Bill Ackman was defending Valeant Pharmaceuticals Intl Inc (NYSE:VRX) (TSE:VRX) today, upon which he is dependent on for a high stock price to fuel his hedge fund’s involvement in the Valeant / Allergan acquisition. The deal to purchase Allergan, Inc. (NYSE:AGN) is based in large part on the price of Valeant shares. In an interview with CNBC today, Ackman also talked about Valeant in terms of its value as a “roll up” company.
Ackman teaming with Valeant to pressure Allergan
As previously reported in ValueWalk, Ackman approached Valeant Pharmaceuticals Intl Inc (NYSE:VRX) (TSE:VRX), a company engaged in purchasing other medical firms, about acquiring Allergan, Inc. (NYSE:AGN) in tandem. The core Valeant business strategy, which comes from a former McKinsey consultant, J. Michael Pearson, now CEO of Valeant, is to acquire firms that have heavy sales and research and development expenses, combine them and reduce costs.
This is classic vertical integration where instead of an expensive sales and marketing program offering a handful of products to customers, they blanket the entire industry, offer the products of several companies through one source. The long term vision could be to become a dominate sales channel and re-invent the sales process. This strategy has considerable value, particularly in the high value, high profit medical products industry.
“Valeant Pharmaceuticals Intl Inc (NYSE:VRX) (TSE:VRX) is not just a roll up,” Ackman said on CNBC, then went into detail to differentiate between good and bad roll-ups. Good roll-ups, he said, have a strategic component to the business logic, such as creating a sales and marketing synergy. Bad roll-ups are based on short term mathematical thinking where games are played with the stock price.
“A bad roll up is a firm that uses an over-inflated stock price and a high multiple and non-cash gap earnings heavily promoted by the CEO to acquire companies at lower multiples,” he said on CNBC today. He noted that high multiple value stocks that typically acquire low multiple companies is issues to a low multiple stock and that is “magically accreditive, the stock price goes up, yet there is really no strategic advantage in the combination.”
Ackman on acquisitions that do not succeed in the long term
Ackman seemed to be implying that acquisitions based on nothing other than the earnings multiples – acquisitions lacking strategic business principle – are not ones that succeed in the long term, specifically citing the example of Tyco, a scandal plagued firm that acquired a myrid of firms with different strategies in the early 2000’s.
Ackman says Valeant isn’t just some average firm using tired mathematical games. It has business logic behind the roll up, which makes it different.
One of the most controversial aspects of the Allergan, Inc. (NYSE:AGN) roll up are the potential cuts to research and development. Those in the medical research and scientific profession argue that in order to develop the next stage of products, research and development is necessary for society to advance.
Here Ackman is pragmatic, noting the hit or miss stakes that can plague investing in businesses depending on developing the next wonder drug.
The roll up strategy with vertical integration generates a return on investment that is identifiable, mathematically quantifiable. The research and development strategy, simply from a hedge fund investor’s point of view, looks more like a gambler playing roulette betting on a number. Low win percentage, high win size, is how a quantitative investor might view that equation.