Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

The unwritten rule for pharmaceutical takeovers in 2016 seems to be to pay big numbers. This has helped U.S. private equity group KKR & Co. extract a punchy $5.5 billion price from Switzerland's Lonza Group AG for the sale of its Capsugel SA pharma contractor.

KKR acquired Capsugel from Pfizer in 2011 for $2.4 billion, investing $1.1 billion of equity. The total gain on the deal is $3 billion, including $850 million in dividends extracted along the way. The internal rate of return will be a jaw-dropping 36 percent.

It's textbook private equity: buy an asset that's underexploited by a big company, restructure it and sell it back to the industry five years later, funding the whole thing with debt. In this case, Capsugel has been transformed from being mainly a capsule maker into a more diversified provider of pharmaceutical technologies.

Lonza's shareholders sold after talk emerged Dec. 11 that it may buy Capsugel from KKR.
Source: Bloomberg
Intraday times are displayed in ET.

Lonza's shareholders are struggling to see what's in it for them to be on the other side. The company has shed 1 billion Swiss francs ($1 billion) in value since its interest in Capsugel emerged earlier this week. That's partly because Lonza is going to issue 3.3 billion francs worth of new shares to help pay for the acquisition. The move could see the share count jump by over 60 percent, which is a lot for the market to digest. But the hostile reaction also shows justified skepticism that the deal is worth the price.

The central difficulty is that the purchase relies on some $100 million of targeted revenue benefits to generate an adequate return on capital. These are going to be hard to achieve and, Lonza says, will take five years to fully materialize. Analysts at JPMorgan Chase & Co reckon the deal will return 6.7 percent in 2020, still below Capsugel's 7 to 8 percent estimated cost of capital. So investors have to both be patient and have faith. 

In the meantime, returns could be around 5 percent, based on Gadfly estimates. 

Lonza will probably make this work in the end. But it has not got a bargain and investors are right to be wary of an expensive deal whose rationale is distant revenue gains. They will want to see proof Lonza really can cross-sell before giving it the benefit of the doubt. As for KKR, the returns here look exceptional. Its clients should not get used to them.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Corrects amount of KKR's total gain, in second paragraph.)

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Chris Hughes in London at

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Jennifer Ryan at