due to safety concerns. But Lilly launched the iconic
Prozac a few years later.

When Prozac’s growth stalled in mid-1990s, Lilly came out with today’s bestsellers: the antipsychotic Zyprexa, the biotech
insulin Humalog, the cancer drug Gemzar and the bone medicine Evista.

When Lilly lost its patent on Prozac in 2001, it launched nine new drugs in less than four years, including its current No.
2 seller, the antidepressant Cymbalta.

But now, Lilly needs to replace nearly 60 percent of its revenue it will lose between 2011 and 2014 when patents on Zyprexa
and other top-selling drugs expire.

Wall Street doesn’t have the same faith in history as Lechleiter. Dr. Tim Anderson, an analyst at Sanford C. Bernstein & Co.,
predicts Lilly’s profits per share will plummet 43 percent between 2010 and 2015—the worst of the 10 companies he covers.

That kind of profit loss could send Lilly’s already battered stock price into a tailspin, removing what Lechleiter has called
the best defense against a takeover. When asked if negative events and pipeline failures could force Lilly to sell, Lechleiter
demurred.

"We always look at contingencies and consider multiple scenarios," he said.

But he’s hopeful Lilly’s own research labs will keep such options off the table. The company is answering stricter demands
from insurance companies and regulators by pushing for big innovations, like finding the first effective treatments for such
major diseases as Alzheimer’s and multiple sclerosis.

"Our investors, as you know, are looking at that and saying, ‘OK, I see what’s there, but geeze, it looks risky,’" Lechleiter
acknowledged.

Michael Levesque, a pharmaceutical analyst at Moody’s Investors Service, rates Lilly’s pipeline in the middle of the pack
of 19 drugmakers he follows.

The problem is that Lilly’s looming patent expirations will cost it more than twice as much revenue as its pipeline will produce,
according to Levesque’s forecast. Several other marquee drugmakers have similar problems.

"I wouldn’t be surprised to see one or two more deals happen in the next six to 12 months," said Linda Heitzman, an Indianapolis-based
consultant in Deloitte’s life sciences practice. "The industry overall is under a lot of stress right now."

Shopping around

With Lilly hunting for takeover prey now, its most likely targets are in the biotech and animal health arenas, areas the company
has targeted for growth.

Lechleiter has said he’d like to do more deals like Lilly’s $6.5 billion purchase of New York-based cancer drug developer
ImClone Systems Inc., which occurred in November.

With stock prices depressed and cash reserves for many companies at less than six months, it’s a good time to buy in biotech.

"Their prices are down from where they were a year ago," said Mike Miles, a managing director for Maryland-based investment
bank Riderwood Group. "And there aren’t that many potential buyers."

The trouble is, there aren’t many companies that fit Lechleiter’s preference of $5 billion to $15 billion.

The most notable biotech companies that fall within that range include California-based Allergan Inc., the maker of Botox treatments.
The company’s stock market value stands at $14.4 billion, after being pumped up by rumors it would be acquired by Lilly rival
GlaxoSmithKline plc.

Another potential target could be Massachusetts-based Biogen Idec Inc., with a market capitalization of $13.7 billion. Activist
investor Carl Icahn—who sold ImClone to Lilly—is trying to gain control of Biogen’s board.

Jason Zhang, a biotech analyst at BMO Capital Markets, said Biogen is a likely takeover target because many big pharmaceutical
firms, including Lilly, are trying to boost their investments in biotech drugs, also called biologics.

"It’s the only company left that will give a pharma company access to the biologics," Zhang said.

Icahn also has expressed interest in soliciting a bid from Lilly for California-based Amylin Pharmaceuticals Inc., another
biotech firm with which he’s fighting for board control. Lilly and Amylin co-developed the diabetes drug Byetta. But Amylin
is tiny, and Lechleiter told Reuters he doesn’t share Icahn’s interest.

There are only four other publicly traded biotech companies that fit Lechleiter’s range.

Lechleiter already has made animal health acquisitions and has mused about picking up assets that might be divested by big
drugmakers.

Whatever Lilly buys, it will relate to the company’s existing specialties, such as diabetes and neurosciences, Lechleiter
assured. And it won’t be just to increase in size, he said.

Any purchase will fit with Lilly’s overall strategy of improving outcomes for individual patients by tailoring medicines.
Or it will help the company diversify into new treatment areas or grow in the world’s emerging markets, like China.

"We’re not betting on large combinations with other pharma companies. We’re not betting on some acquisition that has no connection
with what we do," Lechleiter said. "We’re staying, in the main, focused on that pipeline."