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Big Pharma Gets Bigger

By Chris Hill – Jun 27, 2019 at 9:47AM

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The AbbVie-Allergan merger is massive, but two decaying businesses don't necessarily combine to produce long-term growth.

In this episode of MarketFoolery, host Chris Hill talks with senior analyst Jason Moser about some fresh business news. AbbVie (ABBV -0.83%) and Allergan (AGN) plan to join up, but the market doesn't seem that happy for them. Warren Buffett cryptically reported that there's no tension between Berkshire Hathaway (BRK.A 0.32%) (BRK.B 0.32%) and 3G (and their terrible investment that is Kraft Heinz (KHC -1.74%)). Doth the world's most famous investor protest too much? Plus, Moser shares some investing takeaways he had during his vacation. Find out what makes Zoetis (ZTS -1.15%), Spotify (SPOT -0.43%), and Slack (WORK) companies to watch, and mourn the fact that the eternally useful TripAdvisor (TRIP -0.72%) can't figure out how to build a compelling business.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on June 25, 2019.

Chris Hill: It's Tuesday, June 25th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, back in the United States of America, it's Jason Moser, looking tanned, rested, and ready.

Jason Moser: I feel like, in my defense, I probably am always looking tanned to some level. I was adopted, so I don't know necessarily the bloodline there, but we've all determined that there must be some Mediterranean in me. 

Hill: But as someone who sees you pretty much every day, you're looking tanner.

Moser: Maybe a little bit tanner. There was a lot of sun there. You're a little bit closer to the equator in Costa Rica. 

Hill: Yeah. We'll get to that. And we'll get to some drama, or maybe not drama, between Warren Buffett and 3G Capital. We'll unpack that as well. Once again, we're going to start with a big deal. This time in the healthcare space. I'm saying healthcare. The huge umbrella of healthcare. AbbVie buying Allergan. Allergan, the maker of Botox. This is a $63 billion deal, cash and stock. Allergan, if you're a shareholder, you're having a heck of a good day because the buyout price is 45% higher than yesterday's close. I am curious, though, at the fact that Allergan is now only trading up about 25-28% higher. We'll get to whether or not this deal goes through. This is yet another big deal.

Moser: Whether it goes through is going to be interesting, just from the perspective that it wasn't all that long ago that there was an offer made for Allergan for quite a bit more than today's offer. But then also, the recent calls have been for the company actually to split up and spin off some of its assets to realize more value that way. And then you find yourself where you are today as a shareholder, the deal, is that going to be the best way to realize value for Allergan shareholders? I don't know. Maybe. I feel like it is a deal that brings together two companies that can likely do more together than separately. There's not a lot of overlap there. 

I look at this space, it feels like the chipmaker space in the sense that they're always stuck on this wheel of never-ending innovation. You've always got to come up with something new, the next big thing. If you don't come up with that next big thing, the fall from grace can be pretty severe. 

Allergan, I think most people probably know it for Botox. I'm a little bit conflicted there. I know there's some therapeutic implications there with migraines. It seems to be more something people associate with wrinkles and cosmetic stuff. You have to wonder how necessary that is, other than just someone's vanity, and I don't have a lot of sympathy for that. But it's a difficult line of work. Drugs face a lot of scrutiny. There are going to be plenty of failures. It's questionable, honestly, today, whether you should be using some of them. Interesting to see how this all plays out.

Hill: Yesterday, Dan Kline and I talked about the merger in the casino industry with Eldorado and Caesars. That's one that, at least to hear Dan Kline tell it, over the long term, he feels good about that deal. Clearly, based on what's happening with shares of AbbVie today, it looks like there are plenty of people who don't like this deal, or at least think that they are paying too much for Allergan, because shares of AbbVie are down about 15%, and it's not like this stock's been lighting the world on fire the last 18 months.

Moser: Yeah. We talk about that a lot. The acquirer usually feels a little bit of a pinch on the day of a deal. The acquired feels a little bit of a bump. It does seem like these are heavier reactions than we might normally see. I do get that. When you look at Allergan, its overall business, you're talking essentially, between Botox cosmetics and therapeutics, that's more than $2.5 billion of the company's overall sales, and that growth is clearly slowing down, if you look at those numbers. But then, when you look at the two companies combined, there are risks out there when it comes to generics. A lot of these drugs that they've been benefiting from for so long are starting to come off patent now. Generics are a common threat. There was a depression drug recently that Allergan had trouble with.

I do think we are hitting a new generational mentality that is going to question whether we need a lot of these drugs, whether it's depression -- I mean, they're serious problems. I'm not making light of something like depression. Any of these things require attention. But these commercials for these drugs, it takes more time for them to read off the side effects and potential implications as opposed to the benefits of the drug. Remember that Simpsons -- God, I'll always go back to The Simpsons. Remember that Simpsons a while back, where Homer was approached to be the spokesman for Viagragain? Remember that? "It gives you a lot of hair and what you need down there." [laughs] But then, "Possible side effects include loss of scalp and penis." That's what was said next, and that's what these drugs always feel like! You see this little benefit, and you're like, "That's nice!" Then you hear about the side effects, and you're like, "Why the hell would I take that thing? It sounds like I may die! Maybe I'd rather do it on my own terms." There is something they have to figure out there. I'm not sure it's so simple. It does feel like this space is only becoming more pointed in that direction, where you question the benefits vs. the costs. So, the consolidation is not terribly surprising. But two companies with slowing growth doesn't necessarily make one company that can then accelerate growth.

Hill: Speaking of slowing growth, let's talk about Kraft Heinz. Shares are down about 50% or so this year. There have been reports of trouble between Berkshire Hathaway and 3G capital. Bears remembering that those two teamed up a few years back to buy Kraft Heinz and got a lot of headlines at the time, and rightly so, in part because Warren Buffett had, up to that point, a track record of making acquisitions essentially on his own. So at the time, it was like, "Wow, here's this new deal." Also, Buffett has been critical in the past of private equity. It raised a couple of eyebrows that Berkshire Hathaway would team up with a private equity firm, even one with the reputation of 3G Capital, and then go out and buy Kraft Heinz. 

Apparently, these reports... you hear little rumblings here and there. It never struck me as something that was front-page news. Maybe I missed it. I don't know that The Wall Street Journal had some splashy headline on the front page about some big rift. But apparently, Warren Buffett felt the need to reach out to CNBC and come out today and say that there's no tension between Berkshire Hathaway and 3G. He really downplayed these reports. 

I don't know your reaction, but my reaction was, first of all, given what's happened, given the way Kraft Heinz has performed, particularly over the last two years, the writedowns that have happened for Berkshire Hathaway, the fact that Buffett has had to come out and say, "Oh, yeah, we paid too much for this," I think any reasonable person would expect there to be some level of tension. That seems like a little bit of he doth protest too much.

Moser: Your Slack message made me laugh on my way to work. "Really? Shouldn't there be some tension?" Yeah, you're damn right there should be tension! The stock has gotten killed, and for a lot of not necessarily easy-to-fix reasons. Misreporting notwithstanding, restatements notwithstanding --

Hill: Just to add parenthetically, yes, Kraft Heinz, also some accounting problems.

Moser: We've certainly we've seen other companies have that. You're talking about something that's very fixable. You can recover from it. The thing about this deal that always struck me, on the surface, it's right in his wheelhouse. Consumer brands, not tech-related. It's food. It's something you associate with our childhood. A lot of these brands, you and I associate with our childhoods. I think that's part of the problem. I know he said that the biggest problem facing Kraft Heinz is that Heinz overpaid when merging with Kraft in July, and then they made a mistake in overpaying for that investment. I think it goes far deeper than that. I think these are brands that are not resonating with younger generations of consumers today. I don't think that necessarily changes so quickly, particularly when you see the attitudes toward what people are eating, the brands that are coming up from that, the nature of being able to get out there and brand build that didn't exist when we were growing up, via social media and other channels. 

It's not to say that this is some trip to zero. I don't think that's the case. There's value in Kraft and Heinz and Philly cream cheese and whatnot. But I don't look at those as brands that are going to be leading the way going forward. For them to just think that overpaying was the problem misses the point entirely.

Hill: I'm not rooting against Berkshire Hathaway. I'm not rooting against Warren Buffett. But to be completely honest, part of me is heartened by the fact that, yeah, Warren Buffett's human. He would probably like a mulligan on this one. From time to time, we talk about sunk costs, and how that's hard to fight against as an investor. Turns out, it's hard for Warren Buffett to fight against. At the time of this deal in 2013, one of the things Buffett said at the time was, "Oh, yeah, I've had my eye on Heinz going back to 1980." For more than 30 years, he had, on some level, been looking at the Heinz business and saying, "Boy, I sure would like to get some of that."

Moser: And ironically, had he made that investment back then, I'm sure things would have worked out a lot better. You hit on something there that I would love to know. Given a mulligan, if you could have this deal for half of what you paid for it, would you do it again? I'd ask Buffett that question. Would you do it again if you could do it for half? Maybe he would, maybe he wouldn't. I think the value investor in him quite possibly would. I would still question that. Again, it goes back to, sometimes things are cheap for a reason.

Hill: U.S. News and World Report has come out with their annual list of the best places to travel to. Paris coming in at No. 1, followed by New Zealand's South Island, then Rome, Tahiti, and London, rounding out the top five. No. 29 on the list, Costa Rica. 

Moser: Hey!

Hill: I do want to hear not only what kind of time you had in Costa Rica with your family, but also to the extent that you had business takeaways.

Moser: I always do. 

Hill: But I did note that in the write-up, U.S. News and World Report included this caveat when it comes to Costa Rica. I'm quoting here. "Just make sure you plan a visit during the country's dry season between mid-December and April." I read that this morning and thought, "Huh, let me check the calendar."

Moser: First question. 

Hill: "I'm pretty sure Jason's trip fell outside that window."

Moser: It definitely did. First and foremost, I thank my lovely wife for lobbing this idea up many months ago. Once she said Costa Rica, I thought, "Hey, I'm all in!" That's a place we'd never been and would love to go visit. We planned it for a while. Thankfully for us, the weather worked out really well. We had a couple of days that were total rainouts. Very fortunate that on those days, we didn't have anything planned. The house that we rented was on top of a mountain on the Pacific Ocean side of the country, so we had a nice view and easy way to spend the day, even when the weather was bad. That's first time we've ever been. I loved it! I feel like if you love nature and wildlife and animals, that's a place you need to go visit. I can't speak to the other side of the country. From what I've understood, the Pacific side is better from a wildlife perspective. Certainly, we got to see a lot of it.

Hill: From a business standpoint, I know from following you on Twitter, you were reading John Carreyrou's book, Bad Blood.

Moser: That was just entertainment. I'd spoken with Greg Gauges, a member of ours, at Fool Fest. He had told me -- I was waiting to just watch the documentary on HBO. He said, "Dude, read the book, then watch the documentary; or watch the documentary, then read the book. Either way, do both." I took him up on that. No regrets. It was a terrific book!

I look at that trip, and man, there's so many things I did, that we did, that touch my portfolio in one way or another. The easy thing is to come back and talk about payments and travel. I'm not going to talk about that. I think I've talked about that before, traveling. But because of Costa Rica, because of the nature and wildlife side of it -- we went to an animal sanctuary one day. They were helping injured animals in the jungle recover, so they get hopefully put them back out. We went horseback riding one day through the jungle and on the beach. It was really cool. Saw tons of wildlife. It was so cool. It got me thinking that one of the companies I talk about a lot on the show, Idexx Laboratories. The other one that doesn't get as much attention is Zoetis, ticker ZTS. They're in the business of the animal health, medicines, and vaccines. Whether it's companion animals like dogs, cats, horses, or livestock animals, Zoetis is essentially the world's biggest company when it comes to this. Spun out of Pfizer a while back. A little bit of a bigger company, perhaps the growth isn't quite like a Rule Breaker. Plays in a very, very large and growing market. Pays a nice little dividend. Well-led. I own shares personally. Zoetis struck me as one that, from the wildlife perspective, I'm certain that some of their stuff was being used down there. 

And then, from an entertainment perspective, beyond the book, I do think Spotify is building a strong entertainment platform. Beyond music. I think it's going to become an entertainment platform that people use for so many different things. They've got such a large user base now with a lot of data they can pull from that. They're building their own content. I think they'll be able to do a lot of stuff with it. So, Spotify is another one. 

The Fats Domino award, that goes to TripAdvisor. Ain't that a shame? It's such a helpful service, and for whatever reason, they just cannot build a compelling business from it. I said it from the Bahamas, and Costa Rica was no exception, I got so much help from TripAdvisor on the trip there. But for whatever reason, they've not been able to build a compelling business out of it, at least yet. Maybe that'll change. 

One to keep an eye on, even when you take a vacation, work never seems to escape you, particularly if you love your work like I do. With the new AR service, I was in touch with some people here back and forth, and Slack was really helpful from that perspective. Ticker WORK. New listing, obviously. Everything from work to, I got to go have dinner down there with Mario Gatica and his wife Sophia. They're Fools and they've been to an Austin event and more recently at Fool Fest. We got to go see them in their home country. That was really cool! Posted a picture of that on Slack. People here at work loved it. A lot of different things that the platform does. I like the integrations with other companies we like out there that are doing neat stuff, helping workplaces communicate better. That was what was going through my mind when I wasn't completely unplugging.

Hill: Nice! Glad you unplugged and I'm glad you made it back!

Moser: Thanks, man!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That'll do it for this edition of MarketFoolery! The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!

Chris Hill has no position in any of the stocks mentioned. Jason Moser owns shares of IDXX, TripAdvisor, and Zoetis. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), IDXX, and TripAdvisor. The Motley Fool has a disclosure policy.

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