The mistakes Daiichi Sankyo made in the Ranbaxy deal

'Love for the deal' was evident when Daiichi termed the investigations by the US Foods and Drugs Administration (FDA) as just a "risk call" and did not spend enough time on evaluating the risk, says Shyamal Majumdar.

Joji Nakayama, Daiichi Sankyo's president and chief executive officer, has surely mastered the art of keeping a straight face even while suffering a painful injection.

After announcing Daiichi's decision to exit Ranbaxy in April 2014, Mr Nakayama said, "We gained a lot from the acquisition (of Ranbaxy) in 2008".

Gain? The reality was that it was a distress sale, as Japan's third-largest drug maker sold its stake in Ranbaxy at a 38-per cent discount to what it paid in 2008 to buy it.

Other Daiichi executives went one up on their CEO and said something even more comical - the Ranbaxy deal, they said, helped the company learn about the business model for generic drugs and expansion in emerging markets.

It's only that the "learning" was outrageously expensive, as Ranbaxy had cost Daiichi around $5 billion and was supposed to be a key part of its overseas strategy. Instead, it turned into a major liability and six wasted years.

Though Mr Nakayama and his colleagues would finally have some reason to celebrate after the Singapore arbitration court order last week, their comments after quitting Ranbaxy raise the question whether Daiichi has been in a constant state of denial over its sloppy due diligence procedures.

No one has any clear answer on why Daiichi choose to ignore the obvious red flags, but global consulting company DestinHaus has an interesting observation.

In its report, "Due diligence: Why some acquisitions succeed while others fail", the firm said the most common cause is that the company making the acquisition falls in love with the deal.

It is easy with the excitement of the moment to downplay stumbling blocks or not to make the extra effort on additional research and plain old fashioned physical inspection of the assets.

"Many times a deal is made on the basis of just a financial audit. The risks of not making on-site visits and inspections are illustrated by the acquisition by Daiichi of Ranbaxy," DestinHaus said.

This "love for the deal" was evident when Daiichi termed the investigations by the US Foods and Drugs Administration (FDA) as just a "risk call" and did not spend enough time on evaluating the risk.

This, even when the share-purchase agreement had the following representation from Ranbaxy, "there is no event or situation that has not been disclosed to the buyer (Daiichi) and its representative since the accounts date and which could have a material adverse effect."

Many say a pharma company of the size of Daiichi should have cared to at least send some of its executives before the deal was done just to get a first-hand feel of the situation in the Ranbaxy plants.

If they did, they could have easily sensed that all is not well.

FDA inspectors did just that and wrote in their report that workers at the Toansa plant doctored test results to make it appear as if its raw materials and active pharmaceutical ingredients met FDA standards when they didn't.

FDA officials said they discovered workers retesting ingredients until acceptable results were reached, and deleting evidence of failed tests.

Failure to do this resulted in the partnership tumbling right out of the gate.

Assuming the charges of hiding critical information against the former promoters are true as suggested by the arbitration order, the way Daiichi's famed team allowed themselves to be led up the garden path beats logic.

Sample this: barely three months after the acquisition, FDA issued warning to Ranbaxy and served an import alert for drugs from two of its plants.

Four months later, FDA froze Ranbaxy's drug applications after finding that the company falsified data and test results.

Then the US Department of Justice slapped the company with a wide-ranging consent decree, citing the company's quality deficiencies.

The FDA actions eventually led to a $500-million fine for Ranbaxy as well as the effective mothballing of many of its Indian factories.

Was Daiichi so gullible that its top management took everything the former promoters said at face value?

The general perception is Daiichi was perhaps blinded by the size, scale and scope of the deal which it thought would catapult it to the top of the global pharma league table, and made some cardinal mistakes in the pre-deal due diligence.

Even a cursory glance at documents relating to plant inspections done by the FDA in 2006 and other regulatory submissions made by Ranbaxy would have revealed the seriousness of the problem at hand.

That leaves us with the most predictable answer: the Japanese firm was well aware of the FDA documents but chose to go along with the former Ranbaxy promoters' version that they were not serious in nature and that the company had an enviable pipeline of first-to-file opportunities in the US generic market.

The common perception about Japan Inc is that they don't fall in love so easily and a prized skill for corporate leaders in that country lies in being able to read the air.

In the Ranbaxy case, however, Daiichi threw all caution to the wind. Hopefully, this will remain just an exception.