A Head-Spinning Reversal of Views on Valeant-Allergan

In late April, Valeant Pharmaceuticals, a company domiciled in Canada, but managed in the U.S., extended an offer of approximately $45 billion for Allergan, the company that makes Botox and a range of other products, especially in vision care. Within a month's time, Valeant raised its offer twice, first to the $47 billion range and then to approximately $53 billion. 

By itself this dance of offer, rejection and higher offers represents standard fare in the world of mergers and acquisitions. What appears unusually interesting here, however, is that within this same span of a few weeks, attitudes in both pharma and the investment community made a radical turn from mild approval to complete revulsion. 

By and large this disdain for Valeant taking over Allergan was not based on unfavorable views of the former's price offer or terms. Instead, people in pharma and even some investment analysts came around to expressing their contempt for Valeant's entire business model and its effort to sacrifice a successfully operating pharma company to a pattern of destructive, short-term greed.

When the offer first became public in April, some analysts warmed to the idea and made the point that while Valeant would have to raise its offer, they approved the general idea of it buying Allergan as something favorable for shareholders. Citigroup's Liav Abraham was typical here when she wrote on April 22:

"Valeant and Pershing laid out a persuasive argument for why a Valeant-Allergan combination would be compelling to the shareholders of both companies."

Then something happened. Seasoned observers within pharma started pointing out that Valeant is a pharmaceutical company that prides itself on doing no R&D even as it operates with just pedestrian, bare bones marketing.

Valeant represents the extreme prototype of a finance-directed pharma that acquires its products by buying the companies that own them, then milking those assets for whatever market life remains. As opposed to developing new products when the old ones lose their marketability, the scheme calls for buying another batch of companies and then milking those products. Presumably the process would continue into perpetuity.

Even more galling to pharma veterans is the fact that Valeant was not about to poach some decrepit pharma company to feast on its moribund products. Allergan is a company that does a commendable job of researching and developing new compounds and marketing them with innovative flair. Botox, for example, was developed for the rare conditions of cervical dystonia (wry neck) and optical blepharospasm (involuntary, spasmodic eye winking). The company succeeded in making it a blockbuster as a cosmetic application for reducing wrinkles, but Allergan didn't stop there. It went on to obtain 25 additional indications for Botox involving such uses as limb spasticity, preventative treatment of migraine headaches and relief of urinary incontinence.

Allergan also maintains vigorous franchises in eye care (including products for glaucoma and dry eye, and pipeline compounds for macular degeneration) as well as dermatology (psoriasis and acne).

In other words, Allergan has done what good pharmas are supposed to do while maintaining a commendable, net operating margin of approximately 30%. If a pharma company that does good work and turns a handsome profit can get swallowed in the destructive maw of finance, then the industry's very existence as a sustainable venture comes into doubt.

It didn't take long before some observers started seeing the wolf at the door. On June 2 Seeking Alpha discussed how Valeant had earlier acquired another pharma/vision care company, Bausch & Lomb, and quickly put it into negative growth.

The following day the same analyst wrote that Valeant's stock, some of which it was using to make the purchase, "is hugely overvalued" as the result of an accounting sleight-of-hand.

Within a span of several days a wider range of media outlets started looking critically at Valeant. On June 10 the Wall Street Journal's pharma beat reporter, Jonathan Rockoff, together with Dana Mattioli, tried to give Valeant's CEO, Michael Pearson his due, but the company's scorch and burn approach came through. The former CEO at Teva, Jeremy Levin, told the Journal, " 'Valeant will eventually run out of things to buy and once it does, it faces the problem of how does it keep on the trajectory. A company without R&D short-term and mid-term can be viable, but [not] long-term.' "

Then the New York Times Dealbook chimed in with the reproachful line, "Nobody really knows if Valeant Pharmaceuticals is doing anything that makes money, or is just engaged in prestidigitation that never gets anywhere."

Perhaps the most trenchant criticism of Valeant came from Forbes' Matt Herper. His piece bore the headline, “Valeant Pharma’s Arguments About Drug Research Are Misleading And Wrong,” and then proceeded to make the following point.

“[Valeant’s] treatment of figures relating to the industry’s R&D productivity is so indefensible as to beg the question of whether its executives can really command the facts they are using, or whether they really understand the trends on which they say they are basing their business.” 

Yet despite all the indignation, Valeant is just the ultimate extension of the short-term, finance-driven approach to management that has overtaken not only pharma, but other sectors as well.  

The point was well made about the auto industry a few years ago by Bob Lutz in his memoir, Car Guys Versus Bean Counters. At various times, Lutz was the number two officer at all three U.S.-based auto companies and his book offers a blistering attack on a finance-dominated approach to managing any manufacturing industry.  

Lutz makes the central point that the finance-dominated culture that came to rule Detroit actually held little regard for cars or customers. Both were seen as merely the incidental means of obtaining financial processes that provided the purpose and satisfaction of the business. According to his assessment: 

"[The finance culture created a] generalized consensus that we were, after all, primarily in the business of making money, and cars were merely a transitory form of money: put a certain quantity in at the front end, transform it into vehicles, and sell them for more money at the other end. The company cared about 'the other two ends'—minimizing cost and maximizing revenue—but assumed that customer desire for the product was a given."

Substitute "pills/topicals/injectables” for “cars” and that’s where pharma is heading. Valeant is merely the ultimate, perverse extension of that trend.  

A branded pharma company that does no R&D is analogous to a football team that does not run the ball and tackles only occasionally. Both may win in the peewee leagues but not against top-tier competition. Many people in pharma seem to understand that, but the encroachment of finance on most industry operations continues nevertheless. Perhaps they would do well to remember that it didn't work out too well for U.S. car makers.

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