Valeant Pharmaceuticals: Disruption or Destruction?
Valeant Pharmaceuticals has introduced a new operating model in R&D based on mergers and premium pricing. Is it sustainable?
Valeant Pharmaceuticals is a global pharmaceutical and medical devices company with diversified offerings in branded and generic drugs, spanning fields from ophthalmology to podiatry. [1] Ostensibly focused on service of patients and physicians, Valeant’s business model is consistent with competitive big pharma companies. The company’s operating model, however, diverges significantly from its peers. By focusing on acquisition, cost-cutting, and price optimization, Valeant has enjoyed exponential growth and established a radical concept for success in pharma. At the same time, the sustainability of their operation model is questionable, exploits those in need, and is ultimately not aligned with the core of their business model.
Business Model
Valeant Pharmaceuticals International develops, manufactures, and distributes drugs and devices worldwide in developed and emerging markets, to serve patients and physicians. [3] The company provides a wide array of products in multiple therapeutic fields, including branded drugs, generic drugs, and medical devices. [1] [2] Valeant creates value through the sale of these products through healthcare systems and direct to consumers. Valeant has a robust pipeline, planning 20+ drug launches in 2014. [4]
Operational Model
Valeant has implemented this business model through an organizational structure and processes based on development of new products through acquisition and premium pricing. The company’s pipeline of products has been established exclusively through acquiring companies with marketed or approved drugs (Exhibit 1 details Valeant’s largest acquisitions). [5] They conducted over 100 deals since the firm implemented the current operational strategy in 2008. [6] Next, Valeant has sought to extract value from these purchases by charging premium prices for the acquired drugs. For instance, under Valeant the price of Edecrin, a diuretic drug, increased from $470 to $4,600 per vial. The blood vessel-dilating nitropress price was immediately increased by 525% following Valeant’s acquisition. Drugs acquired by Valeant and the change in price is shown in Table 2. The average price increase this year across all branded drugs was 66%. [7] [8] [9]
For several years large pharmaceutical companies have sought to augment growth through mergers and acquisitions. Valeant took this process to the extreme by eliminating or vastly scaling down R&D. Whereas typical R&D spend is 15-20% of revenue, Valeant spends approximately 3%. [8] Valeant states that R&D spending does not correlate with innovation and performance, and believes that their pipeline is best built externally. They conduct limited internal work in dermatology and aesthetics. [10] Critics believe that this strategy is not sustainable: that by removing more and more R&D from the system, the ability to buy profitable drugs declines. [11]
Alignment Between Business and Operational Models
Reaction to Valeant’s business model has been mixed. The market has rewarded their operational strategy with outstanding returns from 2008 to 2015, before falling by 60% over the past three months. [12] The firm attracted capital from activist investor Bill Ackman. [13] The Harvard Business Review honored CEO Michael Pearson as one of the top 10 CEOs in the world in 2014 and his reputation was ranked in the top 100 by The Reputation Institute. [14] Others have criticized Valeant’s aggressive pricing and R&D-slashing practices. The sustainability of this operational practice is highly questionable.
In September of 2015, The House of Representatives subpoenaed records related to pricing of two heart drugs, bringing the threat of government scrutiny, [15] and the impact of a high profile accounting controversy is still playing out. [16] Despite some short selling over Valeant’s position, analysts remain bullish on the stock: 64% rate as a “strong buy” or “buy,” 32% suggest holding, and less than 5% suggest selling. [17] [18]
Ultimately, Valeant’s operational model fails to align with the business model in the service of critically ill patients. Some may see price increases in drugs as capturing value from an underpriced asset. However, this profit exploits the willingness to pay of those with few alternative options. Thus, Valeant places shareholders above patients in their hierarchy of their business model. Are recent financial results, as well as legal and legislative inquiries, a short-term obstacle for a disruptive innovator? Or a harbinger of impending failure? An assessment of alignment between the business and operating models would suggest that Valeant loses in the long run.
References Cited
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[1] “Valeant Pharmaceuticals International,” 1 December 2015. [Online]. Available: http://www.valeant.com.
[2] “Valeant Pharmaceuticals International,” 1 December 2015. [Online]. Available: www.ir.valeant.com.
[3] Valeant Pharmaceuticals, “Valeant: An Enduring Engine for Growth,” 4 December 2015. [Online]. Available: http://s1.q4cdn.com/484041954/files/doc_presentations/2014/20140528_Valeant%20story%20draft%20deckv87.pdf.
[4] Valeant Pharmaceuticals, “2014 Annual Report,” 2014.
[5] R. Pierson, “TIMELINE-Deals, and doubts, mark Valeant’s acquisition history,” 30 November 2015. [Online]. Available: http://www.reuters.com/article/2015/10/26/valeant-pharmacies-timeline-idUSL1N12N1PL20151026#3cBSKEqM2r1Wg0fY.97.
[6] J. Nocera, “Is Valeant Pharmaceuticals the Next Enron,” 30 November 2015. [Online]. Available: http://www.nytimes.com/2015/10/27/opinion/is-valeant-pharmaceuticals-the-next-enron.html.
[7] “Pharmaceutical Companies Buy Rival Drugs, Then Jack up Prices,” 2 December 2015. [Online].
[8] A. a. T. S. Pollack, “Valeant’s Drug Price Strategy Enriches It, but Infuriates Patients and Lawmakers,” 2 December 2015. [Online]. Available: http://www.nytimes.com/2015/10/05/business/valeants-drug-price-strategy-enriches-it-but-infuriates-patients-and-lawmakers.html?_r=0.
[9] Citron Research, “Why a congressional supoena to Valeant about price gouging on drugs should be granted,” [Online]. Available: http://www.citronresearch.com/wp-content/uploads/sites/4/2015/09/valeant-part-1-final.pdf.
[10] Valeant Pharmaceuticals International, “Valeant’s Perspectives on R&D,” 4 December 2015. [Online]. Available: http://www.valeant.com/Portals/25/PDF/Valeant’s-Perspectives-on-RandD.pdf.
[11] E. Silverman, “The Valeant Strategy: A Sustainable Model or a Shell Game?,” The Wall Street Journal, 4 December 2015. [Online]. Available: http://blogs.wsj.com/pharmalot/2014/06/11/the-valeant-strategy-a-sustainable-model-or-a-shell-game/.
[12] Google Finance, “VRX,” 4 December 2015. [Online]. Available: www.finance.google.com.
[13] A. R. Sorkin, “Bill Ackman’s Enigmatic Approach to Valeant Pharmaceutical,” 2 December 2015. [Online]. Available: http://www.nytimes.com/2015/11/10/business/dealbook/ackmans-enigmatic-investment-philosophy.html.
[14] Harvard Business Review, “The Best-Performing CEOs in the World,” 30 November 2015. [Online]. Available: https://hbr.org/2014/11/the-best-performing-ceos-in-the-world.
[15] J. Rockoff, “Law Makers Seek Answers on Valeant’s Price Increases,” 1 December 2015. [Online]. Available: http://www.wsj.com/articles/congressional-democrats-seek-subpoena-of-valeant-over-drug-prices-1443468385.
[16] C. Harrison, “Valeant Plummets on Allegation of Enron-Like Accounting,” Bloomberg Business, 4 December 2015. [Online]. Available: http://www.bloomberg.com/news/articles/2015-10-21/valeant-shares-plummet-as-citron-examines-specialty-pharmacy.
[17] Thompson One, “VRX: Valeant Pharmaceuticals,” 2 December 2015. [Online]. Available: https://www.thomsonone.com/.
[18] J. Ratner, “Debunking six concerns about Valeant Pharmaceuticals International Inc.,” 5 December 2015. [Online]. Available: http://business.financialpost.com/investing/trading-desk/debunking-6-concerns-about-valeant-pharmaceuticals-international-inc.
[19] H. a. K. A. Schiller, “Valeant Pharmaceutical International, Inc.,” in JP Morgan Healthcare Conference, 2015.
Another Bill Ackman example and another disappointment for humanity. As you mentioned, yes, the operating model is enabling more profit for the shareholders, but given the lack of competition and high barrier to entry Valeant is able to exploit the relatively inelastic demand. From the angle of serving patients I agree it is moving in the opposite direction. Another interesting discussion is Valeant’s choice to outsource innovation (R&D) as opposed to the industry standard of insourcing. I wonder whether it’ll be more efficient for the healthcare system where large pharma conducts all phases of drug approval similar to Wyeth or specialization by phase similar to the Medicines Company.
Interesting post Adam. I agree with your perspective that alignment is missing here: Valeant captures value by marking up drugs to consumers, but it creates value on the operational side by slashing R&D spending which in the long-run is not a way to create consumer value, even if it brings short-term gains. I think the comparison with The Medicines Company is instructive given their priority on developing ‘sustainable’ drugs by which they mean drugs that create more value for stakeholders than their cost, thereby aligning their operational goals and business model. In addition to the regulatory investigations that you describe, the recent controversy over whether Valeant is artificially creating sales through forcing related-party pharmacies to purchase its products suggests that perhaps even in the absence of external pressure, the misalignment of its model is leading patients to stop buying its expensive products.