Valeant Pharmaceuticals' promised slashing of Allergan's costs could trigger a Food and Drug Administration lashing. If the Canadian takeover machine succeeds in its $47 billion hostile acquisition of Allergan – in cahoots with activist hedge fund manager William Ackman – Valeant expects to cut its target's research and development spending by 80 percent. How it could do so without eating into required regulatory spending is a puzzle.
The two companies have totally different models. Valeant thinks R&D is often wasted: Cut it, and the profits will flow. There's something to this idea. The return on investment in a typical biopharmaceutical portfolio often fails to cover its cost of capital, according to McKinsey – the old employer of Valeant Chief Executive Michael Pearson.
Allergan, more old-school, is committed to finding new drugs. Alongside some failures, it has had big successes such as expanding the medical uses of blockbuster Botox. Over half the wrinkle remover's sales now come from treating migraine headaches, overactive bladders and the like.
Wall Street seems to favor Valeant's method. Its stock is up more than tenfold since 2008. Allergan's share price has merely tripled. But Valeant needs more and bigger deals to keep growing. That can't go on forever, perhaps a reason why Pearson told big investors Valeant would consider a break-up if it became too large, according to Reuters.
Going after Allergan so aggressively – including promising an improved offer on May 28 – could indicate that the Valeant CEO is feeling the pressure to deliver growth. Perhaps haste and incomplete information explain why, according to news reports, he told analysts Allergan had a golf course that Valeant could get rid of to save money. There's no such golf course.
A shortage of data also might help explain why Valeant thinks a $200 million R&D budget is sustainable, let alone sufficient to expand the uses of Allergan's existing products and develop some late-stage drugs. Allergan spent $550 million last year on trials for these purposes, and an additional $200 million on studies of drugs already on the market.
Even with outsourcing and contributions from Valeant's laboratories, it's hard to see much scope to fund expansion or research and testing of new drugs. There's even a risk of underfunding mandated studies of already-approved drugs. Skipping those allows the FDA to pull them off the market. That really could throw a wrench into Valeant's financial machine.
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.