Big Pharma’s Bribery Blues

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Big pharmaceutical companies have a knack for getting into trouble with governments. Over the past four years, major names in big pharma - including Pfizer (NYSE: PFE), Novartis and GlaxoSmithKline (NYSE: GSK) - have been fined billions of dollars in the United States for giving physicians kickbacks and perks to promote off-label marketing.

This month, charges of bribery have surfaced in China. The Chinese government is currently investigating GlaxoSmithKline for allegedly running a “bribery web” that drew in government officials, hospitals and doctors to boost sales and prices since 2007. Other companies, like AstraZeneca (NYSE: AZN) and UCB, have also been questioned by authorities. Should investors in these companies be worried?

The shadows of the past

In the past, other major pharmaceutical companies have paid hefty settlements related to foreign bribery.

Pfizer agreed to pay a $60.2 million fine last August, after the SEC accused the company of paying millions of dollars in bribes to doctors and foreign officials in China, Italy, Eastern Europe and Russia. In China, Pfizer purchased lavish vacation and entertainment packages for doctors who prescribed large amounts of its drugs to patients - a similar strategy that the company used in the United States to encourage off-label marketing. In Croatia, government doctors were given a cut of the sales from Pfizer drugs.

Last December, Eli Lilly & Co. (NYSE: LLY) paid a $29.4 million settlement to the SEC amid allegations that the company’s employees bribed officials in China, Brazil, Russia and Poland to win business. In China, Lilly was engaged in the same behavior as Pfizer - falsifying expense reports to cover up spa treatments, lavish gifts and cash payments to government doctors.

A new kickback conundrum

Therefore, it wasn’t surprising when Chinese authorities, who had recently been cracking down on corrupt government officials and their ties to large companies, came down hard on GlaxoSmithKline.

GSK’s troubles in China started after Chinese investigators raided a travel agency in Shanghai and discovered contracts and travel invoices apparently intended to help GSK curry the favor of government officials, hospitals, doctors and foundations. Although the documents appear to be legal, the Chinese government alleges that the invoices, which include hotel bookings and airline tickets, are evidence of a web of kickbacks and bribes similar to those that Pfizer and Eli Lilly were fined for last year.

Gao Feng, the head of the Chinese government’s fraud unit, claims that the travel agencies were being used as fronts for GSK’s bribery network, which provided cash and sexual favors for doctors in exchange for promoting GSK sales. Feng claims that the network included 700 middlemen and travel agencies funneling bribes worth more than 3 billion RMB ($488.8 million).

GSK then allegedly used its dominance in the market to raise drug prices by up to 30%, according to Liang Hong, one of the four detained GSK executives. GSK’s official statement claims that “certain senior executives who know our systems well appear to have acted outside of our processes and controls which breaches Chinese law.”

Meanwhile, AstraZeneca and UCB also disclosed that they were being questioned by police in Shanghai. Although AstraZeneca claims that this is a separate investigation from the GSK scandal, an employee is currently being detained by investigators.

Just like its industry peers, AstraZeneca has had a spotty record with regulators. Three years ago, the company was fined $520 million by the U.S. Department of Justice for kickbacks and illegal marketing for its blockbuster schizophrenia drug, Seroquel. Last December, the EU fined the company $69 million for blocking the entry of cheaper rivals to its bestselling ulcer drug, Losec.

Are the markets underestimating China’s importance?

Despite all this drama in China, shares of GSK and its peers haven’t plunged, since its revenue in China only accounted for 3.8% of its top-line in fiscal 2012. By comparison, China accounted for 5.4% of AstraZeneca’s 2012 sales. Shares of GSK and AstraZeneca are still up 11% and 9% over the past twelve months, respectively.

According to estimates from Kepler Capital Markets, GSK would only need to pay a fine between $5 million to $10 million if found guilty - a slap on the wrist for a company that generated $40.6 billion in revenue in 2012. However, the damage to its reputation in the country would be much more costly.

That doesn’t mean that it would be wise for GSK investors to neglect China, however. China’s pharmaceutical sales are forecast to rise 15% to 18% annually through 2016, according to research firm IMS Institute for Healthcare Informatics. To address that rising demand, GSK tripled its Chinese sales force to more than 4,000 over the past three years.

In other words, declining sales in China won’t immediately hit GSK’s top and bottom lines, but it will throttle its ability to grow over the next few years. That’s why investors in these companies should carefully follow the unfolding bribery scandal, as well as the price fixing investigation that started earlier this month.

The Foolish Bottom Line

Pharmaceutical companies have long considered massive fines, lawsuits and settlements to be the “cost of doing business.” However, investors need to be aware that the investigations in China could have long-term consequences for the entire industry. Pfizer and Eli Lilly, which were fined by the U.S. government, might have only been the opening act for a global crackdown on Big Pharma's controversial business practices. This could cause Big Pharma’s growth to hit a ceiling if this unfavorable perception leads to more compulsory licensing by governments in emerging and developing nations, which could dampen the sales of patented drugs worldwide.

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Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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