To buy Forest Labs or not

by Daniel R. Hoffman, Ph.D.

The Financial Times reported last week (see here) that a growing chorus of equity analysts has been strongly urging AstraZeneca's (AZ's) new CEO, Pascal Soriot, to buy Forest Labs.  AZ is scheduled to lose U.S. patent protection on drugs that will account for one-third of all its sales by 2019. Meanwhile their research efforts to this point have failed to develop new compounds capable of making up the shortfall.

Forest, on the other hand, has benefitted from both skill and luck to produce what the Times calls "one of the industry’s best pipeline hit rates over the past three years." Analysts at the various investment houses point out a strategic synergy to the acquisition because some of Forest's auspicious new products are in categories such as respiratory therapy where AZ maintains a strong market presence but nothing in pipeline to hold that position.

The advice from these analysts seems reasonable, but the argument for snapping up Forest favors their own interests more than it does AZ's. Rumors about such a deal can help churn a substantial amount of action for the investment houses, generating fees for their brokers, returns for their buy-side clients and other revenues. Trading action is the lifeblood of sell-siders and this fact makes equity analysts even more eager than gossip columnists to build up a star one year and tear him/it down the next (after capital gains apply).

AZ's problems are more fundamental and a quick fix, unaccompanied by a major overhaul, is likely to make things even worse by this decade's end. 

Pascal Soriot recently came to AZ from Roche where the Swiss-based company put him in charge of its U.S. pharma operations in 2009 when they acquired the equity in Genentech they didn't already own.  At the time Roche's Basel managers had a clear strategy in place that led them to merge Roche's U.S. pharma operations into Genentech. It appears that AZ lacks such a fundamental strategy for how it can succeed in the pharma business.

Roche's strategy, formulated almost 20 years ago, called for using its molecular diagnostics unit to develop biomarkers that can guide drug development. As an ancillary strategy they decided to retain other business units such as in vitro diagnostics and devices as long as they continued to generate acceptable operating margins. 

The Genentech acquisition allowed them to pursue two goals simultaneously. One was strategically sound while the other was more a matter of corporate dominance and control. The strategically wise objective was to infuse therapeutic classes outside of oncology with the biotech's innovativeness, morale and fervor. Basel's other intention was to crush the independence of their New Jersey-based American affiliate, an operation they referred to as the "New Jersey Mafia," and make it more deferential to headquarters. As things turned out, Soriot succeeded in castrating and then closing Nutley, while innovation and morale outside oncology withered.

AZ lacks such a coherent strategy.  The company under David Brennan decided to forego diversification and make its way as a pure-play pharma, yet its capability for developing new drugs over the past decade has been extremely poor.  Their implementation of that inadequately developed strategy was even worse. For example, when they decided to buy MedImmune in 2007 for the purpose of adding biotech and vaccine resources, they paid too much ($15 billion) and snuffed out the biotech's innovative culture by putting old Wilmington hands in charge and driving out some top managers.  (See the analysis here, "How Not to Do an Acquisition.")

Forest may have some promising drugs, but unless Soriot can make wholesale changes to processes and senior people at the company, AZ's chances for realizing the commercial potential of those products seem doubtful.  Downsizing and poor leadership have created a highly politicized culture where people in marketing and sales reflexively look over their shoulders. Such an atmosphere instills a fear of taking initiatives or even asking pertinent questions.

As usual in such cases, the problem does not come from mid-management. Line managers in Wilmington, De. are as bright and capable as their counterparts elsewhere. They even possess an advantage over some other Delaware Valley pharmas because AZ does not maintain a chauvinistic, arrogant corporate culture that trades on past glories and vehemently denies that their emperors lack clothes. But the marching orders for large organizations, whether corporations, armies, churches or governments, must come from effective leaders.

So if Soriot decides to buy Forest, he should precede the move with some rigorous planning and high-level house cleaning. That way AstraZeneca will be better off whether he makes the deal or not.