BusinessTN

The exterior of the headquarters of Bristol-based King Pharmaceuticals paints a serene picture. Stately brick buildings sit on an immaculately manicured lawn, which itself is enclosed by a black, wrought-iron fence. Perhaps its peaceful aura stems in part from its historical significance as the original site of King College (the current operations' namesake). Or perhaps the grounds benefit from a certain mystique of the wealthy. After all, these buildings are home to quite a few brand name "multi-millionaires"--King products include Altace, one of the country's more profitable hypertension treatments, accounting for $554.4 million in sales last year alone, as well as the muscle relaxant Skelaxin ($344.6 million).

But beyond the gates, over the lawns and behind the stolid brick exterior, King Pharmaceuticals is a company riding out three years of turmoil. Federal investigations. A restatement of earnings. A derailed acquisition bid. On one hand, one should not be too distracted by the headline-grabbing turbulence of recent years--a closer look reveals few of the splashier newsmakers touched on the core of what is happening with the company. On the other hand, there is something profound happening at King Pharmaceuticals--a studied change in game plan being executed by president and CEO Brian Markison that signals a marked departure from the company's decade-long business plan. It's a change that could mean troubled times for one of East Tennessee's most prestigious corporate citizens or catapult King from the barely billion ranks of Mid-Pharma to the multi-billion-dollar big leagues.

The House that Gregory Built

In order to better understand what kind of company King hopes to become, one first needs to understand how it was built in the first place. King Pharmaceuticals was built by a band of five brothers led by Virginia native John Gregory. As founder and CEO, Gregory, along with his siblings, dramatically transformed the ailing drug manufacturing facility from a $10 million shell in 1994 into a $1.5 billion force to be reckoned with during the family's 10-year reign. (All of the brothers would hold leadership roles at one time of another during this span, with youngest brother Jeff's departure in 2004 ending the Gregorys' involvement with the company.)

John Gregory's approach was simple. While many companies sink millions into the early stages of the R&D process, thereby exposing themselves fully to the uncertainties of lengthy clinical trials and a sometimes arbitrary FDA-approval system, Gregory bypassed the front-end research and development expenses altogether.

"These days, it's almost $1 billion to find a drug and develop it. And a new drug application has over 60,000 pieces of paper attached to it, and there's over 5,000 human guinea pigs who are part of the process," says Darren McDaniel, CEO of Coast Independent Review Board who has worked with King on a prior clinical trial. The average price tag for the most costly study segment, Phase III, is $86 million.

A shrewd businessman with refined knowledge of niche pharmaceuticals, Gregory licensed promising drugs in the late stages of development and got them to market. Sales began to ramp up quickly in 1995 after Gregory licensed the Altace ACE inhibitor to anchor its growing portfolio.

King was investing relatively small amounts to acquire drugs that were pulling in hundreds of millions. Soon, the company had developed strengths in three main specialty treatment areas: Cardiovascular/metabolic (Altace); neuroscience (Skelaxin); and hospital/acute care ($220.6 million in sales for Thrombin-JMI, a topical solution used in surgery). Not surprisingly, Gregory's model has since become more commonplace across the pharma spectrum. With $1.5 billion in revenue and its stock teasing $45 per share at its peak, John Gregory left the company riding high in 2001. The legacy of the family name seemed secure. After all, who could complain about a 15,000% revenue increase in less than a decade? But just as the reign of the family Gregory was wrapping up in 2004, things got very interesting.

The Pharm-Raised CEO

Before joining King as chief operating officer in March 2004, Brian A. Markison had put in more than 20 years with Bristol-Myers Squibb (BMS), engaging numerous drug licensing agreements as president of BMS's oncology, virology and oncology therapeutics network businesses. Markison also led the successful integration of BMS's $7.8 billion acquisition of the DuPont Pharmaceuticals Co. in 2001.

Compared to Bristol-Meyers, King's status as more mid than big is apparent. The New York-based company brought in $19.2 billion in 2005. BMS ranks #110 on the Fortune 500 list. King hovers on the periphery of the Fortune 1000 list at #865. BMS is ranked by Fortune as #5 in its industry, King as #17. Still, for Markison the move from BMS to King was a calculated opportunity. The last Gregory in charge, youngest brother Jefferson, made it clear upon hiring Markison that he was seeking a successor. Four months later on July 16, Gregory gave up the reins, and Markison, now 46, was offered the job. As the new top dog, Markison gained the use of the company jet to commute from his Princeton, N.J., home, near the country's pharma capital (and where King's commercial and sales operations are located). Even though he had been with the company for months, it's unlikely Markison anticipated just how messy of a situation he was flying into.

Enter, and Exit, Mylan

Markison's plans for King's future almost became a non-issue. The new CEO had been at the helm less than two weeks when Pittsburgh-based Mylan Laboratories made a bid to acquire King for $4 billion in a stock-for-stock transaction. Together, the companies would have pulled in about $3 billion in revenues and $650 million in operating cash flow that year. Its workforce would have topped 6,000 (600 in Bristol) with an army of 1,400 drug reps.

The generic drug maker had anticipated FDA approval of its new hypertension drug, Nebivolol, and planned to leverage the muscle of King's tailor-made Altace sales force to market it. On paper, the deal looked promising. Both management teams were onboard. Then New York billionaire financier Carl Icahn entered the picture. Icahn's surprise attack on Mylan, of which he had not previously owned stock, stalled the merger proceedings. He criticized the deal and offered to buy the generic drug maker outright for $5.4 billion, or $20 per share. (Mylan's board refused the proposal saying in a letter that "it was not in the best interest" of its stockholders.) Eventually, the Mylan-King merger succumbed to Icahn's pressure. When King restated its earnings from 2002, 2003 and the first half of 2004, it was the out Mylan needed to legitimately sever the deal. In March of 2005, the generics firm walked without having to pony up the $85 million break-up fee.

As the drama between Icahn and Mylan played out, King was fighting its own battles. A three-year federal investigation of the company was wrapping up, costing King about $125 million to which it owed federal and state government pricing programs (such as Medicaid) between 1994 and 2002. James E. Green, King Pharmaceuticals' executive vice president of public affairs, explains this was an oversight on the company's part and needed to be resolved. Though the numbers were small potatoes on a balance sheet, state Democrats took full advantage of the $125 million charge to taint individual Republicans in the 2004 election cycle who had accepted personal donations from John Gregory. Even though Gregory had long ago departed King, Democratic strategists argued that offending legislators were accepting money from a man (and by proxy a company) that had bilked TennCare, the state's then health care insurance program for over a million uninsured Tennesseans. A spin-heavy albeit highly effective strategy, the political concoction impugned the name of King Pharma in counties across Tennessee and remains all that some Tennesseans know about the Bristol-based company.

Bigger Ponds

Ultimately, the political hay made from King's $125 million adjustment, the Icahn-sabotaged acquisition bid, and even the restatement of earnings all share one thing in common: they are pretty irrelevant to the company's future. The true challenge faced by Markison and his management team is much less newsy, and much more daunting: carving out a larger niche among the ranks of Big Pharma. In a bid to gain a place at the same table with industry leaders like GlaxoSmithKline (annual revenue of $39 billion) and Novartis ($32.5 billion), or even with Bristol-Meyers Squib, Markison initiated a no-nonsense, 90-day plan straight out of any business management textbook, identifying company strengths and weaknesses and looking for ways to streamline operations.

Markison's first conclusion: he wished he had been brought in a few years earlier. While he commends John and his brothers for their entrepreneurial spirit, "I think they have the classic founders' syndrome of not knowing when to get out and let someone else run the show," he says.

Markison initiated a three-pronged strategy: Extend the patent life of King's current high-performing brands, move existing products through the R&D pipeline, and finally, extend King's involvement, and investment, in that pipeline back further. Though Markison certainly wants to give Wall Street something to sing about, he's the first to admit his stratagem for a full turnaround "doesn't get a 10 out of 10 for novelty. It just has to work."

Extending the patent life of drugs like Altace should have been the simplest of these tasks. Unfortunately, King got a very late start in extending the lives of its superstars. The usual approach to gain patent extensions involves adding other active ingredients like a sleep agent to the existing formula. But just as crucial, this extension needs to occur nearer the beginning, soon after the product is launched. Early patent extension allows for the brand to establish a wider user base. For all their sales savvy, on this front the Gregory family dropped the ball. Altace could have long ago been seared into the minds of the American consumer alongside the country's more visible heart disease-related medications like Lipitor and Crestor.

"The concept of branding is a dangerous subject to get into in pharma," says Ken Fyvie of London-based PA Consulting's Life Sciences and Healthcare group. "In general, it is not done well--but it is also such a competitive market that the task is extremely challenging and is further complicated."

Even with extensions, King finds itself at the end of the most lucrative part of the life cycle for its current bestsellers. "Prescription demand for King's key products is declining," says Michael Tong, senior analyst with Wachovia Securities. The threat of strong competition on the horizon from the generics, particularly for Skelaxin, King's second highest seller, could result in a decline in King's EPS of $0.94, he adds.

Markison's stance is that Skelaxin should be exclusive, meaning other pharmas wouldn't be allowed to copy it for resale at a lesser cost, "but the generics are contesting that. The [Food and Drug Administration] seems to be in the middle, but nobody knows exactly where they are," he says. "Even if I had an 'S' on my cape, I still wouldn't be able to lend any greater clarity of the situation." Prospects that rely on discerning the intentions of the FDA is unlikely to inspire shareholder confidence.

"There's no rhyme or reason to the FDA," says Coast Independent Review Board's McDaniel, who describes the agency's inefficiency as cover for a "totally broken system" that ultimately hurts stockholder value.

Few at King would disagree. The line extensions of Altace are still undergoing the final phases of approval and none have made it through the FDA yet. The gap between new revenue generation from these new products and backing into more aggressive R&D efforts could mean Markison will be skating on thin ice before a fresh influx of cash comes King's way.

Not that the Gregorys left Markison high and dry. Despite its difficulties, Markison says King "still had a very strong cash balance, and I knew I would be able to use [it] to do additional transactions while I was fixing the company."

As for King's next Altace or Skelaxin-level performer, its quiver is not entirely empty. In 2005, King spent about $74 million on R&D and acquired $188.7 million of products in development, says King's Green, including Remoxy, an abuse-resistant opioid painkiller, and the much anticipated Bremelanotide (PT-141) for the treatment of sexual dysfunction in males and possibly females.

Though analysts recognize the potential, the general stance remains neutral. "While we believe King could evolve into an interesting story in the next two to three years," Tong reports, "we recommend staying on the sidelines until there is further pipeline visibility."

That leaves perhaps Markison and King's biggest move: a departure from John Gregory's risk-light R&D strategy. "We do plan to spend more on R&D," Markison say. "And you're definitely going to see that this year."

While King did dabble in R&D during the Gregorian era with a presence in Cary, N.C.'s Research Triangle Park, a push to discover new drugs wasn't part of the company's strategy. It didn't need to be. The move into footing more of the bill for research brings with it the prospect of much greater risks faced as well as much larger rewards to be won. And Markison's plan to leverage R&D efforts to bolster King to its next level of maturity won't come without a brand new set of problems and crises, says PA Consulting's Fyvie. In other words, succeed or fail, it's going to hurt.

The Huge Unknown

Markison debuted the new King in April 2005 to what he considered a positive response. "There really wasn't anyone out there who said, "Oh my God, what a lemon,'" he says. King's painful transition has been evident in its fluctuating stock price, a figure now bouncing back from a five-year low of $7.51 per share to a more modest $17.65 in mid-April. "We dove off the high diving board; we hit the bottom of the pool, and then we pushed off with a vengeance. We haven't looked back since," Markison says. Indeed, in his short tenure, King's market cap has doubled to about $4 billion in less than a year. "I try not to look at that because sometimes looking at the stock market is like playing roulette," he says.

Analysts remain lukewarm, with a consensus of "wait and see" being prevalent. As one analyst who preferred to remain anonymous points out, in the industry's broader spectrum, many companies want to invest in internal drug development. No matter how energetic the investment, though, results are still years away. "Right now, we have a mixed bag and a huge unknown," he says.