Over the years my experience has covered areas including Mergers and Acquisition, Deal Sourcing and Execution, Feasibility Study, Strategy Planning, Private Equity Fund Management, Project Finance and Budgeting. In response, US companies have had the logical reaction and not repatriated foreign income, leaving that income trapped” in foreign locales. Use debt capacity: One of the enduring mysteries of the drug business, where mature companies have large and stable cash flows from developed drugs, is why these companies do not borrow more to take advantage of the tax code’s tilt towards debt. In the picture below, I look at the aggregate revenues reported by pharmaceutical and biotechnology companies from 1991 to 2014.
R&D is not sacred: In my last post on the drug business, I noted the reduced payoff (in growth) to R&D expenditures at pharmaceutical companies and the unwillingness on the part of these companies to draw back their R&D expenditures. Again, Valeant seemed to be one of the few companies in the business that viewed R&D like any other capital investment and scaled it back, as the payoff decreased.
Quick conversion into earnings: Many acquisitive companies fail at converting great sounding stories into earnings, but Valeant seemed to be exception. Distribution network: The distribution and sale of drugs is different from most other conventional businesses, with doctors, pharmacies and insurance companies all operating in constrained environments, with the constraints becoming more binding with changes in health care laws. The Valeant story reinforces many of my existing biases against companies that grow primarily through acquisitions.
Thus, doctors are asked to consider the relative prices of drugs when writing prescriptions and pharmacies are under pressure from insurance companies to consider cost when filling these prescriptions. As I read the news stories about the pharmacies controlled by Valeant, my suspicion is that the company used this convoluted network (see the picture below from the Globe and Mail about Valeant’s holdings) to extract higher prices through to insurance companies and patients, rather than as device to cook its accounting books. In 2014, biotech companies accounted for 30.63% of total revenues at drug companies, up from 19.23% in 2010.
I am willing to concede that this strategy can pay off, if companies maintain discipline, but my experience with these companies is that they inevitably hit a wall, either because they become too large to stay disciplined or because the accounting creates too many opportunities to obfuscate and hide problems. The pharmaceutical companies at the time were cash machines, built on a platform of substantial up front investments in research and development.