Drug Maker Will Rise from Its Sick Bed

06/20/2007 12:00 am EST

Focus:

John Christy

Founding Editor, Forbes International Investment Report

John H. Christy III, editor of the Forbes International Investment Report, says GlaxoSmith Kline will recover from the recent bout of selling amid concerns over its diabetes drug Avandia. 

Wall Street’s relentless pounding of GlaxoSmithKline (NYSE: GSK) continues without mercy. What began with a skeptical article about its diabetes drug Avandia in the New England Journal of Medicine last month has turned into an all-out assault, lopping a staggering $16 billion off the British pharmaceutical company’s market value in the span of just a few weeks.

Granted, this isn’t something to be taken lightly by either the investing or medical community: Avandia is a $3-billion-a-year drug—one of Glaxo’s best sellers. And patient safety is obviously a paramount concern. But the market’s reaction in this case seems wildly overblown given the shaky nature of the NEJM article’s findings and the strength of Glaxo’s business as a whole.

The study’s approach, a so-called “meta” analysis, found that patients taking Avandia have a 43% greater risk of heart attacks. Problem is, this type of analysis is good at throwing up potential red flags, but it isn’t a rigorous way to test the safety of drugs.

What’s more, the study showed that although the relative risk of developing cardiovascular problems was higher, the absolute incidence of heart attacks and death was extremely small.

None of this is meant to say that the NEJM study is without merit. Indeed, such studies and experiments—even when the methodology is less than ideal—are a key pillar of the scientific method.

But the stock market’s reaction is a different story. Memories of the Vioxx mess that torpedoed Merck’s shares a few years ago are still fresh. So, traders [were] quick to push the Sell button and ask questions later.

But this reaction shows all the classic signs of “herd” behavior. We saw many of the same things unfold in the wake of Merck’s bad news on Vioxx, albeit with a much more dramatic plunge in the stock price. Still, Vioxx didn’t put Merck out of business, and it seems highly unlikely that Avandia will be the undoing of Glaxo.

One of the reasons I recommended Glaxo in the first place was for its well-diversified portfolio of existing drugs and its rich pipeline of new ones. Although the Avandia setback isn’t great news, it’s not the end of the world.

GSK was a cheap stock before, and the recent panic has only made it a more compelling value at 12x earnings. (The stock closed at around $52.50 Tuesday—Editor.) You also get paid a nearly 4% dividend yield while you wait for cooler heads to prevail. When the shouting is over, we’ll be left with a fantastic buying opportunity for a very reasonably priced company.

The picture may look a little bleak now, but I wouldn’t be surprised if GSK turns out to be one of our biggest winners a year or two from now.

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