Value insights: The investment banking sausage
The potential for companies to be taken over at low-ball valuations is a perennial risk for investors, but one that is more acute in cyclical downturns. There are ways to mitigate the risk.
‘Value insights’ presents the Ninety One Value team’s distinctive perspective on global markets.
We’ve recently enjoyed (if that’s an appropriate term) reading ‘Empire of Pain’ by Patrick Radden Keefe, a meticulously researched account of the opioid crisis in the US, particularly the role of Purdue Pharma and its owners, the Sackler family. The historical research by the author is of the highest calibre, for example in uncovering that much of the Sacklers’ wealth initially came via marketing Valium in the 1960s and 1970s, using techniques that would be repeated when marketing opioids decades later. The sheer number of injustices in the book leave you almost screaming out, “Why didn’t somebody do something?”, a question implicitly answered by the author’s diligent analysis. In summary: everyone that tried came up against powerful entrenched interests.
There are many lessons to be drawn from ‘Empire of Pain’ – though the full story is still emerging, as documents currently subject to privilege are released into the public domain, and as the bankruptcy process of Purdue Pharma results in millions more documents being filed for other investigative journalists to explore (Radden Keefe suggests that, regarding some of the documents covering historical depositions by Sackler family members, he was the first person to even open the boxes, let alone review the contents).
The topics that resonated most with us, in terms of their relevance in an investing context, were ‘incumbency’ and ‘inertia’, powerful positive and negative forces, respectively (depending on your point of view). In the case of the Sacklers and Purdue Pharma regarding their drug OxyContin, they realised very early on (informed by earlier experiences with Valium, among other drugs) that once enough players across an industry vertical are invested (financially and emotionally) in your product, your position can be extremely hard to dislodge.
We would emphasise that ‘Empire of pain’ states that this incumbency was achieved by nefarious means, including inaccurate claims about the safety of OxyContin, and aggressive and misleading sales and marketing tactics. This then fed into inertia of the various players in the process, with regulators unwilling to admit any earlier wrongdoing (and hence dragging their feet when it came to making any changes to the drug’s permissions or marketing claims), physicians reluctant to stop prescribing their patients’ ‘favourite’ drug, and the multitude of firms involved in the drug’s production and marketing reluctant to put the brakes on a fast-growing and highly profitable product.
The analogy of incumbency and inertia extends to the patients themselves, hundreds of thousands (possibly millions) of whom became addicted to opioids. Perhaps even more sadly, the eventual reining in of OxyContin prescriptions was followed by a spike in heroin use; evidence points towards a link between these two events, though this is contested.
When incumbency has been achieved by legitimate means, it can be a very positive characteristic for companies, leading to strong (and hard to break) ties between customers and suppliers, building up a company’s trust and reputation in the wider industry, and generally raising the barrier to entry for competitors aiming to break into the incumbent’s turf. We often find that the cyclical leaders that we invest in have occupied the top spot in a given subsector, region or even an entire global industry for decades, and this can provide a great deal of comfort on the predictability of the company’s earnings through the cycle.
When it comes to inertia, though, this negative trait is something we do our utmost to fight, both on a mental level when analysing a company, and on a portfolio level when monitoring and reassessing our investee companies. While we often believe in mean reversion, at both a company and industry level, circumstances can, and do, change, and while it would be all too easy just to assume the future will look the same as the past for companies under our coverage, sometimes the lazy approach is clearly the wrong one, and we need to be open to the possibility that structural changes may have taken (or may take) place in the industries on our radar.
Similarly, while sticking with our original investment theses for our portfolio of companies will generally be the right thing to do for the majority of the stocks, there will be instances where factors have changed for the worse (or better) and which therefore warrant a reassessment, and potentially a trade-off into a better idea that can displace the incumbent position in the portfolio. While some of our peers include ‘do nothing’ as a core part of their investment process, we prefer to remain open-minded to both new and existing ideas, and are always looking for trade-offs to maximise the performance potential of our portfolio. Sometimes it really is better to do something.
The value of investments, and any income generated from them, can fall as well as rise.
