ERICOPOLY

"We understand that patients, doctors and business partners have been disturbed by the reports of improper behavior at Philidor," Pearson said, "just as we have been." Except that they were only disturbed enough to take action when the patients, doctors, and business partners found out. That's when they severed their ties to Philador. Or perhaps they didn't know.

Valeant says that not too much will change in their numbers without Philidor. A trusting girlfriend would believe them and go out and buy the stock. A suspicious girlfriend wouldn't buy it: she'd think that Valeant management is reciting a scripted dialog written for a part in a movie where the character is a naive farm-boy unaware of what goes on in the big city. It's the kind of statement you'd make if you were trying hard to look like you are unaware of any fraud -- so says a suspicious girlfriend. So there really isn't anything they can say that will calm a market where they've lost trust.

+1 I'm as cynical and suspicious about Valeant as anyone, but there's probably some hindsight creeping into the incentive structure discussion. +1 It's very difficult to gaze at the stars in the sky without your mind wanting to form shapes out of them. If you've heard about unicorns before, you'll see a pattern that makes out a unicorn. But you won't see a unicorn if you haven't. In the stars you can find whatever it is that you are looking for.

Philidor immediately agreed to wind down operations. For people with so much money in performance milestones that they were anchored to, they gave it up with just hours to make that call. It's true that with all the major CVS style partners pulling out it was game over. But I'm just amazed at how fast that happened. It's easy to see why Valeant wanted to immediately sever the tie, but the Phildor guys don't need to run so fast do they? Or perhaps they just need to shut it down to contain the spreading rate of potential liability -- that sounds reasonable.

I ask a lot of questions but I'm sort of just brainstorming with the expectation of critical feedback. Including some of the conspiratorial musings... What if some insurance execs own the Philidor shares? That would be something worthy of concealment, but perhaps it would be way too blatantly conflict-of-interest and nobody would be stupid enough to go there.

They didn't hide their relationship with Sergio Marchionne. Let's say that what Philidor does is standard industry practice. What's the point of the deception? That's what the trouble is -- sneaking around. Why? Is the answer this: "we were just doing what everyone else does, but we wanted to be secret so that nobody would find out what we were doing... which is what everyone else does anyway, so why would we feel a need to hide it?". The copay thing -- raise prices by $30 while eliminating $30 copay. I've been told everyone does that... okay, so what part of Philidor was important to conceal?

I take it that there is a market inefficiency that exists in between ethics and the law. There is an arbitrage to be exploited -- many in business won't play right up to the line. However if you are willing to do so then you find yourself walking in an orchard picking low hanging fruit. So perhaps as suggested they are looking out for shareholders in the manner of adding maximum value while exploiting this regulatory/ethical inefficiency in the marketplace. There is little competition that close to the line -- hence it's where inefficient market can be found if you are willing to go there.

I just realized something today that there are similarities with investing and what I did for a paycheck at Microsoft. I worked on the Internet Explorer team as a "software test engineer" and I joined them in 1997 while they were still working on the IE4 Beta 2 milestone. At first I didn't really know jack shit and it took me a while to find out how I was going to remain gainfully employed. I wasn't assigned to a specific feature, I was initially just on a team of people that helped investigate reports coming in from participants in the public beta program (preliminary investigation of the bugs that they reported). The thing that I eventually gravitated to was just ad-hoc testing of Internet Explorer to find way to make it either crash or hang. Then I got adopted by the manager of their stress team and I formally just became somebody who was interested in stress testing the product until it crashed. I had a massive bug count of crashes, and I did so with what I've now come to understand as the "cockroach theory". I would pound heavily on an area of code where a crash was found and I'd find many more. The bad cook in the kitchen was either the developer, or the tester who was formally assigned to test his code, or just that it was a poorly architected or just very complex area of code. In any case, once the first cockroach was found I would pound on it and find many more. Sometimes I would just go right to the source code and just pick them out one by one. I mean, it was really fun for a while. So... enough about that... This latest Valeant thing is the first time I've put any connection between that and security analysis. Somebody finds something odd in a lack of disclosure and if you really stop to think about that... why would any management ever have a good motivation to look like they are trying to hide anything? Because shareholders are like girlfriends and anytime you act in a way that is the least bit suspicious and try to hide it, they'll get really concerned really fast. So why would you ever act suspicious and refuse shareholders requests for better disclosure when you basically know that your girlfriend is just going to hit the ceiling if you do that? So I am starting to get the point here and I'm quite a bit more interested now in the value of reading 10-Ks. It can have the same kind of fun attached to it that I had as a stress tester. My question though -- how would I go about getting started with an education in this field if I wanted to pursue it as a formal career? I have been a bit bored.

This seems like such an obvious game approach: Raise your drug price by $30 and eliminate the $30 copay. You are now the patient's best friend. Did they do anything like that? If so, expect it to not be a sustainable thing.

Disclosure or not though, the gig is up if they are getting their growth by exploiting holes in other companies processes that their managements were completely unaware of. Those managements, unless they don't read newspapers, will be reviewing whether their arrangements can be gamed. Somewhat like in the late 1990s when in the world of Internet connected computers Microsoft had to radically change their approach to security. They adopted new policies and there was much "penetration testing" where you review where your interfaces are exposed and you hire experts to see if they can be exploited. My point is that channel partners and insurers will now look upon Valeant as "The Internet", and will review their interactions with Valeant and it's partners to see if it's possible that they are being gamed. Then they'll make adjustments.

Ah good point, now I understand the problem you were alluding to with my too-simple binary narrative.

As you've seen in my post I did say that your thinking is correct. I don't know where you got the bolded quote above but if it's from the company I think it ties in with my thinking. I think they're in a sticky situation. They've been very aggressive. Maybe in ways that are still unknown. If they go full disclosure or these things come out they'll probably have to stop. Now if a lot of their success has been from being aggressive and without that they become sort of an average pharma it's not that they'll make a bit less money. In their case the whole model crumbles. Full disclosure may be an existential threat. Of course full disclosure is best when you've been caught with the hand in the cookie jar. But if full disclosure is an existential threat then you're not gonna go that route. Plus people often do really dumb things when they're in these kind of positions. Sorry, that bolded quote was just a summary of how I view their message -- not quoting them or anyone. I should have explicitly said "paraphrasing" how I viewed the message.

We know that they paid for an option to own Philidor but they also included milestone payments. Don't you think those milestone payments are dependent on the performance of the "specialty pharmacy channel?" Is that really something Pearson had trouble answering? "Oh, 10%, 20% maybe, oh 10%, nevermind 9%." Either Pearson is asleep at the wheel or he was being misleading. Neither of those reflects well. I'm just having trouble taking their word anymore. So why even assume the numbers they threw at us are even thorough enough to base any real analysis on. We're stuck with 10-K's and 10-Q's and there isn't a heck of a lot to get from there. And I read that Philidor couldn't get a California license because they refused to disclose who owned them. Who owns Philidor? Who is getting these incentives?

There is also a very bad message here to investors. "We can't break out our revenue numbers to help investors track how our acquisitions are faring, because if we were to do that it would tip off our partners that we are gaming them and deceiving them". Like... if the revenue growth alone tells a partner that you're taking advantage of them... what sort of a multiple should the stock market put on a business model that's built around gaming and deceiving the channel partners or the insurance companies? Obviously it will eventually be figured out anyhow, one way or another. And so it isn't sustainable and sustainability is the only thing you can put stock multiples on.

I have to think about that one because I can't swallow it as you've effectively fed it to me: "Disclosing how much revenue a particular acquisition generates post-acquisition is going to reveal things to our partners, competitors and investigators that will hurt our business model and destroy a significant value of our company." Do you think keeping things secretive is going to make the government investigators go away? That seems to be what you said when you wrote " this stuff won't play very well in the newspapers and congressional hearings". People are highly suspicious and the best course of action is to deny everything while refusing to improve disclosure? That just makes you look more guilty and will only encourage more scrutiny. I'm sorry, but the current method of being "secretive" isn't playing very well anywhere and it's not playing well in front of the newspapers and IMO never will. Doesn't being under heavy suspicion and government scrutiny weaken their hands with competitors and partners? Look at how quickly nobody wanted to be seen dealing with Philidor once it was in the newspapers. They were perfectly fine with continuing their relationship the day beforehand. It's not like those audits were all done in a week.

Just to quote from the AZ_Value blog: Folks, for those of us who are users of financial statements, there is an extremely important concept that we all rely on to analyze companies. The concept in question is the sequential nature of financial disclosures, it is the reason why we constantly read disclosures in 10-Ks with sentences like: Company XYZ did such and such for a total of X amount and Y amount in 2013 and 2012 respectively. And one would hope that the principle and accounting behind the sequential numbers disclosed stay consistent enough so that you can effectively operate a year over year comparison. Although we all probably take it for granted, I can guarantee you that, just like the air you breathe, the moment it’s taken away from you, you’re quickly reminded how crucial that concept is. The reason why I quote that is to remind you of my analogy to the suspicious girlfriend. When you get caught talking to pretty girls when you're supposed to be out studying, you are eroding trust. Trust is crucially important. It doesn't mean that they are necessarily doing anything will criminal intent, but they are just following a pattern that was laid out before by people who did have criminal intent. People who look for frauds will be looking for these patterns. So if you are actually honest and want people to respect you as such and you want an unquestionably clean reputation, you basically need to follow a pattern that doesn't fit a pattern that will raise suspicion. And now there's just too much bad stuff coming out and these kind of patterns are getting scrutinized more heavily and rolled up into a narrative that there is just too many dots connected that individually you might talk yourself out of, but all of them put together and your credibility is just really hard to defend. So... That's why I think we'll either: a) find out some really seriously bad news or b) we'll get some really awesome disclosures surrounding the successive performance of each acquisition independently so that these honest people at Valeant can hang their heads high in the community again and be respected. They will have to get those disclosures out super duper fast unless they just want a low stock price that hurts their ability to use it as currency for more acquisitions. So I wouldn't go to 2018 with the LEAPS. I agree with another poster's comment that the stock isn't this heavily beat up because of the threat of fines... it's because people are looking at these suspicious patterns and rolling them into a narrative. You could look past some of them if you had rock-solid confidence in management's integrity, but after the Philidor thing you aren't at "rock solid" anymore. You might not think they are definitely crooks, but it's just relatively harder to rule it out.

The timing could not have been any better for them. Although, I don't think it was planned that way. It's not like they've been sitting on the Phillidor thing for months. I think one has to question the timing of the last Citron Research tweet. The Tweet went out right as the PSH conference call was ending on the last day of the month. I could be completely wrong with my speculation here but I think there is a chance that Andrew Left and company wanted to stick it to Ackman by crushing the stock when PSH has to report NAV). John Hempton already questioned Ackman's NAV figure last month so we know he tracks it (and really hates Ackman). If Citron really has a smoking gun, why not release it like 30 minutes before the market closes to create as much panic as possible before the Friday close? It's not like he didn't have time to write a report before the close. His previous one looks more undergrad level than professional and could not have taken more than an afternoon to write. I'm just speculating here... could be 100% wrong. Full disclosure: No opinion/position on VRX, just enjoying the show. That's a fair speculation. However on the theory that Andreft Left might have been fed some damning internal company document or testimonial, he might not have had it long enough to process it. Might simply be a case of needing more time depending on when he got the information into his hands (if he really has any). If he's got absolutely nothing though, literally nothing, the SEC is going to look harder at Left so he does have something to lose in light of how Valeant just last week asked the SEC to investigate Left.

Original_Mungerville, I know what you are saying about the binary outcome and the LEAPS. The shareholders that ValueAct are gathering will be asking some really hard questions and will want a lot more disclosures. They will be pushing for much better financial disclosures about how each of the acquisitions is doing. Break out their performance independently. And to fully disclose what's going on with the things that people are openly questioning as channel stuffing. They really can't put the suspicions to rest without that. So, I don't think it's necessary to pay for the excessive volatility premium all the way out to 2018. Too much money at risk if the stock rapidly breaks the wrong way. I think it would be more prudent to go with shorter-term options as it's not like we'll be going all the way to 2018 before we get the real scoop. Once we have the real scoop if it's a positive scoop the stock will take off again and that's when you can roll your shorter term stuff to the 2018 options.

Maybe with a prior girlfriend you've had this experience... you maybe have a female friend or classmate that you truly are not trying to seduce, but you share a cup of coffee with her or chat with her somewhere on campus. You get spotted by a friend of your girlfriend and she tells your girlfriend. It just so happens that you "had to study late that night" and this is the time when the conversation took place. Your girlfriend if she's had any experience with perhaps a philandering partner beforehand, is going to get super pissed and hit the ceiling. Yet technically you know that you didn't do anything wrong and didn't intend to, you just wound up spotted in a situation where the dots can be connected by your girlfriend and it's going to take volumes of words to talk her off the cliff if she ever really truly buys your story. Investors are sort of like that -- suspicious wives/girlfriends. It's always going to be difficult to explain your secretive dealings when you are found out because merely by hiding them you look guilty of something. And when there really is something the least bit dirty about them, it just might spiral into divorce. Like what if there was already a rumor that you were sleeping with that girl in the hallway even if you weren't. Or perhaps she had a loose reputation.

Regarding Philidor. I'm willing to entertain the theory that there was a "boys will be boys" attitude at Valeant -- rather than just partnering with "girls" where they knew certain behaviors couldn't physically be possible based on their physical form, they stuck with the "boys" as partners because they were much more aggressive but they put up a firewall due to the greater than normal possibility that the boys might be tempted to just hold down a customer and rape them. In other words, they created an incentive structure that would make super-human sales results HIGHLY lucrative to Philador's employees/management/owners. That kind of money has driven people throughout history to lie/cheat/steal and claw their way to the top, slash throats, kill or be killed, all that great stuff. So if you were setting up really crazy lucrative compensation for a sales team, knowing that "boys will be boys" you'd be smart to isolate yourself from what you know these people could very well be tempted to do in order to get their hands on that huge performance driven bonus. So one way to legally cut all kind of corners is to find somebody to partner with who looks like he'll cut every corner in the rule book just to make quota. Set him up with extremely lucrative quota-driven bonuses, and put him in a separate legal entity then turn him loose!

A week ago it seemed very likely that the original accusations, which were for channel stuffing and phantom pharmacies with fake sales, were wrong. And apparently they were. This is new stuff. All I'm saying is that there are multiple plausible scenarios. A bunch of people immediately jump on "management knew", and I'm saying that the exact same circumstances that we're seeing right now could have arisen without management knowing. Maybe. But I think there's a difference between doing something that is clearly fraud - changing doctors prescriptions, if the media reports are accurate - and what I've seen Valeant do so far. Ok let's look at two scenarios: Scenario 1: Valeant aggressively refills customers' prescriptions. Results in customers getting meds they don't need. Scenario 2: Somebody under the Valeant umbrella changes the number of refills on customers' prescriptions. Results in customers getting meds they don't need. 1 was what you've seen valeant do so far and apparently you're totally cool with that. 2 is new information and is illegal and you're shocked by it. The thing is that 1 and 2 are essentially the same thing in the end. 2 just happens to be illegal and 1 happens to be legal. So you're basically ok with valeant committing fraud as long as they've found a loophole to do it in a legal way. On whether valeant senior management or Pearson knew exactly what was going on at Philidor, frankly it doesn't really matter. Improper behavior has happened at Berkshire - a company that tries to stay as far of it can from the line between legal and illegal. The way that Valeant operates - right up against the line it is guaranteed that these things will happen that people will cross the line. Senior management knew that and didn't care. I guess they thought that when it'll happen they'd just plead ignorance, pay the fine and carry on. I don't think they'd envisioned this shit storm. Now we can probably sit here and split hairs on what exactly the senior management knew or didn't know. But the fact is that senior management has created a culture and atmosphere at Valeant that is condusive to unethical behavior at best. It's hard to defend that. Some investors don't care. Others do. Exactly. Charlie Munger has a great quote on incentives and how they can shape human behavior, which unfortunately I can't recall right now. But it is quite amusing to me how many of Charlie Munger's principles of human misjudgment Valeant fulfills. So the board should make it a priority to review the incentives. And I think a lot of people would feel better with just getting rid of earnings guidance so we can never suspect they are trying to fiddle with quarterly data to meet guidance. Incentives are hard though. I recall an insurer that recently surprised me with a large reserve increase, but the insurer's management recently had their incentives changed to one that only rewarded disciplined underwriting. I can't shake the suspicion that employees could game their incentives by setting up a big reserve increase so that they can have a long runway of lighter reserving to boost underwriting profits and get their bonuses. I'm probably just being totally paranoid though.

Andrew Left: "Now I'm not saying Jublia isn't effective, but I'm not saying it's not Vic's VapoRub either." That's hysterical. But seriously... Tobacco companies buried research showing their product was linked to cancer (major) GM buried data on faulty ignition switches that were killing people (minor) VW lied to governments around the world, faking diesel emissions testing (major) Couldn't a pharmaceutical company be capable of fudging the data to win or maintain drug approval? Just imagine trying to sell drugs when people think you cheat on research. Anyways, what the probability of that? No clue. Just my favorite Dr. Evil plot of the hour.

Ha ha , On my way home from work, I was thinking what story would I like if I were a short. I think a truly sensational story here would do the trick. What can such a story be.... My guess, Suburban single mom with two kids living paycheck to paycheck. Goes through a bad period in life and ends up with a prescription for some neuro drug or God forbid toe nail fungus. She gets dumped with these medicines for free or very low cost. In an effort to better her life and thus her children's,she decides to use the toe nail cream liberally. At the end of the story, she loses her toe or something to that effect. The scene now cuts to fat and snobby Pearson and VRX with big bad hedge fund investors like Ackman partying. Even I can produce a CBS 60 minutes story based of this... I hope this gets us to $60-$70 a share within next few weeks. That might be a good best case scenario. A good worst case scenario would be faking data presented to the FDA.

Valeant must have pissed off A LOT of current and former employees with their actions cutting R&D. Many of those people are very ethical scientist granola types that would have felt very conflicted about seeing their research and hard work to make people's lives better through science, only to see their work bought by hedge fund billionaires who jacked up prices to hurt the patients they were trying to help. So Valeant management if they slipped up in any way ethically and did it in front of those people in any kind of documentable way... they've got a lot of people who would love to see them fall. And there's much to speculate (they play too close to the line) that they've behaved in ways that look VERY unethical on the front page. Lot's of enemies and questionable ethics. There's potential here for an embarrassing internal anonymous disclosure.

For all we know, Monday could be a moment where some uncomfortable whistle-blower employees have anonymously tipped off Citron with internal company documents or emails. Could be about unsavory buried science regarding their drug development labs, or documented internal discussion about Philidor ("we're going to knife the baby!" type stupid comments). I mean... this would be the time when a person in search of a voice would come forward and Citron could be their mouthpiece. Just wondering how he could suddenly have more supposedly damning info already. He can't come out with complete bullshit, it's got to be some kind of company document or testimonial from an internal source. He's already been referred by Valeant to the SEC so his lawyers would likely be making sure he has something real -- or would he ask his counsel first?