The last few years have witnessed the advent of a highly disruptive business model within the heart of the pharma world that fundamentally reconsiders the manner in which R&D is conducted and, as such, we have seen the rise (and sometimes fall) of a new breed of companies that some commentators have dubbed “growth pharma.”
“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…”
Aswath Damodaran, Stern School of Business
Instead of placing vast investments to develop drugs in-house, these entities tend to short-circuit the conventional R&D process and buy their way straight to the top by acquiring other people’s drug development pipelines thus largely avoiding the uncertainty of developing new drugs and the associated regulatory risks.
The most notable example of this modus operandi was former McKinsey consultant, Michael Pearson’s transformation of Valeant Pharmaceuticals into a close to USD 90 billion colossus by letting others do the research, buying up undervalued discovery pipelines and focusing instead on shrewd pricing and distribution.
“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… the central focus of its acquisition strategy was buying companies that owned the rights to under-priced drugs and re-pricing to whatever the market would bear in a exercise known as price-gouging,” explains Aswath Damodaran, professor at the Stern School of Business.
“Most large pharma companies still invest heavily in in-house R&D though they may accumulate other’s pipelines by integrating young firms or signing royalty deals with them, but Valeant handled the problem of falling returns on R&D differently, by all but eliminating it… in that sense it was not a drug company in the classic sense, but rather what could be described as a pragmatic shopper,” agrees Ronny Gal of the research agency, Sanford C. Bernstein.
Executive vice president of Public Affairs at PhRMA, Robert Zirkelbach’s assessment is strikingly similar. “Much like Turing, Valeant Pharmaceutical’s strategy has been more reflective of a hedge fund than an innovative biopharmaceutical company. Both Turing and Valeant behaved as platform companies that systematically make acquisitions in order to increase their own value and could be compared to special purpose acquisition companies, that are shell entities created purely for the purpose of buying other companies.”
“The business model was essentially to hunt aggressively for firms with proven products already on the market, preferring low-profile therapies over major household names, deploy cheap debt to acquire those firms, then to slash their costs, particularly in R&D, jettisoning underperforming products and jacking up the prices for the performing ones,” recalls Fortune’s James Surowiecki. “However, this slash-and-burn approach was always likely to fall foul because it depended on the idea that Valeant alone was smart enough to recognize and exploit the drug industry’s low-hanging fruit,” he adds.
While Valeant would ultimately get caught up in serious pricing scandals to the point where it needed to restructure and rebrand, it nonetheless managed to spur the creation of a whole host of copycat outfits like Endo and Turing and the basic premise of ‘Growth Pharma’ remains very much alive.
“Growth Pharma companies grow their drug pipeline inorganically by means of continuous acquisitions. To some extent, their approach is closer to that of a deal-making company specialized in the Pharmaceutical industry rather than that of a pharmaceutical company. Valeant and Allergan are two of the most well-known exponents of this model. Despite both being highly M&A-intensive and relatively adverse to R&D, they still show differences in the intensity of their approach. Whereas Valeant opted for a more aggressive model cutting costs to the absolute bone, Allergan maintained R&D expenditure to fuel a certain level of organic growth capabilities. All in all, we can now talk of a new mapping of the pharmaceutical industry that includes this type of actor,” write HEC’s Marta Emilia Colomar Roig and Nicolás de la Flor Julián.
Indeed, Allergan, Mallinckrodt, Mylan and even Teva can all, to varying degrees, be said to be pursuing a mode of R&D-poor, but aggressive M&A trajectory. “Companies that grow primarily through acquisitions will always attract negative publicity when you’re dealing with a socially sensitive domain like health products… while Valeant’s radical attempt at creating a new model for a drug business may have crashed and burned, that does not make the traditional pharma model a success either. The search has to go on!” concludes Aswath Damodaran.
Writer: Louis Haynes