Expert Financial Analysis and Reporting

My View on Valeant

I have been asked about my feelings on Valeant. I would start out by saying that I have done no detailed research on Valeant and have no existing recommendation nor any investment in the stock. I have no dog in this hunt and my views are based on news reports that are available to all. Based on this limited research, I am disgusted with Valeant. In my opinion, there is negative societal value in this company and what it stands for. A pox on their house.

The Roll-up Business Model Makes No Sense

The most important point I can make is that the business model of Valeant is so flawed that in my opinion it has no chance for sustained growth and more likely will fly apart over time (a process that is well underway). Valeant has applied a roll-up model to the pharmaceutical industry. It disdains development of new drugs which is the raison d’etre for the industry. It spends less than 25% of the industry norm (as judged by percent of sales) on R&D. It acquires companies to obtain products, then slashes spending at the acquired company and raises prices on older drugs by as much as 5000% in some cases.

The problem with the roll-up model is that as Valeant got bigger, the size of acquisitions that it had to make got bigger. Its last failed attempt was to acquire Allergan, a very well-run company that had produced outstanding shareholder returns over time. Valeant lost out to Actavis in the bid for Allergan. There may be few or no companies of a size and quality like Allergan left to go after. This is like starving a fire of oxygen; the Valeant flame is flickering and is in the process of going out. It is just a question of how long it will last.

Citron Research Alleges Securities Fraud

Valeant has been attacked by the hedge fund Citron Research alleging misconduct in its relationship with the specialty pharmaceutical distributor Philidor. This has played a major role in causing the stock to decline from a recent high of $257 to $99.It claims that Philidor was part of a strategy to get insurers to  reimburse high-priced drugs that insurers otherwise wouldn't pay for and to also raise prices on older drugs by 5 to 50 fold. Citron also alleges that there was over stocking of drugs in the distribution channels that caused sales to be dramatically overstated. If so, this is serious. You may recall that ten years ago Bristol-Myers paid $150 million to settle lawsuits about similar behavior. Citron promises that on Monday, November 1, that it has more grenades to throw at Valeant.

I have no idea if the charges by Citron that Philidor and Valeant have broken securities law and that Valeant has knowingly misstated and overstated earnings is correct. However, there is going to precipitate a long and intensive investigation into Valeant that could take years. Valeant was already under investigation for price gouging. This is certainly going to make it close to impossible for Valeant to make major acquisitions. What shareholder base would want to sell out to a company undergoing this degree of investigation and who would finance such as acquisition? A rollup model without the ability to make acquisitions is in extremely serious trouble.

Price Gouging May Be a Problem

Another problem that Valeant faces is that it should be impossible to raise prices aggressively or at all. I was struck by listening to an interview of the CEO of the Cleveland Clinic. He said that last year his organization had made a major effort to reduce drug spending. They were able to a program to reduce the level of spending on drugs from all other manufacturers by $10 million but this was more than offset an $11 million increase in spending on Valeant drugs which was essentially all due to price increases. With all of the scrutiny, I can’t see Valeant being able to raise prices and I would not be surprised to see them decrease prices.

Balance Sheet is A House of Cards

I have not done a detailed analysis of the balance sheet but it looks scary. As of September 30, 2015 Valeant had cash of $1.4 billion, long term liabilities (mostly debt) of $37.0 billion and stockholders’ equity of $6 billion. Operating cash flow for the first nine months was a negative $14 million as compared to a positive $15 million in the prior year period. This is a financial house of cards.

Bill Ackman of Pershing Square is Going Down with the Valeant Ship

Valeant has had the backing of hedge funds and particularly Bill Ackman of Pershing Square who has come out in the Company’s defense. There is a close tie between Ackman and Valeant. His hedge fund acquired 9.7% of Allergan and then worked with Valeant to attempt to takeover Valeant. Although Valeant was unsuccessful, Allergan was forced into a merger with Actavis and Ackman reportedly made a profit of $2.7 billion. Allergan sued alleging this was insider trading and it is hard for me to see another explanation. Ackman claims that he is an activist trader who finds inefficiently run companies and makes them more efficient. This is tooth fairy material.

I note with certain satisfaction that Ackman owned 19.4 million shares of Valeant at the last regulatory filing so this suggests that he has lost $3.1 billion on his investment from the July 31 closing price of $257 to the closing price to last Friday's close of  of $99. News reports indicate that his cost per share is $186 on the first 19.4 million shares. If so, he has lost in absolute terms just $1.7 billion. Undeterred, Ackman is doubling down on his bet as he just recently acquired another 2.0 million shares. Other hedge funds have also invested heavily in Valeant. Ackman has said that he is absolutely commited to Valeant and will not sell any stock.

What a Sordid  Story

I think that the saga of Valeant is a disgusting story for American business and investors. Hedge funds sponsored the rise of the company from an obscurity that it should never have left. It is reported that Ackman made $2.7 billion on his stake in Allergan which has the appearance of ill-gotten gains. The $1.7 billion hit to his portfolio value in just three months hurts his performance. His fund Pershing Square is down 16% year to date. Just as an aside, Ackman’s involvement as an activist investor in J.C. Penney was also a disaster for Ackman, the company and its investors. His attack on Herbalife has been equally ill-fated so far.

I suspect that Valeant will continue its downward spiral and Citron suggests that the stock could go to zero. Given the sharp decline, it would not be surprising to see the stock bounce in the near term. I am not involved in any way but I must say that I am enjoying watching Valeant and Ackman twist in the wind. As you can readily see, I am contemptuous of the activist investor model favored by Ackman.  I don't want hedge funds playing active management roles in pharmaceutical or other companies.