Google the phrase “do the right thing” to see the many ways in which this mantra is intrinsic to American and other healthy cultures. At HBS this message is paramount. It goes without saying that we all want to be successful in life and business, always in ways that are rewarding, legal, honest, and honorable. We spend two years assembling our toolkit for developing clarity and insights around our business decisions. Soon enough, we take a leadership role, develop the strategy, assemble the talent, design the processes and consult the advisors to make sure that our plan is sound and legal.
But how do we know if it is RIGHT? Sometimes it’s easy to see the bright lines, but in a surprisingly large number of cases the boundaries are vague, ambiguous or entirely invisible. Such is the case with Valeant, the pharmaceutical company recently in the news. Holman Jenkins (WSJ) called the story of Valeant “the standout corporate drama of the past six months.” What can we learn?
Let’s start with the business model. The CEO, a long-time McKinsey consultant and a leader of their biopharma practice, observed that in his opinion virtually all R&D investments in biopharma were wasted. This analysis led him to pursue a strategy of acquiring first small, then larger companies, slashing their R&D budgets and thereby dramatically improving cash flow and income. Brilliant! And it’s legal!!
Is it RIGHT? Consider for a moment, the decision to cut all this “wasted” R&D money. Certainly not all R&D is productive and many companies have difficulty managing it well. However, R&D is risky and exploratory in all industries and only consultants and critics with no real operating experience dare conclude that they have the answers. Our society awards patents that can generate decades of high income annuities to innovators to encourage discovery of lifesaving medicines. Billions of taxpayer dollars go into basic research that often underpins these companies’ development investments. Our citizens pay the highest prices for drugs in order to sustain the economic model of the industry. Is it honorable for one company to exploit this system by milking its acquired product line?
Valeant adopted a second strategic element that worked for a time, resulting in a very high P/E stock, useful as acquisition currency in a classic rollup approach. They were very enthusiastic about their prospects. They undertook aggressive marketing to sell-side analysts who too often touted the stock without enough scrutiny. Then they recruited an aggressive and (previously) respected and successful activist investor to endorse them and to invest. Finally, they made a number of what seem to be aggressive accounting and tax moves to improve their results. Most notably, they relocated to Canada. A move to use a captive drug distributor vehicle to book sales is under scrutiny now. Any one of these moves might be defensible in some circumstances, but in totality, were they right? Is it okay to help a stock to a high position with financial results that are nearly opaque? Are rollup strategies without product development sustainable? Was the activist investor’s glowing endorsements acts of conviction or defensive moves to protect a very large investment?
Valeant’s pricing strategy was particularly noteworthy. Much of the revenue increase that Valeant “delivered” came from enormous price increases for essential medicines which had few if any alternatives. This is legal. Why doesn’t everybody do it? What happens to patients who are priced out of drug availability? What about inflaming an already contentious political debate that, at its extreme, could damage or destroy the American biopharma innovation ecosystem?
This “breakthrough” pricing strategy completely disregards the community of power that biopharma operates within: stockholders of course, but also patients, medical professionals, regulators, legislators. Given a climate where business is routinely assailed and held in low regard, Valeant damaged the reputation of an entire industry, negatively affecting hundreds of thousands of hard-working, dedicated employees of biopharma, who are trying every day to do the right thing. But, this pricing strategy is legal and it generates, for a time, profit and shareholder value.
Governance. Where is the board on this? It’s a board filled with distinguished and experienced individuals from business, medicine and beyond. We can assume that they watched, endorsed and probably encouraged these strategic moves. Do they bear any responsibility or criticism? At one point in the drama, the CEO experienced a medical problem causing him to be absent for several months. A place-holder CEO stepped in, but with a limited mandate. When the CEO returned the company announced it could not explain its financial results, offer earnings guidance or perhaps meet its debt covenants. The placeholder CEO was then asked to leave the board due to alleged misconduct when he was CFO. He refuses to step down and denies misconduct. Was the board doing the right thing?
In October a respected analyst commented, “we continue to believe that Valeant’s fair value should be based on the future which looks bright” with a $200 price target. On March 18th Valeant closed at $27. The shrewd activist investor has lost over one billion dollars. Smart money? Disruptive Strategies? Wall Street? Good governance? As this column goes to press, the CEO is finally out of a job and the activist investor joined the board promising to “fix” the company. But they say it’s all legal….
Harvard Business School Professor Kevin Sharer joined the HBS Strategy unit in the Fall of 2012. Before HBS, he was CEO of Amgen for twelve years and before that Amgen’s President for eight. He serves on the boards of directors of Chevron and Northrop Grumman and is on the Naval Academy Foundation and Chairman of the board of the Los Angeles County Museum of Natural History. Professor Sharer is a Naval Academy graduate and has master’s degrees in aeronautical engineering and business.