The problem with drug companies, according to Valeant ($VRX) CEO J. Michael Pearson, is their insistence on researching new drugs, and the Canadian serial acquirer has developed a replicable strategy under his reign: buy up a company with promising assets, carve up its R&D operation and move on. Now, as Valeant mounts a $53 billion hostile bid for Allergan ($AGN), rivals, analysts and investors are wondering whether the model can survive.
As The Wall Street Journal lays out, Valeant's $2.6 billion acquisition of Medicis, closed in 2012, provides a template. After wrapping the deal, Valeant laid off most of its acquisition's R&D staff and pulled the plug on all but 9 of its 30 ongoing development projects, implementing "a business model that gets rid of the value-destroying part of pharmaceutical companies and keeps all the pieces that are value sustaining," Pearson told the newspaper.
If Valeant succeeds in convincing Allergan shareholders to accept its twice-sweetened offer, it plans to whittle that company's R&D spend down to $300 million a year, from the $1 billion it spent in 2013. Pearson has been steadfast in framing his target as unsustainably committed to wasteful spending, at one point citing an apparently nonexistent company golf course. (In this morning's WSJ, Pearson is depicted in his office, replete with a regulation-height basketball goal and parquet floor honoring his alma mater Duke Blue Devils.)
Deals like the one for Medicis and last year's $8.7 billion buy of Bausch & Lomb have led to short-term jumps in the company's revenue and triple-digit gains in its share price. But, as the New York Times explored recently, Valeant's serial takeover operation has had a murkier effect on profits. Thanks to undisclosed sales figures and a reliance on non-GAAP accounting that ignores the one-time charges related to each acquisition, it's difficult to say whether Valeant is creating any value. Furthermore, all that M&A has run up about $23.4 billion in debt and done little to bolster Valeant's cash flow, the Times reports, leading some to paint the company as a rudderless acquirer only as good as its latest deal.
"Valeant will eventually run out of things to buy, and once it does, it faces the problem of how does it keep on the trajectory," Jeremy Levin, the former Teva ($TEVA) CEO, told WSJ. "A company without R&D short-term and mid-term can be viable, but long-term is not."
That's roughly Allergan's tack. In refusing each of Valeant's high-dollar overtures, the company has consistently said that the buyout would pigeonhole the company into its suitor's restrictive business model, crippling R&D and hamstringing growth. In a presentation to investors last month, Allergan hired a forensic accounting firm to poke holes in Valeant's claims of organic sales growth, questioned its management of Bausch & Lomb and Medicis, and essentially dismissed the company's whole ethos of growth through M&A.
The ideological debate between the two is now likely to be decided by Allergan's shareholders. Valeant has taken steps to mount a proxy fight, offering $72 in cash and 0.83 shares of a combined company per Allergan share, an offer worth about $176 a share at Monday's close. Uncharacteristically, Valeant has also said it's willing to earmark up to $400 million for Allergan's Darpin, an in-development treatment for macular degeneration, and the company wants to add a contingent value right that would pay shareholders up to $25 a share more if the drug reaches its full potential.Bill Ackman
Bill Ackman, the activist investor whose Pershing Square Capital Management is joining Valeant in its hostile bid, said his fellow "largest shareholders" have agreed to accept an offer in the $180-per-share range. Pearson has said he expects to convene a special shareholder meeting as soon as August.