I Got Bumped Off The Stage…

Editor’s note: Traveling to the New Orleans Investment Conference today, Porter has turned today’s Journal over to Martin Fridson, chief analyst for Porter & Co.’s Distressed Investing.

Disappointment at getting my conference presentation postponed quickly turned to relief when a drug-company founder whose business model I was endorsing was arrested for securities fraud… Let me explain myself here.

In 2015, Turing Pharmaceuticals became a focal point of complaints about prescription drug prices. Founded by U.S. investor Martin Shkreli, Turing bought the manufacturing license for antiparasitic drug Daraprim, then jacked up the price to insurance companies from $13.50 per pill to $750. The UK’s BBC News said Shkreli had consequently become “the most hated man in America.” France’s Le Figaro went further, calling him the most hated man in the world.

Then-presidential candidate Hillary Clinton grabbed the opportunity to present herself as the defender of everyday Americans against a villain from central casting. As she framed it, the key issue was Turing’s unjust acquisition of the rights to old drugs while it spent little on research and development (“R&D”). Drug companies shouldn’t make billions on drugs, she said, unless they were reinvesting a big chunk of profits to discover new ones that would benefit humankind.

That interpretation fit neatly with one of candidate Clinton’s campaign proposals. At the time, major pharma producers like Merck (MRK) and Pfizer (PFE) were devoting about 15% of revenue to R&D. She wanted to require all drugmakers to do the same.

I disagreed – and I had a forum for explaining why. It was the NYC Junto, a libertarian-oriented discussion series sponsored by the great hedge fund manager Victor Niederhoffer. Niederhoffer was a fascinating character, an eight-time national squash champion who attended formal dinners in a tuxedo and mismatched tennis shoes.

For my scheduled spot on the monthly program, I prepared a slide presentation that began with an illustration of corporate structures within the energy business. I showed the industry’s various sectors – exploration & production, transportation, refining, and marketing. Fully integrated companies such as ExxonMobil (XOM), I explained, compete in all of those activities. Others engage in as few as one.

Management assesses where their company’s skills and competitive advantages lie and the marketplace determines the success of their chosen business models. The government doesn’t force any individual company to perform all of the functions entailed in getting oil and natural gas out of the ground and delivering the final products to gas tanks and furnaces.

Drugmakers are a similarly diverse group, I explained. The industry titans pour billions into R&D and also manufacture and distribute the new medications that result. Some smaller firms, in contrast, forgo the expense of maintaining manufacturing facilities and marketing teams. They concentrate exclusively on finding new drugs. Their scientists may do their best work in a small-company environment. When these companies come up with a blockbuster, they cash in by selling the rights. The buyers might be from Big Pharma or they might be firms focused solely on manufacturing and distribution.

I wasn’t attempting to resolve the Daraprim controversy. My point was simply that it’s perfectly legitimate for a drug company to concentrate on what it does best. That may mean sourcing its products from companies with expertise in R&D rather than internally.

Neither in energy nor in pharmaceuticals, I argued, is the government likely to improve American economic performance by dictating which business models companies must adopt. Therefore, following Hillary Clinton’s prescription and forcing all drug companies to spend 15% of sales on R&D would be a terrible public policy.

After many hours of preparation, I was eager to be the hit of the evening as I sat among the Junto audience, awaiting my timeslot. Imagine my disappointment when the earlier sessions ran over time and mine was canceled! My consolation, I thought at the time, was that my topic would still be timely a month later, when my postponed presentation would finally take place.

A few days later, though, the drug-price-raising pharma head Martin Shkreli was arrested on charges of securities fraud. The U.S. Attorney in the case claimed that he operated his succession of companies as a Ponzi scheme. Shkreli was ultimately convicted on three out of eight counts.

Thanks to other presenters rattling on at excessive length, I was spared the embarrassment of people inevitably misinterpreting my remarks on efficient market economics as defense of a crooked business. Recognizing that it would be impossible to escape such a perception if I went ahead with my talk, I politely gave up my slot for the following month.

But the principle I was laying out was valid then – and it’s valid now: Entrepreneurs and investors who place their fate in the market’s hands are far better equipped than political strategists to devise the most economically productive forms of industrial organization. What ultimately matters for fostering the optimal utilization of scarce resources is what works, not what wins votes.

Martin Fridson
New York, New York

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P.S. The betting markets now give Democrats a 63% chance of taking the Senate on Election Day. But Porter says even a change of House won’t change what’s coming next for your money.

He believes both parties have already locked in the same dangerous policy, pre-election – and that no matter who holds the gavel in January, it keeps moving full steam ahead.

In his emergency election broadcast, Porter names the one move he believes every American should make before the votes are counted… and the handful of businesses he believes are built to keep making money right through what’s coming.

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