A Shot in the Arm

By Unmesh Kher

In the annals of pharmaceutical fumbles--and there have been some real doozies--the flu-vaccine shortage of fall 2004 occupies a special place. That crisis began when California biotech company Chiron was forced to dump 48 million doses of its flu vaccine, nearly half the U.S. supply.

Reason: British health inspectors had detected bacterial contamination at Chiron's plant in Liverpool, England, and shuttered the facility. Grumpy lines formed at clinics across the U.S., and angry investors pounded the stock, while profits sank. As if that weren't bad enough, Chiron closed another plant in Germany last July for similar reasons. That closing didn't affect the U.S. vaccine supply, but it didn't exactly reassure investors.

Chiron's incompletely recovered operations contributed to a fifth consecutive year of initial vaccine shortages this flu season. But its largest shareholder, Swiss drug firm Novartis, did not dump its stake in the company. Quite the opposite. Novartis CEO Daniel Vasella decided to buy for $5.1 billion the 58% of Chiron that Novartis does not own, and the Federal Trade Commission approved the deal last month. But the California hedge fund ValuAct, which owns 5% of Chiron, has announced that it intends to vote against the deal, calling Novartis' $45 per share offer "tantamount to stealing the company." Vasella, however, believes that Novartis, with its deep pockets and tight quality controls, is ideally positioned to clean up Chiron's mess, expand capacity and exploit its trove of intellectual property. Says Vasella: "When you have 42% ownership, you can't be a passive investor."

It has been a long time since drug firms were this excited by vaccines. For one thing, the margins typically stink; government intervention has traditionally kept prices low. Manufacturing is complicated, tightly regulated and expensive. And there's the constant threat of lawsuits. All this explains why today only five of the large drug firms make vaccines, down from 26 in 1967.

Yet vaccines have lately begun to look more promising. Wood Mackenzie expects the market to grow from $9 billion in 2004 to $13 billion by 2009. Why? Ironically enough, Chiron's 2004 snafu had a bracing effect on Capitol Hill. Beset by fears of a possible bird-flu pandemic, Congress last month approved $3.8 billion for flu-pandemic preparation, most of it earmarked for buying vaccines and medicines. The defense appropriations bill carrying the provision also controversially provides vaccine manufacturers with a virtually airtight shield from liability.

Although Chiron has won a $62.5 million government contract to develop a vaccine against the currently dreaded H5N1 bird flu, which has killed scores of people in Asia, Vasella says the pandemic scare isn't what drove his decision to buy the firm. He points out that there's still a lucrative market for new vaccines against viral and bacterial infections that afflict developed nations, like meningitis and, yes, the flu. "New vaccines for diseases prevalent in developed countries could be priced very differently," he says. And scientific advances, he adds, may soon make it possible to treat a range of diseases, like cancer, with vaccines.

There are other benefits to buying Chiron that Vasella doesn't mention. "One of the reasons that the big pharma companies stay in the business is because it does give you access to the very highest levels of government," says Sanford C. Bernstein analyst Geoffrey Porges. "You are perceived as someone who is solving a problem." That's an image any drug company would be happy to buy.