VALEANT STILL BLEEDING
As the market mauling continues, the drugmaker and its supporters are stepping up the fight.
In 1969, a New Jersey-based vegetable oil company took advantage of a very simple truth to defraud investors: it floated oil on top of water to make its shipments of salad oil appear fuller than they really were. It then used these inflated inventories to qualify for greater loans. Once the scandal was exposed, its creditors, including American Express, took huge losses, and the man who orchestrated the swindle went to prison.
That was just one of the stories hedge fund manager Bill Ackman told during his four-hour investor conference call on Friday morning. The call, planned in advance to address allegations against Valeant Pharmaceuticals International Inc., featured presentations and answers to questions on topics ranging from the company’s investment grade to the introverted character of Valeant CEO Michael Pearson.
The point behind Ackman’s reference to to the Great Salad Oil Scandal of 1969? Amex was hurt badly by the scandal, and its stock cratered, a perfect buying opportunity for a 35-year-old hedge-fund manager to invest 40 per cent of his capital into the credit card company. That manager was Warren Buffett, and his strategy has more than paid off.
Valeant and it’s supporters ended a devastating week on the markets Friday by fighting back on multiple fronts with moves they hope will quell accusations of unethical and possibly illegal activities: the drugmaker severed its ties with specialty pharmacy Philidor RX Services LLC and appointed former deputy attorney general of the United States, Mark Filip, to the ad hoc committee established to review of allegations related to Valeant’s business relationship with Philidor and related matters.
So far, though, those efforts have done little to stem the bleeding to the hemorrhaging stock.
Ackman says he believes it’s perfectly normal for big drug companies to hit regulatory snags that temporarily drive the stock price down and that he would even invest more in the company if he had the capital.
Shares closed down 17.67 per cent to $122.04 on the TSX Friday and down 15.87 per cent to uS$93.81 in New york.
“If you’re an investor in the pharmaceutical sector, you have to be comfortable with the fact that the companies that you invest in, unfortunately, in light of the nature of the industry are likely to suffer sanctions,” said Ackman, comparing the Laval, Que.-based company’s situation to historical examples ranging from Novartis International AG being caught paying kickbacks in 2013 to the salad oil swindle.
In his presentation, Ackman pointed to a list of 10 settlements and judgment involving other pharmaceutical companies whose share prices have gone on to recover, including Merck & co. and Pfizer, Inc.
In the case of Novartis, the company reached a settlement just this Tuesday, agreeing to pay uS$390 million and intends to continue using the specialty pharmacy channel without expecting an impact on it its business.
Ackman does not work for Valeant, but is the ceO of Pershing Square capital Management, whose fund, Pershing Square Holdings Ltd., is now the drugmaker’s second-largest shareholder.
Although it may seem out of place for an investor to address the inner workings of a company, Ackman has big reasons to hope allegations of fraudulent accounting through “channel stuffing,” several subpoenas and negative attention over drug pricing will soon blow over — 21 million shares worth of reasons, valued at about uS$2.23 billion Friday morning on the NySe.
On Oct. 21, in the midst of the scandal sparked by an incendiary report from shortseller citron research, Ackman added two million more shares to his already substantial holdings — and hasn’t sold a single one.
Valeant’s biggest problem, Ackman says, is not with accounting practices but a “meaningful mistake” of under-investing in its public relations and offering an insufficient response when short-seller citron research accused it last week of using phantom sales to boost its bottom line.
“I don’t think their problem is a Pr problem. I think their problem is that they’ve done something inappropriate and they got caught doing it ... this is a fundamental problem in the way they do business,” said Lea Prevel Katsani, a marketing professor at concordia’s John Molson School of business in Montreal and author of Global Issues in Pharmaceutical Marketing.
“All the Pr in the world isn’t going to make that right.”
The citron report, published last week, alleged that Valeant was using specialty pharmacy chain Philidor rx Services LLc to pad its sales numbers, and suggested the drugmaker was the “pharmaceutical enron.” Pearson fired back, calling the allegations “completely untrue” during an investor conference call on Monday.
but, according to former employees and an internal document, Philidor, a specialty pharmacy that fills prescriptions for Valeant, has altered doctors’ orders to wring more reimbursements out of insurers.
Nikki Lee-Wingate, a professor at connecticut’s university of bridgeport, specializes in consumer behaviour involving negative emotions in the pharmaceutical domain. She says health care is particularly prone to credibility damage, even when more positive information is also available.
“One analyst’s inflammable opinion can have a detrimental effect on the company perceptions of investors, who may already have started to feel that their trust in Valeant was eroded by the company’s seemingly insincere attitude toward the potentially negative press,” Lee-Wingate said.
On Friday citron said it will update its “full story” on Valeant on Monday, Nov. 2, with further accusations that this time could be unrelated to Philidor.
Valeant said Friday that it will cut all ties with Philidor and that the specialty pharmacy is shutting down, though Ackman says he believes there is a “low probability” that Philidor was making false scripts.
cVS Health corp. and express Scripts Holding co., the largest drug-benefits managers, in the u.S. said Thursday that they’re removing Philidor from their pharmacy networks and reviewing its practices.
Though Valeant is not an owner of Philidor it does hold a 100 per cent option to acquire Philidor and has the right to access the pharmacy’s books, records and facilities.
“The newest allegations about activities at Philidor raise additional questions about the company’s business practices,” said Pearson in a news release. “We have lost confidence in Philidor’s ability to continue to operate in a manner that is acceptable to Valeant and the patients and doctors we serve.”
Ackman says he believes Valeant has “89-per-cent upside,” though he estimates it should take a two to four years for the Philidor issue to be resolved.
He expects Valeant should be heading to an investment grade company by the end of 2016, and share prices should reach over uS$400 within three years.
Irina Koffler, an analyst with Mizuho Securities uSA Inc. says she believes the downside associated with Philidor has largely been capped, with Valeant not facing anything over a possible uS$500-million fine or settlement under the worst case scenario.
However, she reiterated analysts’ concerns about whether there will be any other negative information about Valeant that will emerge in the near future.
Koffler writes that Valeant has guided its 2016 ebITdA at uS$7.5 billion, though Mizuho calculated it to be in the uS$6.8-billion range to account for Philidor disruptions.
“We believe that (Valeant) will remain relatively resilient from here and could rebound to some extent if management provides updated guidance about the business,” wrote Koffler in a note, reiterating a “buy” rating.
The Philidor channel represented 6.8 per cent of the company’s third quarter revenues and Koffler estimates a full year impact of approximately uS$750-800 million.
The newest allegations ... raise additional questions