Only 40 of the more than 270 publicly traded large-molecule companies are profitable, and the rest must rely on venture capital. Companies without products on the market are having a tougher time attracting funding these days. Up-front payments have decreased about 55% in the past five years, according to Ernst & Young. Money is increasingly contingent on achieving drug-development goals. This strategy might help investors get returns more easily, but it could discourage the kind of risk-taking research that produces real innovation. Indeed, it’s becoming less important for companies to have scientific expertise and more important for them to have “market awareness,” Glen Giovannetti of Ernst & Young’s global biotech unit told Bloomberg.

Investors’ reluctance to fund early-stage biologics firms has hurt the latter’s research and development (R&D) budgets. Companies without products on the market had to decrease research spending by 1% in 2010, according to Ernst & Young. Small biopharmaceutical companies are thus cutting their research budgets just as many traditional pharmaceutical firms are doing. It seems to me that this continuing trend could become a vicious cycle in which small biologics companies keep spending less on research, which in turn prevents them from discovering potentially marketable products that could keep them afloat.

Biopharmaceutical companies do seem to be more innovative than traditional pharmaceutical companies. But it looks like the large-molecule playing field could shrink over time as big companies get bigger and small companies fail. This shift would mirror the evolution of the small-molecule industry. Likewise, market pressures are already making it harder for early-stage large-molecule firms to get R&D funding—and encouraging a conservative approach to research. If the biopharmaceutical innovation engine eventually runs out of gas, what will the drug industry do?

They’re likely to pursue acquisitions, thus continuing the trend of the past few years. The burgeoning biopharmaceutical industry shows potential for yet more growth, making those companies tempting targets for small-molecule manufacturers. In public, pharmaceutical executives describe modest acquisition goals, sometimes mentioning price tags of $5 billion or less.

But David Snow, chief executive of Medco Health Solutions, doesn’t take these statements at face value. Any biotechnology manufacturer—even heavyweights like Biogen Idec and Amgen—could be a takeover target, he told the Reuters Health Summit. “You have to become awfully large to be unaffordable—there’s lots of cash, lots of capital out there for acquisitions,” he said, according to Reuters. Drugmakers who are still flush might see biopharmaceutical acquisitions as a safe path through rough seas.

Not so fast. Regulatory approval for these mergers might soon become tougher to obtain. Late last week, Senator Herb Kohl (D-WI) asked the Federal Trade Commission to examine pharmaceutical-industry mergers with care, lest they exacerbate the problem of drug shortages. “[F]ewer drug companies competing in a therapeutic class may lead to fewer prescription drugs being developed and sold within that class,” said Kohl, citing a study by the Government Accountability Office.

He also quoted a Washington Post article on the same topic. A smaller pool of drugmakers means “that when raw material runs short, equipment breaks down, or government regulators crack down, the snags can quickly spiral into shortages,” said the article. Patients would certainly be in trouble if mergers slowed innovation and made drugs harder to get.

So how will drugmakers stay afloat during these turbulent times? They might well need the cunning of Odysseus.

Not at all. In fact, it’s been a resounding failure, according to an analysis by Burrill & Company. Acquisitions have not improved Big Pharma’s pipelines. The industry now produces roughly the same number of new drugs annually as before, even though it’s spending more money on research and development (R&D). To add insult to injury, small drug companies are producing a growing share of new drugs—and doing it more cost effectively than their bigger competitors.

Acquisitions have translated into financial losses, too. Ten years ago, “the combined market capitalization of 17 of the industry’s most active acquirers was $1.57 trillion, excluding Johnson & Johnson,” according to Burrill & Company’s research. “By Dec. 31, 2010, that figure had shrunk to $1.04 trillion, a loss of more than $500 billion in market value.” The picture is worse when you subtract the value of these companies’ acquisitions: about $425 billion. That adds up to a loss of about $1 trillion.

Mergermania has been profitable for law firms, banks, and investors, though. In one three-month period in 2009 alone, pharmaceutical-company mergers and acquisitions yielded $500 million in advisory fees for investment banks, The Wall Street Journal reported. Merger activity provided banks, such as J.P. Morgan Chase, Goldman Sachs Group, Citigroup, and Morgan Stanley, with much-needed business at a time when the financial sector was struggling, according to Pharmaceutical Technology Europe.

Maybe Big Pharma’s advisors are steering it in the wrong direction, but I think the industry’s best hope is in R&D. If small companies can do it, and if the National Institutes of Health is offering its help, I don’t see why Big Pharma can’t improve its pipelines and secure its profitability by discovering more new drugs.

New Jersey’s pharmaceutical workforce has shrunk as a result of mergers and flagging sales, and observers are searching for a tonic to give the industry new life. One necessary strategy is to form partnerships with international investors or other drugmakers, said David Finegold, dean of Rutgers University’s school of management and labor relations, at the EU–NJ Business Forum. Investors in South Korea, India, and China are putting a lot of money into the industry, but they don’t have people with experience in gaining FDA approval for their products, Finegold said, according to The Record.

Finegold’s model of choice is the partnership between Merck & Co. and the Wellcome Trust medical charity, which is based in the United Kingdom. The partnership aims to prevent diseases that affect poor countries by developing new vaccines and optimizing existing vaccines. Merck and the Wellcome Trust invest equally in the partnership and share decision-making responsibilities.

The partners run the venture like a business, but according to a not-for-profit model, which is a foreign concept to most drugmakers. Yet the pharmaceutical industry will have to get used to this idea. To survive, firms will have to abandon their high profit-margin business models, Finegold said.

Give him credit for trying to get risk-averse drug companies to adopt new and creative ways of thinking and operating. Although Finegold’s recommendations could help stimulate the industry, I wonder whether they would increase domestic employment. The Merck–Wellcome Trust partnership, Finegold’s template, is based in India. An ideal business model would foster international cooperation, create domestic jobs, and encourage the development of needed therapies. If nothing else, Finegold’s remarks will help start discussions that could lead the industry toward this ideal.

So it’s back to discussions and, indeed, the discussions are continuing.

“These discussions have focused on potential terms for a negotiated transaction and have included the possible use of a contingent value right relating to alemtuzumab as part of any potential resolution of differences with respect to value,” said the Genzyme statement.

However, this doesn’t mean the deal will go ahead as Genzyme emphasizes that it can “provide no assurance that these discussions will continue or will result in a transaction”.

A statement from Sanofi also revealed that the companies were in discussions about the value of Lemtrada, an experimental multiple sclerosis drug. However, Sanofi also added: “There remain significant differences on the terms and conditions of the potential Contingent Value Right (CVR) and the value of our offer, and there is no guarantee that the parties will come to an agreement.”

Mid-week, Sanofi also said that the European Commission had cleared the proposed acquisition unconditionally under EU merger rules.

So now Sanofi just needs to actually acquire Genzyme. There’s been talk for some time in third-party media sources that Sanofi may up its bid and this week is no different. According to a piece in Le Figaro Sanofi may go as high as $76 per share. This has not been confirmed by Sanofi, but it’s possible that the company may have to bid even higher if it really wants Genzyme. According to Reuters: “An improved offer of an extra cash top-up plus a CVR would probably not surprise investors — but $76 would likely be viewed by many Genzyme investors as being on the low side.”

Genzyme shareholders don’t like sanofi’s offer and are unlikely to pressure CEO Henri Termeer to accept it. sanofi should offer more money, Fabrice Seiman, portfolio manager of Lutetia Capital and a Genzyme shareholder, told The Wall Street Journal. A fairer price would be $75–80 per share, Seiman said.

Genzyme’s shareholders are not the only ones to consider sanofi’s bid too low. “Investors value Genzyme higher than the current offer from sanofi,” Michael Obuchowski, chief investment officer at First Empire Asset Management, told Bloomberg. sanofi may be alone in considering $69 per share a good price.

A disagreement about the value of Genzyme’s efforts to correct manufacturing-quality violations at its Allston, Massachusetts, plant has prevented the companies from agreeing on a share price. Nor have the companies seen eye to eye about the potential of Campath, a new product that Genzyme wants to market to treat multiple sclerosis.

An acquisition could be a boon to sanofi, which will soon face generic competition for major products such as Plavix and Taxotere. Buying Genzyme would help sanofi develop a pipeline of biopharmaceuticals and establish its position on the increasingly important large-molecule playing field.

Because no alternative bidder has emerged, sanofi might think that if it bides its time, Genzyme’s shareholders ultimately will give in. I think this is a miscalculation. The shareholders’ consensus has held strong for two months. I don’t see it dissolving during the next six weeks in the absence of a sweeter deal.

sanofi could compromise by agreeing to pay Genzyme compensation according to the future performance of Campath. The companies’ financial advisors recently discussed this idea, but it has not borne fruit so far, according to The Wall Street Journal. Driving a hard bargain might backfire for sanofi, and offering a higher price per share now could keep the company from losing more money in the future.

John Lechleiter, Lilly’s chairman and chief executive officer, told analysts during a conference call that acquiring small and medium-sized companies will continue to be part of the company’s strategy, according to the Indianapolis Star. His audience didn’t seem to be convinced that this plan would work.

“I think the prevailing consensus among investors is that given some of the big expirations that lay ahead, at some point, Lilly will have to do a larger acquisition to fill the gaps,” said Tim Anderson, a drug analyst at Sanford Bernstein, according to the Star. He also suggested that Lilly could seek to be acquired.

Lilly expects a “trough period” to begin in 2014, when several patents will expire before the company can launch new major drugs. Derica Rice, Lilly’s chief financial officer, said that the company plans to pursue growth opportunities in overseas markets to help it through difficult times, according to the Star.

Lilly’s situation is emblematic of the problems Big Pharma faces right now. AstraZeneca (London), GlaxoSmithKline (London), Merck (Whitehouse Station, NJ), and Pfizer (New York) all face patent expirations in the coming years. Companies have tried to remain profitable by cutting costs and laying off employees. We’ve also seen Pfizer gobble Wyeth (Madison, NJ) and sanofi-aventis (Paris) pursue Genzyme (Cambridge, MA) to gain access to new drugs and increased revenue. And Lilly is not alone in trying to find new and emerging markets for its products. But I think these tactics treat the symptoms rather than the underlying problem.

What the industry needs is innovation. Without fresh investment in research and development, companies will not discover new drugs that could become the top products of the future. Of course, discovery and development are difficult processes, and setbacks are common. Lilly itself recently abandoned developmental drugs to treat diabetes and Alzheimer’s disease that had failed to live up to their promise.

Although the development process may be tougher now than before, I think it is still the industry’s best route to profitability. After a while, drugmakers will run out of employees to lay off, small companies to buy, and emerging markets to exploit. On the other hand, patients still have medical needs that could be met with new therapies. Companies that redouble their effort and investment in discovery will be more likely to survive the trying times ahead.

So what’s going on?

There’s a long story behind this potential merger, which PharmTech has already reported on (Novartis Buys Majority Stake in Alcon, Novartis faces legal action over Alcon merger and Novartis cannot force Alcon merger), but it boils down to the fact that Novartis is still 23% shares short of full ownership of Alcon, which currently rest in the hands of minority shareholders.

According to a report from Reuters, Swiss merger law would allow Novartis to push a merger through with the approval of two-thirds of shareholders (i.e. Novartis) and a simple board majority, which shouldn’t be difficult given that Novartis has appointed several directors to the board.

However, Alcon claims that the merger cannot go ahead without the approval of Alcon’s Independent Director Committee (IDC), which was established in 2008 after the Novartis/Nestle deal to “protect the interests” of Alcon’s minority shareholders.

In a statement, Alcon explained: “The Novartis designees have a clear conflict of interest with respect to any decision regarding Novartis’ merger proposal to minority shareholders. As previously announced by the IDC and supported in a legal opinion… the role of non-conflicted directors in related-party transactions is established both by Swiss law and Alcon’s organizational documents. Accordingly, a positive recommendation by the IDC is required”.

And at the moment the IDC still says no because the price Novartis is offering minority shareholders is too low.

“The IDC’s position is consistent not only with Swiss Law and Alcon’s Organizational Regulations, but with widely accepted principles of good corporate governance,” Thomas G. Plaskett, Chairman of the IDC, said in a statement from Alcon.

But Novartis is also convinced that it has the Swiss law on its side. “Merger transaction decisions must be made by the full board and cannot be subject to a veto right by a sub-set or committee of directors. The Alcon IDC’s assertions that IDC approval is required to approve a merger with Novartis is inconsistent with well-accepted principles of Swiss law,” Peter Nobel, Law Professor at the University of Zurich, explained, according to a Novartis statement.

Despite its position, Alcon has also frequently iterated that it is not against a merger. “An agreed transaction is in the best interests of all stakeholders and is clearly preferable to protracted litigation, which would delay critical steps in the integration process,” said Alcon. “However, we are ready to defend the rights of Alcon and its minority shareholders if Novartis refuses to negotiate a fair deal.”

The challenge has been issued, but we may have to wait a while to find out what the outcome will be…

A second reason for the company’s name hogging pharma headlines as of late is the announcement that it will be selling its genetic testing business to Laboratory Corporation of America Holdings (LabCorp) for $925 million in cash. According to the announcement, LabCorp has said it is committed to offering employment to the unit’s 1900 employees upon closing, including senior management.

In other headlines, there’s bad news for other Genzyme employees, however, with reports circling the media that the company intends to lay off 1000 workers. According to the Boston Herald, the cuts represent roughly 10% of its workforce. A blog from Pharmaceutical Executive claims that a Genzyme spokesperson has said that the cuts — planned to occur during the next 15 months — are not related to sanofi’s takeover bid from sanofi. The cuts were apparently reported to stockholders back in May as part of a five-point cost-cutting plan. No official statement is available on Genzyme’s website so it’s unclear exactly which company departments will be targeted.

Termeer’s response came this morning. It can be summed up in two words: nothing doing.

In his letter, Termeer said that sanofi’s offer was identical with one it had made last month, which was not public. Termeer called both offers “opportunistic” and said that they did not “begin to recognize the significant progress underway to rectify our manufacturing challenges or the potential for our new-product pipeline.”

Indeed, days before sanofi’s public bid, Genzyme said it would end rationing of its Gaucher disease drug Cerezyme for US patients in September. If things go according to plan, Genzyme will have begun to convince the industry that its manufacturing crisis is nearly over. Genzyme’s board of directors seems to want to use this good news as a bargaining chip to get a higher offer from sanofi.

Trouble is, sanofi might be loath to sweeten the deal. Cosmetics company L’Oréal and oil company Total own roughly 15% of sanofi between them. They probably will not support an offer above $70 per share, bankers close to those companies told Reuters. Yet insiders say that Genzyme won’t come to the table without an opening offer of $75 per share—and will hold out for a final price of $80—according to Reuters.

What will sanofi’s next move be? According to Bloomberg, sanofi might consider buying Celgene (Summit, NJ) or Allergan (Irvine, CA) if Genzyme refuses to negotiate. But OrbiMed Advisors said that Celgene and Allergan would be more expensive targets for sanofi, and that the report was a ploy to push Genzyme’s price down. On the other hand, sanofi could consider buying Shire (Dublin), which would cost them less than Genzyme.

sanofi’s share price has fallen roughly 19% this year, partly because several of its patents will expire soon. Acquiring a biopharmaceutical company could improve sanofi’s sales and profits. Yet L’Oréal and Total seem to think that acquisitions are not a good strategy for the drugmaker, according to Reuters.

So even though sanofi’s offer is now public, its future, and that of Genzyme, is as clear as mud.