Moody's Musings.

Surprise! I bet you thought Moody’s Investors Service rated only bonds and other arcane Wall Street instruments. In fact, Moody’s also evaluates specific sectors of our economy and renders its famous score on a host of individual pharmaceutical companies. I think you’ll find my quick review of Moody’s outlook on the U.S. drug industry to be of interest.1 It should come as no shock to us that Moody’s says, “The outlook for the U.S. pharmaceutical industry is negative. This outlook expresses Moody’s expectations for the fundamental credit con ditions in the industry over the next 12–18 months.”1 What’s behind this gloomy point of view? I would like to explain the reasons and then discuss some future trends. Moody’s has actually maintained this opinion of our nation’s pharmaceutical sector since October 2007. Moody’s believes that the industry is now in a period of unprecedented uncertainty—the result of several factors, such as the expiration of patents in the next four years, hurdles facing the Food and Drug Administration (FDA), rising pressure from shareholders, merger and acquisition activity, and the potential for more radical shifts in the business model. I was surprised to learn that Moody’s gives individual ratings to individual global companies within the pharmaceutical sector. These ratings look a lot like the service’s famous bond ratings; in this case, they range from Aa to B3. For instance, Johnson & Johnson gets the highest rating (Aa), but Elan gets the lowest (B3). Remember, these ratings are only for major branded pharmaceutical companies throughout the world. I found it interesting that Moody’s went out of its way to cite formularies as a significant factor in the unfavorable ranking for the industry. The service cites the launch of several drugs that have performed below market expectations, in part because of formulary restrictions adopted by managed care organizations. I was ambivalent about this aspect of the report, in that I was pleased to see that formularies were indeed a part of the conversation but dis appointed that Moody’s decided to cite the actions made in regard to the formularies as a negative component affecting this sector. Another surprise was Moody’s mention that although the current state of the industry is generally characterized by strong balance sheets and high levels of cash and investments relative to debt, much of this cash has accumulated in off-shore locations. Moody’s believes that this migration of cash to sites outside the U.S. is a detrimental phenomenon. In the past several years, cash needs in the U.S. (i.e., dividends, repurchases, acqui-