The American market for pharma and health products is expansive, the mark-ups generous and any multi-national which sought to ignore it might as well give up the ghost.
Yet the United States also exposes corporations to regulatory and litigation banana skins.
GSK’s shares suffer from the overhang of Zantac, the stomach medicine, which has been claimed – despite solid scientific evidence to the contrary – to have caused cancer.
An even bigger share price overhang faces Britain’s Reckitt Benckiser. For many years Reckitt defied gravity. It demonstrated an ability to turn underperforming hygiene and consumer health assets, such as Cillit Bang and Nurofen, into super brands. However, when it moved into baby formula, with a £13billion takeover of Mead Johnson five years ago, it entered trickier territory.
Baby formula, while providing nutrition, has long been regarded as controversial and a poor substitute for mother’s milk and divides opinion.
Tricky territory: Baby formula, while providing nutrition, has long been regarded as controversial and a poor substitute for mother’s milk and divides opinion
It is often the only food source available to premature babies in prenatal care units before mothers are able to produce their own milk. Plaintiffs are claiming Mead Johnson (and Abbott’s baby formula) is responsible for causing the death of prenatal babies. The litigation brought by well-funded specialists was given fuel by an Illinois jury. Earlier this year it ordered Reckitt’s Mead Johnson offshoot to pay $60m to the mother of a premature baby who died of an intestinal disease after being fed the Enfamil formula.
The case has become a serious problem for Reckitt chief executive Kris Licht. At a time when FTSE100 shares have been advancing Reckitt’s stock has declined by 30 per cent over the last year.
Broker Barclays estimates that the cost of dealing with the litigation being brought against Mead Johnson – still structured as a separate entity – could be anything between £500m and £2billion. Suffice it to say US class action suits are a notorious lottery and the outcome unpredictable.
Reckitt should have little to worry about. In most intensive care neo-natal units medical experts have no choice but to administer formula to supplement or replace mother or donor milk.
GSK’s battle over Zantac tells us it doesn’t really matter about the underlying truth. In jury cases, even if the evidence is piecemeal, the panel is always going to be more sympathetic to the plaintiff than big corporations. The emotional pull of the death of a baby will be hard to overcome. It may not help that Reckitt has form of being careless, notably over deaths in South Korea caused by a totally unrelated malfunctioning humidifier disinfectant.
Reckitt’s managerial problem is how best to deal with it and restore investor confidence. One mooted solution is to hive off Mead Johnson into a separate entity.
A proposal put forward by analysts at Barclays would call for Reckitt to spin off a majority stake in Mead Johnson and re-list it in the US. The numbers suggest that such a move, with Mead Johnson taking on a share of the debt, could resolve the legal overhang. The formula company generates sufficient cash flows and profits to meet potential liabilities.
There are lessons to be learned from Reckitt’s downfall. Transforming mergers rarely deliver the growth and dividends that the protagonists promise. A more politically aware Reckitt board should have recognised that involvement in baby formula would be fraught and carry enormous litigation risks. The price is now being paid.
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