Wednesday, January 23, 2008

Industry: Will private equity arise in the pharmaceutical sector?

Following my recent blogs about the trouble that Big Pharma is in, I thought that it would be appropriate to start talking about private equity and what role it might play in the pharmaceutical sector.
First, let me explain something. For some time I’ve believed that private equity would begin to supplant publicly raised capital. Public stock companies came into being a couple of centuries ago because capital was scarce. Markets and regulations developed over time (not always in tandem) to provide and manage these capital flows. Some argue that the West’s ability to raise and guarantee capital was the primary reason for its global dominance. However, lately, we’ve become very good at raising, if not outright creating, larger amounts of capital than anyone else had ever done before. Probably more than we need. Notwithstanding the excesses, the sub-prime meltdown being a good recent example, availability of capital is no longer an issue. Interest rates levels in modern economies for the ten years have not been terribly exciting. Investors’ willingness to throw cash into the late stages of the dot-com and real estate bubbles only proves the lack of decent returns for financial assets. Next, let’s go back to those regulations that I just mentioned. Regulations have become very cumbersome, expensive, and with the addition of Sarbanes-Oxley, very risky. Once upon a time, if a corporation fell afoul of regulations, it was a civil matter. A civil matter that would be settled with fines and penalties. Worse case, senior management would resign and maybe deal with some unpleasant litigation. Now, a CEO and a CFO could find themselves doing the perp walk with serious jail time because of the actions of a few low level flunkies that they didn’t even know worked for them. That changed the game.
I’m proposing that corporations will begin to avoid the expense and personal risk of these regulations by going private, or, at least leaving the U.S. equity markets. Anecdotal evidence from the New York Stock Exchange seems to hint that companies are choosing to list overseas as a consequence of U.S. regulations. The rise of large private equity firms like Cerberus has facilitated the migration of publicly traded companies into private ownership away from the prying eyes of the markets. One last point, have corporations become too large to effectively manage especially when the stock market’s quarterly expectations are added on? How does a CEO continue to meet analysts’ and investors’ expectations in an economy teetering on recession? It’s difficult enough for companies like GE and McDonald’s. How do you do it when you’re in a regulated industry like the one Big Pharma is in?
Let me go back to my earlier posts where I wrote about the decrease in FDA drug approvals, price resistance by national health services, and a changing political environment that may haunt Big Pharma for the next ten years. This is a very challenging environment. When does Big Pharma begin to feel the effects of all this and begin to move away from the publicly traded markets? When does private equity step in to take advantage of depressed market values and excess capacity? Former J&J COO Jim Lenehan joined Cerberus last year. Somehow I don’t think that he’s working on the Chrysler deal.
In closing, I expect to see private equity firms becoming more active in the pharmaceutical sector. The only question for me right now is which of the big companies will begin to break up and spin off their assets.
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Contributed by Guy de Lastin

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