[Ip-health] FT: McKinsey’s fingerprints are all over Valeant

Thiru Balasubramaniam thiru at keionline.org
Tue Mar 29 05:17:58 PDT 2016


March 23, 2016 5:53 pm

McKinsey’s fingerprints are all over Valeant

John Gapper

Pearson as chief executive brought a consultant’s clinical eye to the
pharma industry

Bill Ackman, the activist hedge fund investor, sent a typically blistering
letter to the chief executive of Allergan, the pharmaceuticals company, two
years ago. “It is time for you to look in the mirror,” he instructed David
Pyott sternly, suggesting that Mr Pyott’s rejection of a hostile bid from
Valeant was damaging “your long-term reputation and the way you would like
to be perceived” by others.

Mr Pyott has been vindicated and Valeant is in deep trouble, with its go-go
approach to the pharma industry badly discredited, its chief executive on
his way out, and its former finance director refusing to leave the board
despite being accused of “improper conduct”. It is a suitable moment for
various people to examine their reflections.

Mr Ackman’s Pershing Square Capital and ValueAct, the other activist hedge
fund at the heart of the debacle, are among them. Valeant’s board, which Mr
Ackman has joined in an attempt to rescue his investment, is too. So are
the banks that advised on and underwrote its acquisition spree while
joyfully recommending its shares. One contributor, though, deserves
particular attention: McKinsey & Co, the pre-eminent management consultancy.

Valeant’s downfall is not exactly McKinsey’s fault but its fingerprints are
everywhere. Half of its six-person senior executive team formerly worked at
McKinsey, including Michael Pearson, its chief executive, and Robert
Rosiello, its finance director. So did Ronald Farmer, the director who
chairs its “talent and compensation” committee, which temporarily
transformed Mr Pearson into a billionaire.

It is as if the McKinsey alumni network now meets in Canada, the country to
which Mr Pearson moved Valeant for tax reasons following a 2010 merger. He
had been hired as its chief executive in 2008, when the board liked his
strategic advice so much that it asked him to take charge of implementing

Mr Pearson, who worked for Mc­Kinsey for 23 years, rising to head its
global pharmaceuticals practice and sit on its 30-member shareholder
council (the equivalent of its board of directors), was not the
quintessential suave and intellectual McKinsey partner. He was loud and
profane and was seen, in the words of one former colleague, as “sharp edged
and sharp elbowed”.

Nor is McKinsey as intertwined with Valeant’s strategy as it was with that
of Enron, the energy trading company that failed in 2001, leading to the
jailing of Jeff Skilling, the former McKinsey director who was its
president. Although Mr Pearson rose along with Mr Skilling in McKinsey’s
years of rapid global expansion under Rajat Gupta, its disgraced (and
jailed) former leader, they are different individuals.

There is, however, a McKinsey element to Valeant’s fate. Like Enron’s
“asset-light” strategy of trading power rather than owning power plants, Mr
Pearson brought a consultant’s clinical eye to pharma. He despised costly
research (“Be prudent about investing ahead of need — curse of the
industry” was one motto), preferring to acquire proven drugs and raise

McKinsey provided the intellectual underpinning for pharma companies to
rethink radically in the mid-2000s, when drugs pipelines seemed to have
dried up and research productivity fell. As the firm’s partners concluded
repeatedly in calling for “a bolder, more radical approach to Big Pharma’s
operating model”, boards and executives had to alter course and cut costs.

No one did this more abruptly than Mr Pearson: “Our strategy is basically
the education I had through McKinsey,” he said in 2014. He turned Valeant
into a hyperactive acquisition vehicle, which not only benefited Wall
Street banks but consulting firms for whom post-merger integration work is
a labour-intensive, high-margin operation.

Mr Pearson was highly incentivised, as they say in the consulting industry,
by a ballooning pay package. It was crafted by ValueAct, which recruited
him, to make him perform energetically without taking excess risk (it
achieved the first but clearly not the second). He initially bought $5m of
equity and his holding multiplied as he hit three-year shareholder return

At their height last summer, Mr Pearson’s 9.9m shares were worth $2.6bn but
have fallen to a fraction of that (he cannot sell until 2017). Mason
Morfit, the ValueAct partner who championed the scheme, rejoined Valeant’s
board last year, although its compensation committee is now chaired by Mr
Farmer, a former managing partner of McKinsey’s Canadian business.

Dominic Barton, who was appointed McKinsey’s managing director in 2009 (and
also happens to be Canadian), has taken a dim view of the shortcomings of
the “shareholder value” mantra that dominated Valeant. “Short-term capital
will beget short-term management through a natural chain of incentives and
influence,” he warned in the Harvard Business Review in 2011.

Mr Barton wrote that companies should treat “long term” as at least five to
seven years and advised them to make executives put “skin in the game” by
buying equity. He needs to refine his ideas. Mr Pearson had plenty of skin
in Valeant’s game and built what seemed a thriving business for seven
years, at which point it fell apart.

McKinsey’s broader problem is that its alumni do not seem to have been
listening. As Mr Barton signalled danger, Mr Pearson embraced it.

john.gapper at ft.com

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