Tuesday, November 3, 2015

Uncertain Health in an Insecure World – 63

“Too Big to Fail?”

On Halloween eve 2015, the U.S. Federal Reserve proposed that the banks "too big to fail" in 2008 set aside billions in long-term debt reserves as a cushion against scary financial failures.These same banks were saved 7 years ago by the government to protect the longer term public interests.

Until the Fed’s latest spooky move is ratified, the big U.S. banks and large global banks’ U.S. subsidiaries must demonstrate that they can pass annual “stress tests” and write “living wills” stating how they would safely be wound down in the process of restructuring. If there’s a complete bank failure, their bondholders, not the taxpayers, would be on the hook.

So, while this financial sector has dramatically concentrated since 2008, it is also heavily regulated to protect the public interests.

What, and who, regulates the healthcare and big pharma sector?

Also on Halloween eve 2015 came scary news that the tenth largest U.S. company, Pfizer, was seeking a merger with Irish Botox and Restasis maker, Allergan PLC. It would be the biggest market cap combo of an already big year (US$216B + US$113B) – a blockbuster deal for two blockbuster drug makers! Pfizer revenues have been declining since cholesterol-lowering Lipitor came off patent protection in 2011. But its >80 pipeline drugs and new products for breast cancer (Ibrance) and blood clots (Eliquis) are signals of pent up growth.

High U.S. corporate taxes are the main reason for Pfizer-Allergan merger & acquisition talks.

The effective tax rate for Pfizer is 25%, while Allergan’s rate is 15%. Pfizer CEO Ian Read (above) says that Pfizer is competing against foreign companies “with one hand tied behind our back”. Mr. Read has called U.S. tax rates “highly disadvantageous to American multinational high-tech businesses.” The proposed deal would move Pfizer headquarters from New York (below) to Dublin, and likely cost many U.S. jobs.

Recognizing their tax problem, last year Pfizer attempted a “tax inversion” takeover of U.K. based AstraZeneca PLC. The move was blocked by AZ’s board in the face of intense U.K. political opposition. The capacity of U.S. drug companies to get around the current tax regulations requires certain conditions be met – shareholders of the newly created overseas entity must own >40% of the combined entity. This makes the only remaining hurdle the price of shares involved in the transaction: on Oct. 29, 2015, Pfizer shares (PFE, below left) closed below $35 and Allergan shares (ACT) traded above $310 (below right).

The math isn’t the only thing getting harder for the Viagra-maker.  
In March 2015, Allergan successfully competed with Quebec-based Valeant Pharmaceuticals for the purchase of California-based Actavis, but only after Actavis pulled off a “white knight” purchase of Allergan. Allergan revenues grew this year by an estimated 10%, despite selling its generic drug business to Israel’s Teva for US$40.5B.

While such big pharma M&A activity raises share prices, this hyperactivity is breeding contempt.

For example, Valeant has grown by voraciously acquiring 150 mature off-patent drug companies since 2008, then using its specialty pharmacies to increase drug prices by 200-500% (above), abruptly inflating its sales revenues. Pfizer CEO Read called Valeant’s acquisitive business model a non-sustainable “dead end” for new drug R&D. But Valeant has handsomely rewarded Wall Street investment banks >US$500M since 2012 to close its M&A deals.

Only GE, Allergan, AT&T and Dell Inc. have paid more Wall Street fees than Valeant since 2012!

One major Valeant shareholder, Bill Ackman (above), is also founder and CEO of the hedge fund Pershing Square Capital Management. His investor-oriented point-of-view recently saw him characterize Valeant as “a very early stage Berkshire Hathaway”, based on its aggressive M&A style. Last week, a disruptive report from short-selling Citron Research called Valeant “the pharmaceutical Enron”. Others have called Valeant “a conglomerate”, like ITT Corp., implying that it should be forced to split itself up. To avoid this, Valeant began “severing all ties” with some of its specialty pharmacies like Philidor Rx Services. In nearly the same breath, Ackman spoke of joining forces with Amazon CEO Jeff Bezos to spawn mail order services, touting that “specialty pharmacy is the future of the industry.”

Valeant CEO Mike Pearson (above), an American running the company from its north Montreal headquarters, has been staying quiet since 2014 when Ackman outed him as a billionaire, based on the fact that Pearson owned 10.6 million Valeant shares (VRX). Ackman has also lauded the business synergy between senior management’s shareholdings and the company’s long-term share price performance.

But for most Valeant investors, this kind of bottom line alignment does not remove their risk.

There is no golden parachute for Valeant’s common shareholders, who have seen share prices drop 40% in the last week (above), reminding Canadian investors of the collapse of R.I.M./Blackberry Ltd. (2012-2013) and bankruptcy of Nortel Networks Corp. (2009). Pershing Square Capital has already seen $1.5 B in paper losses from Valeant in 2015. Citron Research just projected that there is a real risk of Valeant shares going to US$0. Quebec’s Authorité des Marches Financiers regulators are investigating “worrisome” allegations. 

Whatever the currency exchange rates, US$0 and CDN$0 are the same price per share.
Is it any wonder that current public sentiment towards the big pharma sector is so negative?

One observer commented that they should “run before the torches and pitchforks show up.” Of course, U.S. presidential candidates like Hillary Clinton are joining the fray, with her spokesperson saying “there is a lot more work to be done to stop them”. Donald Trump believes that Pfizer’s move is just another reason to overhaul to the U.S. tax code, “so companies will be coming to America, not looking for ways to leave.”  Well before the recent Valeant “phantom sales” scandal, U.S. presidential candidate Bernie Sanders (below) began a government investigation of the company’s extreme price hikes.

According to Thomson Reuters, the accelerated 2015 rate of healthcare and pharma sector M&A has already set a historical high of US$448B! Last week, other major market-changing deals saw Walgreens Boots Alliance Inc. purchase Rite Aid Corp. (below), while health insurers Aetna and Humana Inc. merged, as did Anthem Inc. and Cigna Corp.

These big pharma and healthcare sector M&A’s raise big questions.

       Do these deals stimulate economies, or simply churn the public markets and cost jobs?
Does the U.S. need to build a Trump-like tax wall to protect this business sector?
Is it time for greater government regulation to prevent more conglomeration?
The public wants affordable drug prices, and resents price gouging behaviors. Patients benefit from new blockbuster drugs that require expensive R&D. There will never be a national Viagra or Botox or Liptor or Restasis shortage crisis severe enough to require direct government funds infusion. 

But what and who protect the long term public interests amid such M&A hyperactivity?

The what is markets that punish deceptive behaviors out of bounds with regulations, and reward creativity in business practices within the rules.

The who is the regulators and policymakers. Unfortunately, these market controllers take time to connect the dots, and may be swayed by perverse incentives to look the other way.  

We in the Square know that company failure is natural selection in the business world. And just like in bad Halloween movies, bad CEO's should be the serial ax murderer's first victims.     

No comments:

Post a Comment