In this transformative age, there are a number of reasons as to why any company could end up in a challenging strategic situation. In the case of Allergan – which found itself at the center of a takeover bid – a premortem could have strengthened dialogue with investors to ensure they understood its growth strategy and demonstrated the productivity of its long-term R&D investments.
In 2014, pharma firm Allergan learned of two US Securities and Exchange Commission filings that placed it in the crosshairs of Pershing Square Capital Management LP, an activist shareholder, and Valeant Pharmaceuticals International, Inc., a hostile acquirer.
The move surprised Allergan – it had increased revenue by 12% and had a 90% shareholder return in 2013. Moreover, its flagship product was growing at double-digit rates, and it had recently divested a struggling business to free up resources.
However, the company’s allocation of 17% of its total revenue to R&D and 38% to selling, general and administrative expenses were considered high, while its tax rate was 8.5 percentage points higher than the average for similar companies. In addition, it held roughly $1.6 billion in cash on its balance sheet and little debt – meaning it had substantial reserves waiting to be deployed.
What they didn’t spot
Valeant’s growth-through-acquisition model made Allergan a particularly attractive opportunity. While Allergan’s performance was strong relative to its peers, its absolute performance created an opening for Valeant’s critique, as some saw a path to even better results.
With a heavily leveraged balance sheet and a market capitalization almost equivalent to Allergan’s, Valeant needed help from Pershing Square to launch its bid. Pershing Square’s valuation analysis of Allergan’s relatively high tax rate and operating expense levels showed that its likely return was worth the risks of an activist campaign.
After a seven-month struggle of competing investor presentations, press releases and litigation, Allergan was acquired by Actavis PLC through a white-knight bid of more than US$70 billion. This was roughly twice Allergan’s market capitalization before Valeant weighed in.
The benefit of hindsight
Although Allergan’s journey proved lucrative for its shareholders, its former CEO and board were left wondering what went wrong.
While the company’s high SG&A-to-revenue ratio was viewed as a weakness by investors, David Pyott, its former CEO for 16 years, countered that Allergan had “to create not only sales forces, but market competencies.” Nonetheless, looking back on what went wrong, Pyott conceded that Allergan should have looked harder at M&A opportunities – “we should have used the balance sheet more aggressively [instead of] trying to be disciplined,” he said.
A thorough premortem of Allergan’s capital strategy may have helped identify some of the underlying issues facing the firm before they became existential.