My Favorite Pharma CEO

At The Motley Fool, we love to invest in companies with great management. My colleague Sean Williams wrote a series of articles about this year's top five CEOs. I can't criticize any of his picks; they all have impressive track records. However, one of my favorite CEOs was overlooked: J. Michael Pearson of Valeant Pharmaceutical (NYSE: VRX  ) .

Pearson joined Valeant in 2008 with a fairly non-traditional resume. He isn't a scientist, and he'd never had an operational role in a pharmaceutical company. He also came with a pretty radical strategy: Eschew R&D, focus on returns on capital, avoid government payers, etc. He implemented this strategy, and it's been incredibly successful for shareholders. He's generated 10-bagger stock returns without R&D in defiance all conventional wisdom.

Unscientific background
Michael Pearson has all the traits you'd want to see in a CEO. He has a long record of achievement, outstanding educational credentials, and work experience at a top firm. He grew up in a lower-middle-class household in Ontario, where was an Eagle Scout. His family sacrificed to send him to Duke University, where he excelled as a hockey player and a student earning degrees in math and engineering. He won an academic scholarship to University of Virginia's rigorous MBA program. He was recruited by the prestigious McKinsey & Company consulting firm, and spent 23 years at McKinsey, eventually rising to become global head of its pharmaceutical practice and a member of its board. From there, he was recruited by ValueAct, a major Valeant shareholder, to become the company's chairman and CEO.

While Pearson's resume is impressive, it is a bit unusual as the CEO of a large pharmaceutical company. First, he doesn't have a research or scientific background. Science is core to the pharmaceutical business, and many great pharma companies are led by scientists and PhDs -- for example, John Martin of Gilead Sciences. Pearson doesn't fit this mold at all. He's not a scientist -- he's a business person. Second, prior to joining Valeant, Pearson had plenty of experience in advising pharmaceutical clients, but he didn't have any experience working at a pharmaceutical company. Serving as a senior advisor or consultant is quite different from running a company as a senior manager.

Unconventional philosophy
Before Pearson was hired to run Valeant, he served as a consultant to the company. Pearson is known for brutal honest, and in 2007, he told the board, "Your current strategy is not only not working, it doesn't have much of a chance to be successful." He pointed out the company's presence in unattractive or highly competitive markets, the risks of products that rely too much on government reimbursements, and the falling productivity of R&D spending. As a solution, Pearson laid out a strategy to focus on attractive markets and treatments, curtail exposure to government reimbursement, and replace R&D spending with smart acquisitions. The board liked Pearson's suggestions, but management was slow to implement them. So the board, led by ValueAct representative Mason Morfit, asked Pearson to compile a list of qualified CEO replacements. Pearson humbly suggested himself. In February 2008, he officially started as Valeant's CEO.

As CEO, Pearson rapidly put his strategy into effect. He cut the R&D budget, sold off underperforming products, and began searching for acquisition targets. Since joining Valeant, Pearson has purchased more than 50 companies, transforming the company into a highly diversified specialty pharmaceutical company with strong positions in dermatology and ophthalmology.

Unbelievable results
The strategy has worked. Since Pearson became CEO in 2008, the stock is up nearly 10-fold, completely crushing the market. Over the past five years, Valeant has delivered compound annual returns of 65% compared to 17% for the S&P 500. Obviously, this has been a windfall for shareholders. It's also been a very lucrative for Pearson.

When they hired Pearson, Valeant's board members heavily tilted his compensation toward performance-based pay. Instead of a big guaranteed salary or annual bonuses, he agreed to performance-based pay based on long-term stock appreciation. The incredible performance of the stock has made him very rich. At present, he owns $700 million of company stock, which he has committed not to sell until at least 2017. Obviously, that's a big paycheck for Pearson, but I think he earned considering the shareholder returns during his time as CEO. And I like that he's holding his shares for at least another three years -- it should align his interests with that of shareholders.

My Foolish prescription
I like to invest with great management teams and CEOs. Michael Pearson's background and strategy are a bit unconventional, but they've delivered great results. Considering his relatively young age (53) and long-term dedication to Valeant, I'm happy to continue investing alongside him.

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