GlaxoSmithKline: Sins Of The Father And The Right Strategy

| About: GlaxoSmithKline (GSK)
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In the largest settlement ever, GlaxoSmithKline (NYSE:GSK) agreed to pay the settlement of all settlements clocking in at $3 billion to the Federal Government. How did the mountain of penalties get so behemoth? Count just about every disparate egregious behavior which includes fraudulent marketing and using undue influence in swaying the intellectual capital of prescribing physicians by using a trove of gifts and other sundry item, and roll them all up and you arrive at a this lofty sum. This sets a new standard in terms of being the largest healthcare fraud settlement in history, eclipsing Pfizer's (NYSE:PFE) 2009 $2 billion payment.

The Charges:

According to the Department of Justice, The Associated Press, Reuters, and GlaxoSmithKline Pharmaceuticals' own press release, GSK will plead guilty to two (2) misbranding charges and a third count of failing to report Avandia safety data to the FDA. GSK also is guilty of marketing Paxil for use in children and teenagers from 1998 to 2003. These are patient populations that Paxil was not tested in and approved for by the FDA and constitutes "Off-Label" use which is forbidden by the FDA. GSK agreed to plead guilty to the charges and to pay criminal fines of $757 million for the Paxil and Wellbutrin abuses and $242 million for its Avandia actions, said the Department of Justice (DOJ). The company will pay an additional $2 billion to resolve False Claims Act liabilities on those and other drugs, as well as charges of pricing fraud, said the DOJ. Wellbutrin was promoted 1999 to 2003 as a veritable panacea for everything from Sexual Dysfunction to Weight Loss, which is significantly removed from its approved indication as an antidepressant.

The product credited with creating a huge financial drain on GSK: Avandia, was also cited for having allegedly failing to document and submit safety data to the FDA with respect to cardiovascular incidents during the period of 2001 and 2007. On 14 June 2007, an article was published by Steve Nissen, Chair of the Division of Cardiovascular Medicine at the Cleveland Clinic in the New England Journal of Medicine. This meta-analysis showed an increased odds ratio of myocardial infarction in patients taking Avandia. This was Avandia's death knell as physicians became exceptionally leery of using it in their type II Diabetic Patients. This fear factor was amplified when the FDA mandated that Avandia's Prescribing Information have a "BLACK BOX WARNING" which accentuated the increased risk of cardiovascular events in patients taking Avandia.

The civil claims are more extensive since they encompass a host of off-label and kickback allegations relating to a significant portion (nine products) of the GSK portfolio of products. And lastly there was the matter of covering false prices reported to Medicaid from 1994 to 2003. The company will pay an additional $2 billion to resolve False Claims Act liabilities on those and other drugs, as well as charges of pricing fraud, according to the DOJ.

The Corporate (Right) Reaction:

The response by GSK CEO was swift and direct. Andrew Witty stated:

The civil settlement reached with the Government does not constitute an admission of any liability or wrongdoing in the selling and marketing of Lamictal, Zofran, Imitrex, Lotronex, Flovent, Valtrex, Avandia or Advair products, nor in its nominal pricing practices.

GSK has made fundamental changes to its procedures for compliance, marketing and selling in the US over the last few years. The company has adopted new policies, enhanced others, and implemented measures to strengthen training and compliance programs, including adding compliance staff.

The GSK world that I lived through in my last several years with GSK morphed into a state of steady reflection and caution of every interaction we had with customers. Having lived through it, I would have to say that although it was very rigid and stifling at times, it did limit the exposure of the company and its people from crossing the ethical divide.

As part of the settlement, GSK has entered into a Corporate Integrity Agreement (CIA) with the US Government. Part of the CIA covers obligations that GSK has agreed to as it pertains to the manufacturing facilities in its former Ciadra PR plant. GSK will also enter a five-year Corporate Integrity Agreement, brokered with the Department of Health and Human Services Office of Inspector General, that mandates changes in sales force compensation

"to remove compensation based on sales goals for territories, one of the driving forces behind much of the conduct at issue,"

according to the DOJ.

An Important Side Note:

GSK, in the United States, made a commitment to be better aligned to their customers by removing compensation based on sales goals. A bold new step in a totally new direction. Although philosophically GSK is where it needs to be, I have several questions about its implementation. Originally touted as the brain child of Deirdre Connelly - President of GSK North America Pharmaceuticals, now we find that according to the CIA, it is an important and mandatory term, and condition, of the settlement. What an interesting twist on something that GSK would have been mandated to do from the onset. Having said this, I believe that once GSK finds the implementation groove to be totally aligned to its customer and properly reward its sales representatives to be in alignment with their goals, that GSK will enjoy the first move (speaking in chess and marketing terms) advantage as a pharma company that has transitioned to this paradigm.

Why it Made Sense to Settle:

The facts are that with this one galactic settlement, GSK effectively was able to conglomerate an immense variety of separate issues that would, individually, keep a steady stream of negative publicity of GSK in the minds of the media hungry public for decades to come. It would also have an unknown cost burden on the company for the same period of time. The brilliance of Andrew Witty is that all these alleged acts, that are part of the settlement, were actions that were literally Sins of the Father. From a timeline perspective they all occurred before the assumption of the corporate ship by Andrew Witty. In fact, the great bulk of the alleged infractions came to GSK as a result of the leadership of his predecessor, Jean-Pierre Garnier, who was CEO of GSK from 2000 - 2008. The investigations by the DOJ were from 1997 to 2004. And with Advair it was extended out to 2010.

The Financial Impact:

With respect to the accounting of the settlement and the effect it will have on total earnings Andrew Witty goes on to say:

The net effect of these movements on total earnings is expected to be neutral.

In one fell swoop, GSK has attempted to corral and quantify all the disparate legal trials and legal morass into an orderly herd to deal with and neutralize. Sure, there will be other things that crop up that will be fodder for the attorneys to hang their hat on to earn their keep, but, this effort goes a long way in limiting the collateral damage: principally cauterizing the constant drone of negativity that permeates the air waves about GSK and Big Pharma. This also serves to limit the unknown cost of all the separate litigation that is covered by this settlement. Combined and coupled with its reliable dividend yield (4.8%) and promising pipeline of products makes it a staple in my long positions.

The Future and the Baked In Settlement:

The future of GSK looks exceptionally promising. That is precisely why it is important to prevent a legal wormhole from appearing that would have the past mistakes of GSK (the Sins of the Father) haunt the future of GSK for decades to come and result in amputating the vision of the man on top for a bright GSK future. Based on this strategic move, I believe that this settlement is already baked into the valuation of the company and should have very little effect on the companies future total earnings. It will leave GSK in a position to harvest the fruit of its R & D efforts and move ahead on its merger and acquisition activities. Especially, either pursuing Human Genome Sciences (HGSI) or just planning to walk-away to spend $2.6 billion elsewhere. But, that is a whole other story. Add two (2) cents to the aforementioned and you should have a dollar.

Disclaimer: The information in the aforementioned article is provided for informational purposes only. It represents the opinions of the author and is not a call for action relative to the buying or selling of stocks and other investment vehicles. It is highly recommended that you conduct your own research and reach your own conclusions before you make an investment in anything.

Disclosure: I am long GSK, NVS.

Additional disclosure: I have 31 years of experience in the Pharma Industry in a wide variety of positions.