CHICAGO – It was announced on Monday that First Data, which is one of the nation’s major credit-card processing companies, agreed to be bought out by huge private equity firm Kohlberg Kravis Roberts & Co. (KKR) for $29 billion. As the New York Times reported:

The deal ranks among the 10 largest buyouts ever and signals the continued might of private equity firms aided by a flood of cheap debt and eager institutional investors like pension funds.

What does this mega deal have to do with pharmaceutical drug pipelines?

As many people know, we are currently basking in an era of low interest rates. Many would regard this as a good thing. Indeed, I don’t mind the relatively low mortgage rates now – certainly as compared to the 1970s and 1980s – but there is no free lunch and there is a price to low interest rates.

There are the macroeconomic arguments that point to overheated economies leading to higher inflation. Some would also say the current housing meltdown is related to easier money policies. While not necessarily a “price to be paid,” one implication of the low cost of debt financing is the current boom in private equity (as evidenced by today’s KKR deal with First Data).

There is also another price to be paid for an economy that is tilted in favor of debt rather than equity. Roughly speaking, debt is a conservative financing instrument. While not inimical to innovation, it is not the currency that lubricates revolutions.

While private equity firms can provide great value to the economy, they too will acknowledge that this value involves incremental improvements to an existing company’s operations.

To be sure, this can sometimes create stupendous value. Why else would pension funds risk their capital? Private equity, though, exacts value through mechanisms such as management changes, business process improvements and new market developments. While this adds value, it is not innovation in any substantial sense.

Innovation is the job of universities and venture capital and indeed that is the case. However, despite our high levels of liquidity, the world does not have unlimited money. The $29 billion for First Data means that much money doesn’t go to venture capital or other forms of more equity-based innovation financing.

Say it costs $1 billion to bring a new drug to market (more on this later). That means we could have 29 new drugs being financed instead of having your Visa or MasterCard processed with slightly more efficiency. I am simplifying, of course, but the same argument has been held for growing government debt.

Within the private sector, there are “crowding out” phenomena and this is one of them.

Note that these points do not constitute a value judgment. I have nothing against private equity and truly believe that value creation is a good thing. Even the much-maligned Gordon Gekko – glaring out at the top-heavy phalanx of vice presidents at the Teldar Paper shareholder’s meeting – had a valid point.

As a society, we should not kid ourselves that these debt-financed investments will be directed toward fostering innovation. It would be irresponsible of KKR and its investors to think otherwise. So why doesn’t this money go toward more research and development and in particular to medical technology or pharmaceutical discovery?

As many have noted (including the Economist in March 2007), corporate R&D has decidedly shifted more toward the development side and largely away from R&D in general. To many firms, the returns on capital from R&D (especially in the context of this bias toward debt financing) have simply not been great enough to justify more effort.

The KKR deal with First Data is simply an acknowledgement of that on a grand scale.

With respect to pharmaceutical discovery, one cannot simply blame investors or management for such decisions since frankly the underlying paradigms of drug design seem to be fatally flawed. Though this may be a surprise to some, basically we know very little about how drugs bind to or act upon their targets.

The genomic revolution promised thousands of new targets – and a brave new world in medicine – but relatively little has come of that.

This past week, the American Chemical Society held its annual meeting in Chicago where renowned Harvard chemist George Whitesides was awarded the Priestley Medal, which is the industry’s highest honor. In his acceptance speech, he commented on this problem as follows:

The binding of a small molecule – a drug, ligand, substrate or transition state – to a protein is arguably the most fundamental molecular process in biology. The idea of rational design of drugs … was an objective we all understood. We have made mostly a kind of negative progress over the … years.

[While] we do understand better now … what we don’t understand and why the problem remains so difficult, we still cannot design ligands.

How do reactants in any process (especially those in molecular recognition) interact with solvent and especially with water? We find that our current theories – of … tightly coupled kinetic networks, protein-ligand binding … [and] non-covalent interactions – simply do not work.

While in college, I attended several of his lectures and can truly say he is an optimist at heart. His comments here are especially sobering.

In this regard, I would agree with KKR and most investors that throwing $29 billion at pharmaceutical drug development using the current paradigms would likely not return as much value as investing in better credit-card processing. Scary as that sounds, that’s what the market is telling us.

Like the famous Indian legend of the three blind men and the elephant, we have glimpses of the fundamental process of molecular interaction but by no means a full view.

There has been much turmoil in the pharmaceutical industry. Fellow MidwestBusiness.com columnist Michael Rosen has commented on this subject and many of us (myself included) have proposed on improved business models and R&D processes to solve the sparse pharmaceutical pipeline problem.

Ultimately, however, in the absence of a more complete understanding of protein-ligand interactions, the sparse drug pipeline will largely remain a wasteland. Despite the great benefits to society from improved medicines, this is something from which investors will continue to avoid.

Previous Columns in 2007:
What Patients Want: A Story of Choice, Trials, Evidence-Based Medicine (3/19/2007)
Gov. Blagojevich Announces IllinoisCovered to Insure 1.4 Million in Illinois (3/5/2007)
Medical Design Excellence Awards Offer Decisive Glimpse Into Future of Health Care (2/20/2007)
What’s More Important in Medicine: Diagnostics, Therapeutics or Prognosis? (2/5/2007)
Lance Armstrong and the Future of Cancer Care (1/22/2007)
Subtle But Powerful, Publication Bias Goes Beyond Financial Incentives (1/9/2007)
Click for 2006 column archive.

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