Ann: Market Update , page-3

This announcement may seem just a rational change in accounting policy given the strong move towards risk aversion following the recent financil crisis. However, this may be just the first sign of an overdue impending shake up of the retail pharmacy industry.

A few years back the guarantees that the wholesalers gave against bank loans to pharmacist were considered very low risk and not including the potential contingent liabilties on the balance sheet would not have raised an eyebrow. The only pharmacies that ever went under were where the occasional owner had a gambling problem, other spending vices or felt the weight of divorce settlements and were completely inept business persons anyway. You have to look a lot deeper that today.

There has been a forced change to accounting standards. The banks have determined that a change in API's accounting standard in this area was prudent. The banks and there new analysis of pharmacy valuation has been reported recently in a broad Ferrier Hodgson report into retail pharmacy. I have read it and it is quite provocative to say the least.

It says in a few words that changes to the pharmacy market place over the last few years will have major effects on the banks current assesment and valuation of pharmacies. Principally and the major root cause of course is the Government's generics policy which have reduced and will continue to reduce margins on these products. Secondly, the reduced terms from wholesalers and thirdly the inherent flow on industry effects of the self destructing discount business models. Noted are that the discounting model and its adoption by many pharmacies has been largely suppoted through unsustainable supplier discounting. This has occurred as the generic suppliers ruthlessly fight for market share to position themselves in the market as blockbuster drugs come off patent.

Thanks to government policy all of the wholesalers have also been desperate to maintain market share in a market place where margins are tightening and economies of scale and other efficiencies are becoming more important. Bank guaranties and favoured terms (mainly to rapidly expnding entrapreneurial groups) have been a key elements in the strategy to solicit key accounts.

Well the demand by the API's banker to secure their contingent liability on guaranties should tell us all that we are about to see the banks call in some of these loans to pharmacies. This was predicted to occur in the near future in the Ferrier Hodgson report. Highly leveraged pharmacies that have paid some of the exorbitant prices will be the most at risk as the bankers reexamine their valuations in light of the changing market environment and profitability. If the pharmacist companies and their directors don't have the capital funds to deal with the bankers demands then these businesses or in fact the entire group could go under. Could not happen soon enough in my book as a pharmacist who started a small moddestly leveraged, non discounting, professional service based business that grew successfully by reinvesting some of its own earnings.

The one off $50m charge will be made against API's half years current account. OK it does not impact API underlying operational profitability and I suppose that it is going to occur in a problematical half year anyway. Once all this is out the way and API gets back to normality things may look up.

The next announcement on this front is probably going to come from Sigma if they don't already have guaranties as a contingent liabilities on their balance sheet.

With two very troubled wholesalers in API and Sigma we don't have a very pretty picture at the present time. Things can only get better.....did I hear call for a merger again?