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Companies, People, Ideas
Faith Healers
Zina Moukheiber, 10.28.02

The born-again Gregory brothers worked a financial miracle from cast-off drug brands.

Late one night in 1987, John Gregory reached for a gun, ready to take his life. His wife had left him, and his business--selling perishable vaccines and drugs from a small office near Roanoke, Va.--was a shambles. All because Gregory had succumbed to the ravages of alcohol. At the last minute he relented, and decided to seek help from a pastor. Soon after, Gregory became a born-again Christian.

With his new-found piety, Gregory went forth and formed Bristol, Tenn.-based King Pharmaceuticals (nyse: KG - news - people ), named after Jesus' epithet, the King of Kings. One by one his brothers Jefferson, Joseph, James and half-brother Henry joined him in his efforts to build the company, all becoming born-again Christians.

They did a mighty job, lifting King from its humble beginnings to an operation that will earn $333 million this year, up 38% from 2001, on sales of $1.2 billion, predicts Donald Ellis at Thomas Weisel Partners. The firm mints money out of drugs the big pharmaceutical firms no longer want and turns them into mini-blockbusters.

By not having to shell out billions of dollars on research and lengthy clinical trials, King cuts much of the risk and nets fat margins: 27%, compared with 18% for a typical pharmaceutical firm. The company sells 50 drugs that once belonged to companies such as Bristol-Myers (nyse: BMY - news - people ), Johnson & Johnson (nyse: JNJ - news - people ) and GlaxoSmithKline (nyse: GSK - news - people ). Drug firms have been merging rapidly, and combined companies typically try to shed drugs that plateau at $350 million in order to focus their sales force on bigger drugs.

King's top seller, the antihypertensive Altace, will likely generate $500 million this year, up from $92 million when King bought it from Aventis in 1998. "We let opportunities define our model," says Jeff Gregory, 47, King's chief executive since his brother announced his retirement in January.

But a fly has landed in the holy water: King's strategy may be losing steam. More bidders are going against King for branded drugs. In the past four years prices have risen from one or two times sales to as much as five times. King is also locked in the perennial battle against cheaper generics. The stock fell 7% one day in May on rumors of a filing for a generic Altace (no such filing emerged). King's shares trade at $18, 58% off their 52-week high, compared with a 28% drop in the S&P drug index.

Meanwhile, rivals that once played the same game as King have moved on to research their own potential blockbuster drugs in the hopes of far greater profits. Competitor Forest Laboratories (nyse: FRX - news - people ) spent $158 million, or 10% of its revenue in fiscal 2002, on R&D this year; Medicis Pharmaceutical (nyse: MRX - news - people ) spent 7%. While King has increased its R&D budget from $26 million last year to $35 million this year, that's still only 3% of revenue.

Management says the company will do fine combining its old strategy with a low-key effort at drug development. In November 2001 King raised $1 billion both for R&D and to purchase cast-offs. In 2000 King acquired a research outfit that is working on an injectable stress-test drug for heart disease suspects who are unable to hit the treadmill to get their heart rate up. Despite those efforts, research will likely take a back seat to King's plan to buy its way to growth. "The key is not to get ahead of yourself. R&D is a risky endeavor," says Kyle Macione, King's president.

John Gregory, 50, won't be the one to see the changes through. He retired a wealthy man--his 5% stake is worth $220 million--at King's shareholder meeting in June. One of the company's two chaplains led with prayers and colleagues later toasted him with soda, since alcohol is banned from company functions. Now John devotes part of his time to the King Pharmaceuticals Benevolent Fund, a not-for-profit that spreads the gospel in developing countries, dispensing acetaminophen tablets imprinted with "Jesus Loves."

Preaching and profits have paired well for the Gregorys. By the early 1990s their perishable-drug distribution business, General Injectables & Vaccines, was being eroded by shrinking margins. In 1993 they got into contract drug manufacturing by forming the subsidiary called King. They paid $5 million for a former SmithKline Beecham plant in Bristol, Tenn. and started making drugs for the likes of Novartis (nyse: NVS - news - people ) (then Ciba-Geigy) and Boehringer Mannheim (now part of Roche). In 1994 they sold their stake in Injectables to partners and focused on King.

Boehringer was looking to unload its painkiller Anexia, a $6-million-a-year seller that King manufactured. The brothers decided to buy it, offering a $17.5 million promissory note payable after one year. As the deadline loomed, King found itself unable to come up with the money. So instead it sold both Anexia and a generic version to Mallinckrodt, a medical products company that's now part of Tyco, for $32 million. Despite its wobbly start at selling branded drugs, Anexia gave King a taste for bigger gross margins: 75% for a brand drug, versus 20% or less for contract manufacturing.

When the merger wave washed across the pharmaceuticals industry in the mid-1990s, King picked up its acquisition pace. Wanting to build a cardiovascular franchise, King set its sights on Altace, which belonged to Hoechst. Hoechst's merger with Marion Merrill Dow in 1995 seemed to provide an opening. Altace was bringing in under $90 million in revenues; Hoechst had stopped promoting it, but the drug's patent extended until 2008. Jeff started lobbying Hoechst to sell him Altace. In 1998 Hoechst announced it would merge with Rhone-Poulenc to create Aventis, and King got Altace for $363 million, or four times revenue.

Under the aegis of brother Joe, who is vice chairman, King moved quickly to revive Altace. It quadrupled, to 600, the number of sales reps promoting Altace. For more marketing muscle, it teamed up in 2000 with Wyeth (nyse: WYE - news - people ), which brought an additional sales force of 1,000. In exchange, King splits revenue with Wyeth.

Last year King purchased four drugs from Bristol-Myers for $287 million. But the deal was costly. King paid four times revenues, edging out more than 15 bidders. Though King was mainly interested in the beta-blocker Corzide, it was forced to take another beta-blocker, Corgard, which faces generic competition. A third drug, the corticosteroid Florinef, went generic soon after King bought it. "King paid a little bit much," says Peter Crowley, head of health care banking at CIBC World Markets. As the tide shifts in favor of generic drugs, Altace could come under fire. Sixty 2.5-milligram tablets of Altace cost $65. You can get the generic lisinopril for $25.

King is banking on continued consolidation in the drug industry to create more buying opportunities. But its chief rivals have moved on. Forest Labs, which once sold only generic drugs or cast-offs, now generates 98% of its $1.6 billion in revenue from its own pipeline. Forest's market cap is more than three time King's. Medicis also has a diversified strategy. "Innovation is key. [Buying] is a great way to start a company, but a research strategy is the only durable strategy," says Medicis chairman Jonah Shacknai. "Mergers will present more opportunities, but maybe not as interesting." It might be time for the Gregorys to put a little more faith in R&D.