There's still good money to be made in medicine. Just ask Dr. Patrick Soon-Shiong, a former surgeon from UCLA who founded generic-drug maker American Pharmaceutical Partners ( APPX). With a net worth of $2.2 billion in 2005, Dr. Soon-Shiong was ranked the 116th-richest American in the Forbes 400. The good doctor likely will see himself catapult into the top 100 after American Pharma acquires privately owned American BioScience in an all-stock deal worth $4.1 billion.

First, let's be clear: I believe in capitalism and the marketplace. I think there is nothing wrong with captains of industry profiting from their creations -- especially in the biotech/pharma area, where incentives should be great to encourage costly research that can ultimately add to the common good. However, the American Pharma-American BioScience deal raises questions about incestuous corporate relationships that enrich executives and their minions at the expense of average shareholders.

You see, Dr. Soon-Shiong is the chairman, CEO and founder of both companies and owns over 80% of American BioScience. American BioScience currently owns approximately 64% of American Pharmaceutical Partners. The merger proposal was submitted to American Pharma by American BioScience. Think about that for a minute. A private company (owned by Dr. Soon-Shiong) approaches a public company (majority owned by Dr. Soon-Shiong) with a proposal to be acquired.

Under the terms of the deal, American Pharma will issue 86 million new shares to American BioScience. This will raise the latter's ownership share to over 83% and, in the process, dilute American Pharma's 72.2 million shares outstanding by 119%. The deal is expected to close in the first half of the year.

Based on a flat 80% ownership of American BioScience, Dr. Soon-Shiong's take in the deal is over $2.4 billion at current market prices. At the same time, the holders of American Pharma's existing 72.2 million shares will suffer from the dilution of ponying up 86 million new shares, most of which go to Dr. Soon-Shiong.

Although Dr. Soon-Shiong is a majority shareholder in American Pharma, due to his controlling interest in American BioScience, he has in effect created a windfall of $2.4 billion for himself. Minority shareholders of American Pharmaceutical Partners get left holding the bag.

American Pharma did not respond to several interview requests for Dr. Soon-Shiong.

The problem lies not only in the appearance that Dr. Soon-Shiong shifted money from minority shareholders to his own pocket, but in the fact that the company has not disclosed how it came up with the valuation for American BioScience.

Watching the Watchdogs

In July 2005, American Pharma set up a special committee of independent board members to evaluate the deal. Dr. Stephen Nimer and Leonard Shapiro will be paid $125,000 each and Kirk Calhoun is to receive $150,000 for their services regarding this transaction. In sum, these three gentlemen unanimously approved a deal for which they were paid six-figure incomes by a company whose CEO was dramatically enriched by their decision.

American Pharma did not respond to several interview requests for Kirk Calhoun. Dr. Nimer, Shapiro and former CEO Al Heller, who resigned when the deal was announced in November, have not returned phone calls seeking comment.

It's not unusual for board members to be paid for serving on special committees. But considering that independent directors of American Pharma are paid just $2,500 per meeting (not particularly generous), the six-figure payments for examining the American BioScience deal appear excessive.

Todd Fernandez , senior research analyst with proxy adviser firm Glass, Lewis & Co., believes the American Pharmaceutical situation is a classic example of why investors should beware of companies that are controlled by another entity. "Such actions prove why owning minority positions in majority-owned shares is not a good idea," he says. "Shareholders will have to take what's given to them."

Morningstar analyst Brian Laegeler has issues with what appears to have been a rubber-stamped deal. "Did the board do a market test? We don't know if APP overpaid. Nothing has come out to make me think it was a fair price."

What is unclear is if American Pharma was the only suitor. With other bidders, theoretically, American Pharma should have had to pay only $1 more than the highest bid. But with no other bidders, the valuation in this incestuous relationship is an even more important consideration.

Be Careful What You Ask For

A bit of history: In fairness to Dr. Soon-Shiong and American Pharma, Wall Street had been pressing for this deal. American BioScience is a startup biotech with one successfully marketed drug -- cancer fighter Abraxane. Prior to the acquisition, American Pharma had 50% of the rights to Abraxane.

Some on the Street felt that the two companies -- controlled by the same person -- entering into a revenue-sharing deal was a conflict of interest. So, Dr. Soon-Shiong removed the conflict by swallowing up its majority shareholder.

Many on Wall Street have no problem with the strategy behind the acquisition. Abraxane is expected to be a significant drug. It currently has above 14% of the market share for the chemotherapy class known as taxanes. The drug is currently used to treat breast cancer and has shown to be effective with fewer side effects than its competitors. It is currently in 74 clinical trials, including seven phase III trials for lung, ovarian and prostate cancers among others. Merrill Lynch, which advised American BioScience in the deal, estimates 2006 Abraxane sales of $250 million.

But does this deal create shareholder value? Obviously, American Pharmaceutical Partners will argue that it does. By owning the exclusive worldwide rights to what someday could be a $1 billion drug and a pipeline of early stage medicines, shareholders could now own stock in what will be an important player in the health care space sometime down the road.

But investors will have to be patient in order to see the payoff. Shares of American Pharma tumbled 18% when the deal was announced on Nov. 28, and analysts have slashed their earnings forecast as a result of the dilution. Merrill Lynch's Greg Gilbert cut his 2006 EPS forecast by more than half to $0.81 from $1.75. He doesn't see American Pharmaceutical Partners earning $1.75 (actually, $1.78) until 2009.

The success of the rest of American BioScience's pipeline is anyone's guess, according to Morningstar's Laegeler. With early-stage development drugs, "You can't say, one or two out of 10 should hit. Sometimes it's none out of 10."

The drugs may be good. The company may see profits grow. But perhaps investors in American Pharmaceutical Partners should be asking themselves a more important question: Do you need to put up with conflicts of interest, secretive deals, questionable committees and CEOs lining their own pockets with shareholders' dollars?

That's up to you. But I wouldn't.

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