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Will Pharma's Future Be Based On The Carl Icahn Business Model?

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For today, the buzz surrounding Carl Icahn derives from his initiative to separate PayPal from eBay (EBAY).  More frequently, people tend to equate Icahn with his investment strategy; including his activism in Apple and significant profits in Netflix ownership. But an Icahn initiative that is drawing less attention and may have far greater social impact is his activism in the upcoming merger of Actavis  and Forest Laboratories (FRX).

Frequently it has been my opinion that the bloated, behemoth, big-pharmaceutical model is unsustainable.  Now, courtesy of Carl Icahn, we are witnessing the creation of a right-size pharmaceutical company to meet the needs of 21st century medicine with a 21st century business model and 21st century double-digit, bottom-line profits.  When a pharma company is too small it doesn’t have the resources to see it through good times and bad; when too large, it becomes bloated and unable to respond quickly to changes.  The Actavis/Forest merger puts together two companies with complementary resources and acts as both a warning to large pharma and a model to be followed for survival and success in the coming decades.

Although Icahn is not traditionally associated with the healthcare space, throughout his career, and especially in recent years, he has involved himself in healthcare company transactions.  Icahn was active in consummating the Actavis/Forest deal.  Icahn remained involved from his Miami home while negotiations for the merger were conducted in a New Jersey hotel.  When it is completed, the deal is rumored to yield $1.7 billion in profit to Icahn.  This is not a big deal for Icahn, yet the ramifications can be considered to be far greater.  His investment in ImClone Systems, which was sold to  Eli Lilly & Co  for $6.5 billion in 2008 and Genzyme , which was acquired by  Sanofi in 2011 for $20 billion are just two examples of many such deals.

I believe Icahn has been successful in healthcare because big pharma is in retreat, maybe in the early stages of a death spiral.  The evidence for this is in the news daily.  Downsizing, consolidation of multiple business entities, blockbuster drugs losing exclusivity and stock buybacks, are all signs of a business segment that is facing mortal threats.

The 20-80 rule of modern medicine is that 80 percent of revenues come from older, often chronically-ill patients, whose daily existence only can be sustained by ten or more prescription drugs.  Hypertension, high cholesterol, acid reflux, prior heart attacks, diabetes, anxiety and/or depression, and other physical problems each require their own medication.  The plastic box with A.M. and P.M. pills can be found on many bedsides in America, and increasingly, throughout the world.

What makes the prospect for a combined Actavis/Forest company so promising is access to physicians.  Physicians, especially primary care physicians, face significant challenges -- high demand for services, limited time to see patients and increasing financial pressures.  Taking patient time to see salespeople is burdensome, so a company that can more efficiently present new drugs to a doctor has an advantage.  The combined Actavis/Forest Laboratories sales representative, with a strong and focused pipeline of brand and generic drugs, plus biosimilars when they come into play, will be able to present information on five or six drugs in one visit, where representatives from traditional pharmaceutical companies can only talk about one or two drugs at a time.

This merger makes sense for the future as well as the present.  Forest Laboratories brings with it nine clinical-stage drugs, three of which are in Phase III and three of which are in the NDA stage of approval.  Growth potential in Canada and Latin America is promising.  The combined research and development budget for the two companies in 2015 will be $1 billion and some Actavis functions that are now performed outside the company will be brought in-house for further savings.

The financials of the merger also make sense.  A combined revenue of $15 billion, $4 billion in free cash flow, $1 billion is pre-tax operational synergy with 10% coming from a combined, pro-forma 16% tax rate given a global tax approach.

These objective reasons for this merger make it look extremely attractive.  But there also is a subjective reason why this merger should cause executives from large pharmaceutical companies to be afraid -- very afraid.  If you compare the mood of the Actavis merger conference call with the conference call from a big pharmaceutical company, you can hear that difference in the voices of the participants.  While the big pharma CEOs and CFOs drone on lugubriously, Actavis executives sound enthusiastic, energized and committed to growth.

In short, I think this deal is a harbinger of a positive future for the U.S. pharmaceutical industry.  I think this deal creates a highly competitive model, which will force others in the U.S. pharmaceutical industry to think about change. The big pharma model was unsustainable before the merger in the long run – now the model faces an immediate threat.  I think this merger makes sense for physicians and their patients, as well as investors and company executives.  It doesn't get any better than that.