Avoid the 3 card monte – Sell Abbott

by Adam Hartung | Oct 19, 2011 | Current Affairs, Defend & Extend, In the Swamp, Leadership, Lock-in, Science

The giant pharmaceutical company Abbott Labs announced today it was splitting itself.  Abbott will sell baby formula, supplements (vitamins,) generic drugs and additional products.  The pharmaceutical company, (gee, I thought that's what Abbott was?) yet to be named, will spin out on its own.  Chairman and CEO Miles White will continue at the new non-pharma Abbott, and the Newco pharma company will be headed by the company's former COO, being brought back out of retirement for the job.

The big question is, "why?"  The CEO gamely has described the businesses as having different profiles, and therefore they should be split.  But this is from the fellow that has been the most acquisitive CEO in his industry, and one of the most acquisitive in business, putting this collection together. He spent $10B on acquisitions as recently as 2009, including dropping $6.6B on Belgian drug company Solvay – which will now be espunged from Abbott.  Why did he spend all that money if it didn't make sense? And how does this break-up help investors, employees and all us healthcare customers? 

Or is this action just confusion, to leave us wondering what's going on in the company – and why it hasn't done much for any constituency the last decade.  Except the CEO – who's been the highest paid in the industry, and one of the highest paid in America during his tenure.

Mr. White became CEO in 1998, and Chairman in 1999.  Just as the stock peaked.  Since then, investors have received almost nothing for holding the stock.  Dividend increases have not covered inflation for the last decade, and despite ups and downs the share price is just about where it was back then – $50

Source:  Yahoo Finance 10/19/11

Abbott has not increased in value because the company has had almost no organic growth.  Growth by acquisition takes a lot of capital, and because purchases have multiple bidders it is really tough to buy them at a price which will earn a high rate of return. All academic studies show that when big companies buy, they always overpay.  And that's the only growth Abbott has had – overly expensive acquisitions.

Mr. White hid an inability to grow behind a flurry of ongoing acquisitions (and some divestitures) that made it incredibly difficult to realize that the company itself was actually stagnant.  Internally in a growth stall, with no idea how to come out of it.  Hoping, again and again, that one of these acquisitions would refire the stalled engines. 

This latest action is another round in Abbott's 3 card monte routine.  Where's that bloody queen Mr. White keeps promising investors, as he keeps mixing the cards – and turning them over? 

Because his acquisitions didn't work he's upping the financial machinations.  By splitting the company he will make it impossible for anyone to figure out what all that exasperating activity has been for the last decade!  He won't be compared to all those pesky historically weak results, or asked about how he's managing all those big investments, or even held accountable for the tens of billions that he spent at the "old Abbott" when he's asked questions about the "new Abbott."

But re-arranging the deck chairs does not fix the ship, and there's nothing – absolutely nothing – in this action which creates more growth, and higher profits, for Abbott shareholders.  Because there's nothing in this that produces new solutions for health care customers. 

And look out employees – because now there's 2 CEOs looking for ways to cut costs and create layoffs – like the ones implemented in early 2011!  Expect the big knife to come out even harder as both companies struggle to show higher profits, with limited growth prospects.

Along the way, like any good 3 card monte routine, Abbott's CEO has had shills ready to encourage us that the flurry of activity is good for investors.  Chronically, they talked about how picking up this business or that was going to grow revenues – almost regardless of the price paid or whether Abbott had any plan for enhancing the acquisition's value.  Today, most analysts applauded his actions as "making sense." Of course these were all financial analysts, MBAs like Mr. White, more interested in accounting than actually developing new products.  Working mostly for investment banks, they had (and have) a vested interest in promoting the executive's actions – even if it hasn't created any value. 

Meanwhile, those betting for the queen to finally show up in this game will just have to keep waiting.

Abbott, like most pharmaceutical companies, has painted itself into a corner.  There are more lawyers, accountants, marketers, salespeople and PR folks at Abbott (like all its competitors, by the way) than there are real scientists developing new solutions.  Blaming regulators and dysfunctional health care processes, Abbott has insisted on building an enormous hierarchy of people focused on a handful of potential "blockbuster" solutions.  It's a bit like the king and his court, filling the castle with those making announcements, arguing about the value of the king's court, sending out messages decrying the barbarians at the gate – while the number of people actually growing corn and creating value keeps dwindling!

Barely 100 years ago most "medicine" was sold based on labels and claims – and practically no science.  Quackery dominated the profession.  If you wanted something to help your ails, you hoped the local chemist had the skills to mix something up in his apothecary shop, using his mortar and pestle.  Often it was best to just take a good shot of opiate (often included in the druggist's powder;) at least you felt a whole lot better even if it didn't cure your illness.

But Alexander Fleming discovered Penicillin (1928), and we realized there was the possibility of massive life improvement from chemistry – specifically what we call pharmacology.  Jonas Salk sort of founded the "modern medicine" industry with his polio vaccine in 1955 – eliminating polio epidemics.  Science could lead to breakthroughs capable of saving millions of lives!  The creation of those injections – and later little pills-  changed everything for humanity. And that created the industry. 

But now pharmacology is a technology that has mostly run its course.  Like all inventions, in the early days the gains were rapid and far, far outweighed the risks.  A few might suffer illness, even death, from the drugs – but literally millions were saved.  A more than fair trade-off.  But after decades, those "easy hits" are gone. 

Today we know that every incremental pharmacological innovation is increasingly valuable in a narrower and narrower context.  10% may see huge improvement, 30% some improvement, 30% marginal to no  improvement, 20% have negative reactions, and 10% hugely negative reactions.  And increasingly, due to science, we know that is because as we trace down the chemical path we are interacting with individuals – and their DNA has a lot to do with how they will react to any drug.  Pharmacology isn't nearly as simple as penicillin any more.  It's almost one-on-one application to genetic maps.

But Abbott failed (like most of its industry competitors) to evolve.  Even though the human genome has been mapped for some 10 years, and even though we now know that future breakthroughs will come from a deeper understanding of gene reactions, there has been precious little research into the new forms of medicine this entails.  Abbott remained stuck trying to develop new products on the same path it had taken before, and as the costs rose (almost asymptotically astronomically) the results grew slimmer.  Billions were going in, and a lot less discovery was coming out!  But the leaders did not change their R&D path.

Today we all hear about patients that have remarkable recoveries from new forms of biologic medicines.  We know we are on the cusp of entirely new solutions, that will make the brute force of pharmacology look as medieval as a civil war surgeon's amputation solution to bullet wounds.  But Abbott is not there developing those solutions, because it has been trying to defend & extend its old business model with acquisitions like Solvay – and a plethora of financial transactions that hide the abysmal performance of its R&D and new product development.

Mr. White is not a visionary.  Never was.  He wasn't a research scientist, deep into solving health issues.  He wasn't a leader in trying to solve America's health care issues during the last decade.  He never exhibited a keen understanding of his customer's needs, trends in the industry, or presience as to future scenarios that would help his markets and thus Abbott's growth. 

Mr. White has been an expert in shuffling the cards – moving around the pieces.  Misdirecting attention to something new in the middle of the game.  Amidst the split announcement today it was easy to overlook that Abbott is setting aside $1.5B for settling charges that it broke regulations by illegally marketing the drug Depakote.   Changing investments, changing executives, changing  the message – now even changing the company – has been the hallmark of Mr. White's leadership. 

Now Abbott joins the list of companies, and CEOs, that when unable to grow their companies lean on misdirection.  Kraft and Sara Lee, both Chicago area companies like Abbott, have announced split-ups after failing to create increased shareholder value and laying off thousands of employees.  These efforts almost always lead to more problems as organic growth remains stalled, and investors are bamboozled by snake oil claims regarding the future.  Hopefully the remaining Abbott investors won't be fooled this time, and they'll find better places for their money than Abbott – or its Newco.

Postscript – the day after publishing this blog 24×7 Wall Street published its annual list of most overpaid CEOs in America.  #4 was Miles White, for taking $25.5M in compensation despite a valuation decline of 11.3%!