Valeant CEO Spurns Research for Deals With Cephalon Fight
Stock Chart for Valeant Pharmaceuticals International Inc (VRX)
Valeant Pharmaceuticals International Inc. (VRX) Chief Executive Officer J. Michael Pearson has built the little-known Canadian drugmaker into a stock- market favorite with 21 friendly acquisitions for $1.8 billion since he took over in 2008.
For number 22, his biggest yet, he’s going hostile.
Valeant’s $5.7 billion bid for Cephalon Inc. (CEPH), the Frazer, Pennsylvania-based maker of sleep and cancer drugs, was rejected on April 5. Pearson says Cephalon, which spent 16 percent of its $2.81 billion in 2010 revenue on research, needs to restructure as it faces the loss of sales from its top-selling drug to generic competition next year without a quick replacement.
It’s a familiar refrain from the 51-year-old Pearson, according to analysts. As he has acquired companies, he has gained a reputation for cutting jobs and slashing research funding. He’s tripled Valeant’s stock price in the process.
“R&D is a very risky investment,” Pearson said in an interview. “The odds of you succeeding in that are kind of against you.”
Valeant, which spent less than 6 percent of last year’s $1.18 billion in revenue on research, has soared to more than $50 from less than $15 when Pearson became CEO in February 2008 after 23 years at McKinsey & Co., a management consulting firm that advises on strategy and efficiency.
Cephalon fell 51 cents, or less than 1 percent, to $76.51 at 4 p.m. New York time in Nasdaq Stock Market trading. Valeant, based in Mississauga, Ontario, dropped 42 cents to $51.95 on the New York Stock Exchange.
‘Into Making Money’
“His approach isn’t one that most executives in the drug business take,” Chiang said in telephone interview last week. “He’s even said in past presentations: ‘We’re not into high science R&D; we’re into making money.’ I think that’s why Valeant sort of trades in a league of its own.”
Cephalon is nearing “a very tough 2012,” Pearson said on a conference call last week. Its top-selling medicine, a narcolepsy drug with $1.12 billion in 2010 revenue, faces generic competition in April 2012. Its next best-seller, the cancer drug Treanda, had 2010 revenue of less than $400 million.
At the same time, Cephalon is in late-stage studies on medicines for lupus, bipolar depression and pain, according to its website.
Pearson’s strategy and viewpoint on research costs have been consistent. When he combined Valeant with drugmaker Biovail Corp. in September, he cut about 25 percent of the workforce, sliced research spending and established a performance-based pay model tied to Valeant’s market value.
“I recognize that many of you did not sign up for either this strategy or operating philosophy,” Pearson wrote in a letter to staff at the time. “Many of you may choose not to continue to work for the new Valeant.”
For those who stayed, it paid off. Valeant has doubled since the merger was completed, while the New York Stock Exchange Healthcare Index of 110 companies rose 8.4 percent. The stock sells at 21 times estimated 2011 earnings, more than twice the 9 times estimated earnings for Cephalon shares, according to data compiled by Bloomberg.
Cephalon rejected Valeant’s $73-a-share cash offer this week, saying the bid was “opportunistic” and undervalued its marketed and experimental medicines. Valeant named a slate of directors it proposes to replace Cephalon’s board.
“We put what we believe to be a very fair value out,” Pearson said. “It’s supposed to be a very friendly approach to them. If they prefer to stick with not selling the company to us for cash, that’s fine. We’ll just move on.”
If Valeant succeeds in its bid, spending on Cephalon’s experimental medicines will likely drop, said Charles Duncan, an analyst with JMP Securities in New York.
For Pearson, “The pipeline is in some ways an afterthought, if not just a way to finance” the deal, Duncan said in an interview. “Valeant will look at the pipeline, be very selective and probably out-license” many products.
Pearson isn’t alone in his strategy. New York-based Pfizer and Sanofi-Aventis SA (SAN), based in Paris, are following a similar model, as each prepares for its drugs to face generic competition. Pfizer’s top product, Lipitor, a $10.7 billion seller in 2010, began losing patent protection last year.
Sanofi cut its research spending by 4 percent last year as it pursued acquisitions to bolster its drug pipeline. In February, Sanofi bought Massachusetts biotechnology company Genzyme Corp. for $20.1 billion.
Pfizer Research Costs
Pfizer, the world’s biggest drugmaker, last year spent 14 percent of its revenue developing drugs, and in February cut its spending projection for R&D next year by $1.5 billion. The company’s new CEO, Ian Read, said the drugmaker will close labs and cut research spending to focus on the most profitable programs.
Read also said Pfizer will demand more accountability from business managers and scientists for the commercial success of experimental drugs. If the research team finds a promising compound and the business team chooses not to pursue it, Pfizer may sell the rights to other companies, he said.
When Pearson arrived at Valeant from McKinsey, he, too, took steps to pare down the company in areas where it seemed to be overreaching. Valeant “was trying to emulate a big pharmaceutical company, but didn’t have the financial breadth or capacity to do so,” he said.
At the time, Valeant was operating in more than 80 countries and had large investments in research and “risky projects,” Pearson said. In response, he divested businesses in areas that weren’t making money, including Western Europe and Asia Pacific, and focused on North America, Mexico, Brazil, Central Europe and Australia.
Pearson also partnered some of the company’s experimental drugs, collaborating with London-based GlaxoSmithKline Plc (GSK) on the epilepsy medicine retigabine, and with Kadmon Pharmaceuticals LLC of New York on the antivirals taribavirin and ribavirin as a way to share the costs.
Valeant now is seeking to acquire companies with assets that could be managed better, Pearson said.
“We’re looking for companies that have products in them that we could grow,” he said. “And maybe do a slightly better job than current owners.”
In Cephalon, Valeant would inherit Provigil, a medicine for the sleep disorder narcolepsy that faces generic competition next year. Cephalon has been trying to move patients to a new version called Nuvigil, an effort Valeant may manage more efficiently, JMP’s Duncan said.
“While the market has been somewhat concerned about the revenue cliff that Cephalon has, I think it seems to be less of an issue for Valeant,” CRT’s Chiang said. “Valeant, I imagine, is going to cut a significant amount of the costs out of the Cephalon business.”
Cephalon’s cash flows from operations, which have doubled in the past three years to $782 million in 2010, make it particularly appealing to Valeant, coupled with potential for cost-cutting, Chiang said. “This is sort of his specialty,” Chiang said of Pearson.
Additionally, Cephalon’s slate of experimental medicines “offers interesting opportunities for partnering,” Pearson said last week on the conference call.
“We do not bet on science, but on management,” he said. “We’re actually pretty good at restructuring. It’s always a lot harder to restructure yourself than to have someone come help you restructure. That plays a little bit to our strengths.”
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