The Financial Times Rips Bill Ackman's New Deal Apart

It seems totally normal - one pharmaceutical company wants to buy another pharmaceutical company. Dog bites man, the world turns on its axis, nothing to see here.

But the deal between Bill Ackman and drug-maker Valeant to buy its competitor, Allergan, the maker of Botox, isn't normal. It's a choice between two ways the pharmaceutical business model can go.

The difference is clear in two deals announced this week, the deal between GlaxoSmithKline and Novartis, and of course the $45 billion Ackman-Valeant deal.

In one model companies laser focus on certain segments of the industry that they've mastered to lead innovation. In another model - the Ackman Valeant model - companies become massive and chase innovation wherever they think they see it.

The FT's John Gapper paints an ugly picture of the difference in a brutal op-ed.

Lets start with the good stuff first.

In case you missed it, GlaxoSmithKline and Novartis announced this week that they're doing an almost $25 billion deal in which they essentially swap some businesses so they can focus on what each company does best.

Glaxo will hand over its cancer drug unit, which plays to Novartis' prescription drug strength, Novartis will sell its vaccines business which better suits Glaxo. Together they will form a new consumer health venture as well.

Then there's the bad.

"If the entire industry adopted Valeant's approach, drug discovery would grind to a halt," says the FT piece's sub headline.

The Ackman-Valeant approach is to cut costs as much as possible, especially any expensive, early stage R&D, and simply acquire innovation by acquiring companies with simple products that consumers understand (like Botox).

That is why, if Allergan is acquired, it's $1.1 billion R&D budget will be cut by $900 million.

That is why Valeant's R&D expense is only 3% when industry-wide expense R&D is 19%.

It is also why Valeant's pre-tax return on capital is 8-10%, versus 25-30% for the industry.

The pharmaceutical industry grows, but at too slow a rate for ambitious Valeant CEO Michael Pearson. He wants to grow Valeant from a $40 billion company to a $150 billion company in 2016 by lagging innovation ever-so-slightly and giving the people what they want, not discovering what they need.

He and Ackman have both said they have a long term vision for the company and this deal, but Ackman's fund need only stick around for one year. In the pharmaceutical industry - an industry measured in decades - that is faster than the blink of an eye.

It is on that point that Gapper brings out the knives. From the FT:

In a presentation this week, Mr Ackman compared Mr Pearson to other managerial iconoclasts such as Warren Buffett, the investor, and Katharine Graham, former publisher of The Washington Post.

That analogy would work if Graham had fired most of the Post newsroom, including Bob Woodward and Carl Bernstein, who broke the Watergate scandal, and bought wire copy instead on the grounds that investigative journalism was a high-risk, low-return activity. In reality, she took a much longer-term view of investment in a business, as does Mr Buffett.

Valeant and Ackman will go into Allergan and cut jobs. On the flip side Novartis announced during its first quarter earnings release Thursday that it's creating them with a new unit called Novartis Business Services. It will employee 7,000 people.

Oh, and Novartis reported a 20% Q1 earnings jump.

Remember what your parents told you about short cuts, people.