Once again, a potential substantial takeover in the pharma business has hit the headlines. And once again, the motivations for the proposed acquisition raise questions about how Big (and Medium) Pharma see the future of their industry. This time the parties are Canada's Valeant Pharmaceuticals International, Inc. and the target of their hostile offer, Cephalon, Inc. a U.S. rival. As reported at the end of March, Valeant made an all-cash offer for all of Valeant's shares, based on a valuation of $5.7 billion. This amounts to nearly a 25% premium over the closing price of Cephalon at the eve of the offering. Funding will be provided by Goldman Sachs. Valeant has also indicated that it intends to replace replace Cephalon's board if the acqusition takes place.
The motivation for the the transaction, as described in a March 30, 2011 report in wsj.com, is as follows (here):
"The offer suggests just how much the anticipated loss of revenue from patent expirations on key products is re-shaping the pharmaceutical industry. As drugs lose patent protection in coming years, drug makers stand to lose hundreds of millions of dollars of revenue and are searching for growth through acquisitions that plug those expected holes and allow companies to cut costs."My interest is less in the dynamics of the hostile offer itself (I leave that to my M&A colleagues down the hall) and more on the commercial thinking that was reported to lie behind Valeant's offer. The following points are noted: 1. Cephalon faces a patent cliff in 2012, especially for its Provigil-branded narcolepsy product, with the expected concomitant loss in revenue that will follow such loss of patent protection. 2. The two companies share branded generic businesses in Europe and the acquisition will enable Cephalon to achieve cost-cutting in this area. This will help the company make up at least a part of these projected revenue losses.
Lying behind these two considerations are two quite different views of how Pharma should address the challenge of declining revenues in the face of a patent cliff. Cephalon's position seems to be that the company has acquired several promising compounds and it is confident that its development activities with these compounds will bear fruit in the coming years.
By contrast, the CEO of Valeant, J. Michael Pearson (a former McKinsey consultant),is said to view the matter more from the vantage of "financial engineering". In particular, Mr Pearson emphasized that he would focus on acheiving cost-cutting efficiencies, especially in the marketing of Provogil and other drugs when they come off patent protection. Moreover, he would spend less on R&D in favour of entering into partnerships to develop commpounds. In the spirit of financial engineering, Mr. Pearson also noted in a letter that since Cephalon has itself recently made two offers for acquiring companies, this will "... reduce your cash on hand by over $400 million dollars, which makes Cephalon a less attractive acquisition from our standpoint."
These two views reflect the quite different histories of the two companies. Cephalon was established in 1987 and it focuses on drugs in the area of central nervous system disorders, pain and cancer treatment. Its founder, Frank Baldino Jr., passed away in December 2010 after being in charge of the company for more than 20 years. While the company faces an imminent patent cliff next year, it remains fixed, it seems, on a strategy based of continued R&D to develop new products.
Valeant deals in both branded and generic drugs and it has a particularly interesting past. A former CEO, Milan Panic (and also a former prime minister of Yugoslavia) disposed of $1.24 million in stock, only thereafter disclosing that a major drug lacked regulatory approval. The present company itself is the product of the merger of several pharmaecutical companies. If Mr Pearson's announced intention to deemphasize R&D on the part of Cephalon is an indication of the company's general view on the issue, R&D would seem to be taking a back seat to more downstream development and commercialization.
All of this raises the larger question: whence will come the drivers for the next generation of patented drugs? The belief is sometimes expressed that nimble start-ups (like Cephalon) are a prime source for future dynamic R&D. The trend of Big Pharma to seek to acquire companies, rather than to invest these amounts in internal R&D, supports this view, at least in part. On the other hand, Valeant is hardly Big Pharma, and its announced strategy lying behind the proposed acquisition is hardly a vote of confidence for the ability of a one-time start-up such as Cephalon to continue to be a source of fruitful R&D, at least not on its own.
And so the question remains: whence will come the drivers for the next generation of patented drugs?