P&U's Fred Hassan: The Virtue of "Been There, Done That"

P&U managed to turn itself around following the near-disaster of its merger between Swedish Pharmacia and American Upjohn, with much of the credit due to its CEO and the subject of this interview, Fred Hassan. Hassan consolidated its autonomous research and marketing centers and focused development and marketing efforts on a few heretofore under-resourced drugs. He had the advantage of being new to the job, brought in to salvage an already bad situation. His experience with previous deals at American Home certainly helped. And he argues his consolidation experience will help with Monsanto, too--though now he's an insider trying to manage a merger of equals. But the central value of the P&U and P&U/Monsanto deal is the same: create a vastly increased marketing force to turbocharge the launch of the company's new products.

In the teeth of a stock market grown disenchanted with pharmaceutical M&A, Hassan argues the value of consolidating marketing mass tempered with managerial experience.

by Roger Longman

• With P&U in desperate straits following its merger, Hassan and his team managed to turn the company around by consolidating its autonomous research and marketing centers and focusing significant efforts on a few, heretofore under-resourced drugs.

• At P&U, Hassan had the advantage of being new to the job; merging P&U with Monsanto will require a different managerial touch.

• The central advantage of the P&U/Monsanto merger is a vastly increased marketing army, for use in turbocharging the launch of Pharmacia's new products. The new Internet marketing techniques will not undercut the value of these expensively acquired sales forces, Hassan maintains.

• The market's current enchantment with biotech and the Internet is unsustainable, Hassan claims; and while they had previously overvalued pharmaceutical companies, and pharmaceutical mergers in general, investors have now swung too far to the other side.

The turnaround at Pharmacia & Upjohn Inc. is one of the unjustly neglected pharmaceutical success stories of the late 1990s. And the man given much of the credit for that story is Fred Hassan, the company's CEO. As Big Pharma piles onto the consolidation bandwagon, we felt it would be appropriate to talk to one of the few pharmaceutical executives with both deep and successful experience in managing large organizations through acquisitions.

The Upjohn Company and Pharmacia AB had agreed to merge in 1995 [See Deal]).

Eventually, CEO John Zabriskie resigned and the board, in May 1997, brought in Hassan, the well-regarded head of the Wyeth-Ayerst Laboratories drug unit at American Home Products Corp. and heir apparent to the company's CEO, John Stafford. Given P&U's situation, and Hassan's own likely trajectory at AHP, plenty of people were surprised that he took the job. And as he admits, he underestimated the challenge before him—despite having had senior management roles in AHP's own two large pharmaceutical deals, its 1989 takeover of AH Robins Co. and its 1994 hostile acquisition of American Cyanamid Co. [See Deal]

P&U was in serious trouble when Hassan arrived. Its revenues in 1997 had actually declined by 8%; earnings were down 43%. The company was missing one of the greatest pharmaceutical bull markets of all time. While the drug index grew by 50% in the year and a half from the P&U merger to the hiring of Hassan, P&U itself lost 20% of its value.

Hassan performed a classic turnaround at P&U. He consolidated its regional centers and sold or spun off a number of non-pharmaceutical divisions to focus the company's efforts on the higher-margin drug business. The market responded: over the next two years, P&U beat the industry index, its stock price more than doubling.

But since its stock-price peak in April 1999, P&U's value has fallen, as has the industry's. For Hassan, the problem is fairly simple: acquiring the sales resources to power earnings beyond the industry average. And to do this, he turned to the merger option. Hassan is merging P&U with Monsanto Co. to gain access to its fast-growing drug unit, GD Searle & Co. Searle's biggest product: celecoxib (Celebrex), the blockbuster anti-arthritis drug launched in 1998 in a co-promotion with Pfizer Inc. [See Deal]

The deal, creating Pharmacia Corp. , values Monsanto at roughly $42.64 per share, a price that, at least initially, irritated Monsanto shareholders, who quickly shaved 20% off the value of the stock. They were not unreasonably angry. A 1998 deal with American Home Products Corp., valuing Monsanto at $52 a share, hit the rocks, at least in part because of the unworkability of its vision of a company run by two CEOs (Monsanto's CEO Robert Shapiro and AHP's John Stafford) [See Deal].

Once that deal had fallen apart, and as Monsanto's price began its decline, Monsanto began talking with plenty of other companies. It moved fairly far down the road with Novartis AG , which, in November 1999, offered to acquire Monsanto for $49 per share. But since Novartis isn't traded on any American exchange, its offer was largely theoretical: it would buy Monsanto with American Depositary Receipts once it had been listed on a US stock market. And Novartis demanded a heavy break-up fee: a 50-50 co-promotion of Searle's Celebrex, effective with the signing of the merger agreement, which would continue if the merger fell apart. In late November, Monsanto backed away from the Swiss firm.

With Novartis out of the picture, P&U stepped up its courtship of Monsanto, a process it had begun in September. The deal-making moved quickly: P&U's board approved a draft agreement on December 18 and Monsanto's a day later.

Not that P&U's shareholders, when they heard about the deal, felt any better about it than Monsanto's. P&U's stock likewise lost about 20% following the deal's announcement. P&U shareholders aren't certain whether Monsanto's agriculture business is an asset they want to own. The biotech-based operation is ground zero in the furious European backlash against genetically modified organisms in the food supply. And anti-GMO fervor is growing in the US, too. But Hassan can't get rid of it entirely or he'll risk losing favorable pooling-of-interest accounting treatment for the deal. Instead, the companies plan to spin off nearly 20% of the division.

For his part, Hassan isn't particularly interested in getting into the ag business. He hasn't, for example, tried to convince a skeptical investment crowd of the scientific synergies among life science businesses—until recently an almost canonical argument among companies with dual citizenship in the ag and pharma worlds. But Hassan argues that making visible the ag business's financial performance will both highlight its attractions to investors and spur the division's management to even better results.

What Hassan really wants is marketing muscle—indeed, he initially contacted Monsanto to sound out its interest in co-promoting tolterodine tartrate (Detrol) and signed a co-promotion with the Janssen Pharmaceutica Inc. unit of Johnson & Johnson anticipating the US launch of the still-unapproved anti-depressant reboxetine (Vestra in the US, Edronax in Europe) [See Deal].

In particular, Hassan wants to bolster his forces in the US, the major market for Vestra. With Searle, 75% of whose sales come from North America, Hassan figures he's buying the relevant set of marketing assets without also having to buy an ex-US sales force that won't provide the same bang for his buck, given his current portfolio.

This isn't the first bet that Hassan has made on sales force expansion at P&U. Early in his tenure as CEO, he brought on an additional sales force, anticipating the launch of Detrol, and the bet worked out. Detrolwas approved just as the sales force came on stream.

But the bet is much bigger this time. Pharmacia will have $16.5 billion in total sales, $11 billion in pharmaceutical sales and a pharmaceutical research budget of more than $2 billion, a significant step beyond the management experience of either company's research executives. Hassan is looking at a two-headed research group, with Searle's Philip Needleman, PhD, the prime force behind the invention and development of Celebrexand its follow-ons (and a key player in Searle's unique IIb/IIIa inhibitors, which were to power the second phase of Searle's growth but which failed to meet their clinical endpoints) in overall charge as chairman of R&D—the passionate project manager, Hassan calls him. P&U's Goran Ando, MD, EVP and president, R&D, will keep his title but report to Needleman. He will be, says Hassan, the senior process manager.

But the larger bet is on the value of a huge sales force—one that will be the fourth largest in the industry (barring any further consolidations). In the short term, there is little question of its value. But disintermediation is the watchword of the day, and a host of Internet companies are looking, if not exactly to replace sales forces, then at least to make smaller ones more effective. Consolidators are thus wagering that the sales assets they are now acquiring for such high prices will keep their value in the face of the coming electronic competition.

Question:When you arrived at P&U, what did you find?

Hassan:We were in a very difficult situation. Upjohn had been unable to follow up its successes with Xanax and Halcion with other CNS products. They had spent a lot of money on the lazaroids and they didn't work. They also had some management issues regarding the transition from the former CEO [Ted Cooper]—unclear transitions are always problems for companies. Upjohn finally merged under stress with another company under stress, Pharmacia, which was an agglomeration of European regional boutiques [including the Italian drug firm Carlo Erba]

In effect, the previous management had taken three companies [Upjohn, Pharmacia, and Erbamont] and, through an elaborate set of governance rules, allowed them to work autonomously, with the central office in London acting like a coordinating center. All that did was to perpetuate the past, creating three fiefdoms. It did not create the conditions for a merger of equals. It was a compromise of equals. If you don't have central controls, then a lot of strange things can happen in the fiefdoms. The local chiefs control the information. There's no one in the center to know what's going on; there's no transparency and no accountability, and without them you can't pull off a successful merger. I probably underestimated how difficult this repair-and-build job would be. But I was 51 years old, young enough to feel that I could take it on.

Question:What did you do when you arrived?

Hassan:Within ten weeks of my arrival, we decided to shut down these three regional silos. Normally I would have waited.

Question:The P&U merger had not been working when you were brought in. It almost seemed to us as observers that you were brought in when the management and board had thrown up their hands and said, "Save us."

Hassan:That's why I could move in ten weeks. I was able to confront the board with some fundamental policy decisions that were contrary to the spirit of the original agreement [guaranteeing the regional autonomy of the formerly independent companies]. We had to globalize research and marketing; without these two globalized functions there's no way you can succeed in this business. That was a fundamental departure from anything that had been discussed before.

Where I take credit is going to the board so quickly rather than analyzing it for six months. Because time was of the essence. We were hemorrhaging. So I moved fast, using my instincts rather than all the analyses. That's where experience helps—instinct based on experience allows you to take fast decisions.

You can imagine my situation: when a CEO joins, the first priority is to build a relationship and trust with the board. I didn't have that luxury. I had to get this thing going and get it fixed. I'll never forget the first board meeting I attended after becoming CEO. The board was seeing me for the first time and I was confronting them with a fundamentally new proposition. They were concerned about going in a different direction than the one that had been negotiated earlier. But I give them credit in trusting to let me go with my instincts.

The result was that we were able to globalize marketing and research, which led to some very tangible results. The biggest is that Zyvox[linezolid, an antibiotic apparently effective in treating all significant gram positive infections] is now almost ready for market—it's coming up for an approval meeting soon. Zyvox had been hidden in the Kalamazoo silo and only really known there. Without a global research budget, the Kalamazoo group couldn't spend the money required to develop it globally. But with a global research budget, we were able to invest $100 million in this product last year. That's the beauty of globalization. You work with a bigger pool of resources that you can pour onto the best opportunities.

The other beauty of globalization is that you can attract the best talent to take the senior jobs. If you don't have the best talent inside, you can always go outside—but a global job is attractive enough so you can provide the best possible management. When I came in we made some senior management changes; some people moved on; others came in. When it came to marketing, we were able to get world class people like Carrie Cox [EVP, Global Business Management] and Tim Rothwell [EVP, head of global pharmaceutical operations]. And then they in turn brought in some world class people.

Question:What had you underestimated about the job before taking it?

Hassan:After I joined I found problems with the company's two biggest products for the long term, Detrol and Edronax. Detrol was compromised in the US [Forest Laboratories Inc. claimed marketing rights there]. Edronax hadn't been developed in the US, which probably accounts for 80% of the market for depression products. And because of the lack of a central research organization, some of these products had been sitting around for some years with very old data. And if you don't keep a product up to date, the data starts to become stale. The science moves on; new methods of measurement and new protocols come along. [The issue may have bitten P&U. While issuing an approvable letter for Vestra, the FDA had nonetheless asked for data from two studies then ongoing; the data turned out to be equivocal, with the second study showing no statistical difference in efficacy between Vestra, Prozac, and a placebo].

The one accomplishment we were able to pull off was that before the end of the year, 1997, we settled our Detrolissue. At that time it looked like a very expensive settlement [P&U agreed to pay Forest up to $25 million based on approvals and milestones, including $10 million in the last two quarters of 1997]. But in hindsight the deal was a good one because we got the whole of Detrol for ourselves in the US.

The other smart thing we did was to take the risk of adding another US sales division. The financial markets weren't happy. P&U had sold a lot of stock in the $40s following a road show in August 1996. But the stock sank into the $20s. You can imagine how investors reacted when in comes a new CEO and says he's going to add to the cost structure by investing in a sales force. But it turned out to be a good bet: we resolved the Detrolproblems; we got it through the FDA on time; and we were able to launch it just in time for the new sales force to get busy.

Then the product was launched by very high quality business professionals, people such as Carrie and Tim. So the launch was a success—it sold more than twice its original forecast. And it will do even better in the future.

Question:If you look at the Monsanto deal, what are the parallels? You no longer have the advantage of being new—the man entrusted with saving an already failed situation.

Hassan:It's a different situation altogether and must be approached differently. But my special qualification is that I've helped manage four separate mergers and every one was a different situation. This one will be my second experience of a merger of equals [the first was the P&U merger itself]. There aren't too many CEOs around who can say that.

The second thing that will help us move forward is that Monsanto is going through an inflection point. In comparison with its other businesses, Monsanto's pharmaceutical operation is becoming very important. That allows us to take the Monsanto drug business and reshape everything under a global pharmaceutical umbrella. At the same time, we can redefine the status of the agriculture business as a standalone, transparent, accountable unit—accountable also to minority shareholders. If you make a business visible and accountable, you'll quickly get better performance than if it's part of a big umbrella. The joint pharmaceutical operation can take the superior talent and energy that's been developed on both sides and maximize the value of Celebrex.

But we are going through an inflection point, too. With our success, we're at the point where we have to start expanding our resources. Instead of both companies making a major infrastructure investment, we can now pool our resources. The complementarity is unique—Monsanto is a better fit with us than with any other company. We need to beef up the US in order to launch big products such as Vestraand Detrol OD. Because we fixed a weak point and added a strong point for Detrol, we've raised our sights for it to over $1 billion, moving it from a urology focus to a primary care market. That will take a lot more marketing muscle. The once-a-day version of the product eliminates some of the dry mouth associated with the drug and we've shown compelling evidence that it works in ordinary incontinence [not just overactive bladder].

Question:Do you not worry at all about incurring so much dilution and managerial expense in order to acquire selling resources? In the first place, there are more sales reps then ever and one has to worry whether adding more is economically sensible. Second, given the disintermediation promised by the Internet and the potential for electronic detailing, might not large detail forces become a drag on earnings, not an engine for them?

Hassan:It's a very good point. The total headcount of reps used to be about 40,000. It shrank to the low 30s around the time of the health care debate; now it's back up to about 60,000. My own feeling is that doctors could see more reps, but we're reaching a level where we'll begin to see diminishing returns. A typical high-prescribing doctor is targeted by the same companies. Let's say that the doctor is called upon by 60 different reps of various companies, including multiple sales divisions of the same company. The doctor has a capacity to build trusting relationships with maybe 15 of those 60 reps. Where the rep is able to break through, build that relationship, he or she creates the channel for whatever therapeutic areas are relevant to that company. But the other reps are going to get marginal business. And that's where companies will see diminishing returns. The doctor is a human being and generally has the capacity to build only a few of these relationships, which will generate 80% of the business. Companies will start to insist that their reps be capable of creating these kinds of franchises—or they will be very careful of the resources they expend.

Even as the industry consolidates, the total headcount in the US will go up a little bit more. Keep in mind that there has been a lot of new innovation that will require new reps in the next 6-10 years. And European and Japanese companies are hungry to break in to the US market, either directly or through partnerships. If you're spending money on basic research you have to have an American strategy. You cannot rely upon European governments to give you the pricing you need. The US is the only market that will reliably provide you a reasonable return on your investment.

Question:But can't the new Internet-based technologies replace some of the need for reps—undercutting the value of the sales infrastructure the consolidators have been buying for such high prices?

Hassan:I don't think any technology will replace face time, which is what you get with a relationship. That part's not going to go away. Technology can improve productivity and efficiencies in those areas where reps spend a lot of time in service work—sample fulfillment, for example. But my own feeling is that the Internet will help more on the consumer revolution than with doctors. Doctors appreciate a certain number of relationships with the better reps who call on them. The science moves so fast in our business that they almost look to the rep to keep them up to date. That won't be displaced by technology. Ten years ago, people were talking about displacing reps with technological solutions. But doctors are human beings; they appreciate the relationship.

Question:One of the arguments we've heard for years justifying mergers is that they aggregate money for better, more productive research. Do multi-billion dollar research budgets help—or are they counterproductive in that the bigger research organizations are also far less efficient?

Hassan:Size helps because it allows you to diversify your risk. You can make a few big bets—and you have to take big bets. You can chase a big idea with big resources. And downstream the bigger your resource pool the more you can do things in parallel and thereby save time, moving drugs to the market faster. That's the big advantage of a huge research budget.

To me, however, the most important element of success is the ability to manage the budget very well. In particular, it means making sure we have the right resource allocations based on a dynamic understanding of science—the ability to constantly learn not only from one's own successes and mistakes but also from others'. I have seen so many examples where people have pursued programs even though other people have been down the same road and failed. Take zopolrestat [pulled from development by Pfizer Inc. after the drug failed to meet its endpoints in Phase III trials for diabetic neuropathy]. Tolrestat at American Home had already shown how not to do something and yet Pfizer went and did the same thing. Bigness doesn't answer those problems. That is an execution issue.

Question:But can bigness exacerbate those problems?

Hassan:To some extent. In larger companies, the senior director of R&D is removed from the trenches where the real work gets done. In the old days, in the 70s and early 80s, there was enormous productivity at Janssen and Astra [now AstraZeneca PLC ] where you had a director who was close to the trenches. Now you have the person making resource allocation decisions who's in charge of a VP, who's in charge of a director, who's in charge of a manager, and then you come to the project leader—who's many layers away from the resource allocation mechanism. That's where the law of diminishing returns can be a problem. Those companies that can deal with this issue in some manner will come out ahead. But it will require special top management who know how to deal with bigness.

Question:Has anybody been good at this?

Hassan:All companies have had flourishes. Pfizer went through a very powerful innovation stage but they've run into a dry period. Glaxo [now Glaxo Wellcome Inc. ] went through an extraordinary stage as a fast follower, but then have had some difficulties. Sometimes the same thing that makes somebody a success also breeds complacency down the road. You have to sometimes move people along so that you can have the very best people running the shops.

Question:Will you run into this problem?

Hassan:We have a tremendous guy in Phil Needleman. In a mid-sized operation like Searle, he raced Merck & Co. in the Cox II business and beat them. He used the Astra/Janssen model against a big company and it worked. Now the challenge is that we have a huge company. And that's where Goran Ando and Phil Needleman together can make a lot of good music. Needleman is a passionate project manager, a project driver; Goran Ando is a very good global process oriented R&D person. Once you get to this size, you need both skills—portfolio and process management and intense, passionate project management. Maybe sometimes you don't have everything in the same person. You need a blend of skills. I think the Warner-Lambert Co. combination was pretty successful—Pedro Cuatrecasas and Ronnie Cresswell—who did Lipitor [the two R&D executives more or less jointly ran Warner's research program for much of the early and mid-1990s; they had also run Wellcome PLC's R&D in the early and mid-1980s]. It can be made to work.

Question:Do you not sense that the stock market has, to some extent, decided that mergers aren't the answer to the pharmaceutical industry's productivity problems—particularly given the Internet craze and biotech's sudden revival?

Hassan:If you look at the economic theory we all studied in college, you ultimately return money to shareholders through dividends. And the Internet sector doesn't provide strong cash flow. So how does the money get back to investors? The pharmaceutical industry is one of the best cash flow sectors out there. And the price/earning multiples and the flow of funds into the sector are not reflected at all in the stock prices. The funds flow is going into many sectors where there is no assurance that I can see for big cash flow within a reasonable time. There are some sectors developing out there where there will be some benefits from disintermediation. But those benefits are not long-lasting. With pharmaceuticals, you bring in a new product, like a Celebrex and sales will grow as the population ages. We're now entering an era of demographics which will benefit this sector enormously. You have an expanding cash flow situation—not a disintermediation window. If you can sell books on the Internet, you can displace bricks and mortar—but for how many years before that catches up with you? And I don't know if investors are seeing that.

Question:But isn't the market asking whether pharmaceuticals can continue to grow earnings at historic rates? Certainly the market is no longer capitalizing consolidation synergies the way it used to—most consolidators' stock prices have fallen after a deal is announced; in the past, they rose.

Hassan:There was a period when the market overreacted to consolidation, putting too much of a value on it. The rough rule of thumb was to put a multiple of ten times annual synergies on these deals—one can question whether that was sensible. Maybe the industry got overextended by early 1999; we'd been through a very strong period. But now we may have been sold off too much as a sector. If you look at the larger picture, at how certain sectors have become so rich, so highly valued, compared to sectors that are truly grounded in high-value products, it just seems that there is a disconnect here. It will soon be our industry's turn to go up. You are aware that [majority-owned] subsidiaries of American Home, like Immunex Corp. [market cap: $25 billion], are worth substantial percentages of American Home's value [market cap: $61 billion]. Immunex is driven by just one large product. When these valuation mismatches start to happen—when Genentech Inc. [market cap: $41 billion] has the value of an established pharmaceutical company like P&U [market cap: $25 billion]—then you start to wonder about the valuations. P&U has a global reach and a global assembly of assets, which you can't duplicate in a specialty house. Remember when Levitz was a high-value furniture chain? It happens again and again—there's a fashion element to this.