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Sovereign Risk: Why pharma can't afford to ignore it

09 March 2012 Milena Izmirlieva

When German pharma company Merck Serono announced job cuts two weeks ago warning bells sounded through the pharma world. Job cuts and restructuring are nothing new for the pharma industry, of course, but one of the reasons behind Merck Serono’s troubles is a relatively new one.

The company had reportedly accepted Greek government bonds in exchange for hospital debt payments. With hospital payment delays for pharmaceuticals in Greece out of control, accepting the bonds as a government guarantee would have seemed like a good course of action. But in Merck Serono’s case, it backfired. The nominal value of bonds the company received in exchange for the delayed payments was EUR56 million (USD74.1 million), but when Merck Serono sold these bonds, it received substantially less.

End result: job cuts “in all divisions and regions” for a company that has otherwise done comparatively well. It recently gained approval in Europe for Rebif (interferon beta-1a) for wider use in the treatment of relapsing forms of multiple sclerosis and last month the company signed a deal with United States-based pharma firm Threshold to co-develop and commercialise Threshold's small molecule hypoxia-targeted drug TH-302 globally.

The Significance of Sovereign Risk for Pharma

Whilst it is too much to single out the Greek bonds as the only reason for Merck Serono’s job cuts, it had a major impact on its outlook. What has undermined Merck Serono’s performance is Greece’s so called Sovereign Risk – the risk of the government of Greece defaulting on its payment obligations. Considering the government is the main payer for pharmaceuticals in most countries with a public healthcare system, the sovereign risk rating is a major – though often unrecognised – contributing factor to the financial performance of pharmaceutical companies.

IHS Global Insight’s sovereign risk rating for Greece is currently 65 (corresponding to a CCC+ on a generic rating scale). This risk rating places Greece among the countries at risk of possible default, with an “extremely high payments risk.” IHS Global Insight downgraded Greece's Sovereign Risk Rating from 60 to 65 with a negative outlook in October 2011, following previous downgrades from 50 to 60 during the second quarter of 2011 and from 40 to 50 during the third quarter of 2010.

Merck Not Alone in Risk Exposure

It is known that Merck Serono is not the only company to have accepted Greek government bonds – and come to regret the decision. There are clearly lessons to be learned for other pharma companies. Sovereign risk ratings may not have mattered much for Pharma in the past when key markets had a low risk of default. But with its current rating, Greece is now in the company of countries like Congo, Equatorial Guinea, Gambia, Pakistan and Tajikistan – to name a few. If pharma companies have in the past safeguarded their interests in those countries by limiting the quantities of medicines provided on credit, such limits were not normally applied to the more “trustworthy” debtors in Europe.

The debts of the Social Insurance Institute (IKA) and military hospitals in Greece have now approached EUR500 million (USD657.2 million), according to the Hellenic Association of Pharmaceutical Companies (SFEE). The SFEE warned that unless the government intervenes, there is a serious risk of restrictions in the supply of medicines and drug shortages.

Ending Drug Deliveries is Politically Risky

Despite the rhetoric, the pharma industry is so far unwilling to pull the plug completely on drug supplies to Greece – considering the political fallout that will ensue. We already got a taste of that fallout when Swiss pharma giant Roche recently decided to stop supplying drugs in another country at risk of default – Portugal. As of 27 February Roche stopped supplying medicines on credit to 23 National Health Service (SNS) hospitals in Portugal.

The company’s change in drug supply policy was immediately attacked as "ethically reprehensible and illegal" by Portuguese drug regulator Infarmed. Roche was reminded of its legal obligation “to ensure an adequate and continuous supply of the market in order to supply patient needs.” The company’s decision indicated it had had enough. The 23 hospitals in question had, according to Roche, accumulated debts of more than EUR135 million, and deferred payment interest of about EUR6 million, with an average delays in payment of more than 420 days.

We shall see in the coming weeks if Roche is forced into a climbdown or manages to stand its ground. The latter outcome would encourage other pharma companies to follow suit – not just in Portugal, but also in the more controversial Greek setting.

Stay tuned for further updates on the unfolding debt repayment saga. And watch out for those sovereign risk ratings!


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