Valeant shows how some M&A favors the brave

By Robert Cyran

Valeant Pharmaceuticals shows how some M&A favors the brave. Buying $8.7 billion Bausch & Lomb is the biggest deal yet for the acquisitive company, but it comes with huge cost savings that investors glorified. Chief executives elsewhere should take note.

A big part of Valeant’s success has been its ability to find drugs in the marketplace instead of the lab. It shares have gained 10-fold over the past five years compared to just 50 percent for the sector at large.

The industry spends huge sums on research and development because the prospect of developing a blockbuster is so alluring. Unfortunately, lab productivity has lagged, broady delivering a poor return on overall investment. The internal rate of return for the top 12 pharmaceutical companies last year was only 7 percent, according to a study by Deloitte and Thomson Reuters.

Instead, Valeant buys up smaller firms and deeply slashes costs. Whatever expertise it may lack with test tubes it more than makes up for with the accounting ledgers. Valeant’s tax rate is only about 5 percent. The combination has been potent, especially when new purchases are thrown into the mix.

Valeant estimates it can cut $800 million of costs by uniting with Bausch & Lomb. It’s an impressive sum – amounting to about half its target’s R&D and administrative costs – considering the eye-care company was already owned by notoriously stingy private equity. Applying a standard corporate tax rate of 30 percent would make the savings worth about $5.6 billion today, or about the same amount added to the company’s market value following the deal’s announcement. If Valeant can keep its tax rate down, the value created will be greater.

Chief Executive Michael Pearson sees room for more takeovers, particularly in ophthalmology and dermatology. He even alluded to the idea that Valeant isn’t yet as large or diversified as $250 billion Johnson & Johnson. That’s plenty of ambition for a company almost a tenth the size. So long as Pearson adheres to the same financial logic, investors will stay on side. And with M&A activity broadly stagnant, CEOs elsewhere might consider the lesson from Valeant.

Published on May 28, 2013

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