Liberty

I'm not saying they didn't have ultimate control over the entity's destiny. I'm saying that it's one thing to have high level, strategic control (of the kind of "we should get distribution in states X, Y and Z... we will invest in more staff to add two new products in 6 months...") and to have day-to-day control over how employees are trained, how they're told to fill out form, compliance, etc. Maybe Valeant knew about everything and told them to do it. I don't know. But I think it's also plausible that Philidor management committed fraud to get their earnouts without the knowledge of Valeant. The net worth of Andrew Davenport and his cronies might double if they get those earnouts, so that's certainly an incentive for someone unscrupulous. But Valeant was doing quite well long before Philidor was ever on the scene, these tactics were worth at most a couple points of growth (I'm sure a lot of the 6-7% was legit, and if Philidor hadn't existed, it would've gone through other channels -- after all, doctors do prescribe the stuff), and the downside is huge... So maybe they did it, I don't know. But I think right now a lot of people are ready to put handcuffs on management with very few hard facts.

I'm just trying to look at different scenarios. Right now, we just don't know what happened there and who's responsible. Maybe Pearson himself was at the call center filling orders and knew exactly what was going on and that's why they structured things with that option, or maybe they did those things for other reasons that now happen to look bad. I'm genuinely looking forward to the day when we can have answers on all this. I hope the investigations don't drag on too much. Yeah, maybe they were in on it and it's all a big cover-up. But let's say that they truly don't have much operational involvement with Philidor. They have a few people over who set up the IT stuff, make sure it all works, keep track of some inventory, gather sales data, etc... But they aren't exactly looking over everyone's shoulder. And if Philidor really has been through lots of PBM audits and until now they were ok, it's possible that Valeant's own audits were fooled just the way the PBMs were.

Thanks for reminding us the other side of the argument Liberty, but I don't buy this argument as much. To me, they could have bought Philidor for the same price $100M and having that entity as part of the organization would only incur some additional salary/admin expense etc. for them. For the size of VRX, I don't think that additional cost would have been significant. I have no idea how many people work at Philidor but VRX could have easily afforded to employ those people without entering into this very questionable mechanic with them. When you hear the business practices at Philidor, it's not hard to guess why they did not want to own them. VRX employees actively getting involved there etc. no way they did not know what was going on there... I think the point was that they didn't want to buy it because being a pharmacy wasn't their business, they didn't understand it well. I don't think it was necessarily about size or costs. But it grew fast and they wanted exclusivity, and if it was to becomes important to them or down the road they decided that they wanted to make it their business (after learning about spec pharma over time), then they had that option. And pretend everything went well and Philidor became super important to their distribution 5 years down the line, they wouldn't want them to have leverage over them and threaten to go to other manufacturers or sell to a bigger competitor, so the option keeps them captive. You can believe that's not true and they were actually aware of bad practices and just wanted to play legal games to pretend there's no responsibility, but I think there's a logic to the CFO's version. It's kind of like the superhero names. Maybe it didn't look like anything at the time, but now that there's a scandal, it looks suspicious as hell.

Looking forward to what the investigations will reveal about what was going on at Philidor. Until then we can only speculate, but I think it's likely that if the Philidor guys gamed the system, it was to get their performance earnouts. I seriously doubt that Valeant asked them to break the law or knew that they were, they have a lot more to lose than to gain from that, just like with fraud in any other part of their business; the Philidor people, though, probably had a lot to gain proportionally to their net worth by meeting their earnout targets. Ackman talked to Howard Schiller (former CFO) and got a bit more color on why they structured the option that way. I think it sounds plausible; they had that young experiment in distribution which was growing fast and working well, Philidor probably wanted to start expanding to more drugs from other manufacturers, which would have reduced the attention/throughput/service that Valeant would've gotten. Valeant didn't know the specialty pharmacy business, which is different from the pharma business, with complex laws and regulations in each state, so they did an option which bought them the exclusivity they wanted without the headaches of actually running operations. I think it was interesting to see how many settlements most big pharmas paid out and how big they were (Merck had 29!). Some of them for really bad stuff that went on for over a decade and put people's lives at risk... Kinds of put things in context. Ackman also made it sound like the superhero emails at Philidor were to keep patient information at Philidor out of Valeant. He didn't say this exactly, but to me it sounds like because when people email each other they have autocomplete fill out the address, and if one name is linked to two emails, sometimes you have emails going to the wrong place (and a lot of modern email clients even hide the email and just put the name, so it's even harder to notice), and you don't want emails with patient info to end up on Valeant's servers. So you make up ridiculous names to make sure the two emails are completely separate. Probably seemed benign at the time... It's not like Philidor is the only specialty pharmacy out there. There are other third-party specialty pharmacies that Valeant could use, and they offer the same kind of things (auto-refills on no-copays, co-pay assistance, etc). The difference is that they probably would be more expensive to use than a captive spec pharma, so margins would be a bit lower, and if Philidor did screw with the prescriptions, some of the fraudulent volume will be gone. How much was that? Hard to say... You can't do that on every prescription, but even if you assume half (which is probably high -- it would show in audits if it's that much), that's still low single digit impact. Not sure that's worth a more than 60% drop in market cap. So yeah, it appears there's bad stuff going on, and I hope they are ruthless in getting to the bottom of it and step up the transparency a lot. Of course I don't like it. But some people seem quick to jump to the conclusion that this was VRX and not Philidor acting independently. In normal times, this would probably barely make the paper (like the recent Allergan settlement, or the Novartis thing with their specialty pharmas, etc), but in the current panic, everything is magnified a hundredfold.

"*CVS TERMINATES PHILIDOR FROM CAREMARK PBM NETWORK, DJ SAYS"

that would really send a bad message to markets --- things are so serious that we need to immediately take care of this in a way that we never would have considered before this. and their stated strategy is to sell more quality and durable products, so selling one or the other would be a setback and make what remains less desirable. selling either doesn't make sense to me. anyway, I really don't see the debt as being all that dire. this is not a distressed equity yet. it still trades for close to $40b. it seems dire because we are right in the thick of the extreme negativity. but rationality has to be the order of the day. all they need to do is take acquisitions and buybacks off the table for a couple of years and start paying it off. faster than they had planned to as their largest shareholder has advised. having said that I don't see this stock getting a multiple of over 10x "cash earnings" any time soon. so the shareholder base needs to make a transition from hot money, to managers that utilize time arbitrage. long slog ahead. I'm absolutely not saying they should do it (unless someone offers them a crazy multiple, and then you have to consider it). The thought experiment was just to put the debt in perspective and show how much value there is in the assets, most of which are now worth a lot more than what was paid for them originally. I always hear about how the company has so much debt, but in relation to the likely market value of the assets, it's not that much.

Times like these I wish this tax issue didn't exist and they could have done a 100bn tender when the stock was at 60... Oh well.

Sure, its possible. If we assume something like a 15% repatriation tax (no real basis -- just for argument sake). I have that adding something like $4 a share in net cash and ~$.75 - $1.00 in eps. What if they go to a territorial tax system like the rest of the world and just don't tax it? Can sell it politically as "when the money comes back in the country, it'll end up being reinvested in all kinds of things, creating jobs, increasing tax take indirectly, etc". Might not happen, but would make sense for the US to get on the same system as the rest of the world to be on a level playing field. Even Icahn is using the Pfizer-AGN news to push on tax reform: "1/3 Unfortunately, my warning concerning the imminent exodus of many of our best companies is coming true." "2/3 Today Pfizer confirmed they are planning to move out of the country. The situation is much more dangerous than most people believe." "3/3 There is no reason Congress cannot act now to pass international tax reform with the Highway Bill.Read my letter https://t.co/fbbB8mNWMR" http://www.wsj.com/articles/pfizer-ceo-says-u-s-tax-regime-pushing-him-to-seek-alternative-1446140269

Here's a thought experiment. I'm not advising this, but I think it's interesting. If VRX was to sell either B&L or Salix in the near future and got a good price (auction, multiple bidders, strategics get involved, etc), I think they could wipe more than half of their debt, if not more than 2/3 of it. B&L is performing much better than when they bought it, the fat has been cut, and they have some new launches (Ultra, biotrue) that should keep growing fast for years and a nice pipeline. They've been regaining market share. I'd be surprised if they got less than twice what they paid for it, if not more. Salix was depressed at the time because of the scandal and uncertainty. But selling it with a clean bill of health, with Xifaxan IBS-D approved and growing at high double-digits and other fast growing drugs and a nice pipeline, with some fat trimmed. Wouldn't be surprised if they got significantly more than they paid, especially to a strategic who wants to establish a GI platform or already has one and would have synergies and remove a competitor.. So they'd lose one of the big therapeutic platforms, and that would shrink the company a fair bit, but you'd have a lot of stuff left over and relatively little debt. Obviously I think they should keep growing these assets and use them as platforms for tuck-ins and other deals, but I know that management considers everything for sale, so if some day they get an offer like the one that TEVA made to AGN for the generics, they'll probably take it.

I think we're about due for some tax reform in the US (becoming more and more widely understood that it's a huge competitive disadvantage and pushes jobs and companies to invest outside of the country and keep their foreign cash out). But even if it takes 10 years, I think Apple will be patient and won't throw tens and tens of billions away to bring back capital that they don't need to run the business anyway (even with the 15bn of capex planned for 2016). They have an extremely low borrowing cost, so if they want to return more capital than they generate in the US, they'll just borrow. But that's just my guess...

http://www.wsj.com/articles/visa-nears-22-billion-deal-to-buy-european-counterpart-1446136455 Visa Nears $22 Billion Deal to Buy European Counterpart

Sequoia letter on VRX situation: http://www.sequoiafund.com/Letter%20to%20Clients%20and%20Shareholders.pdf (thanks to Max0205 and MarAzul for forwarding to me)

One thing to keep in mind is that insurance companies are sophisticated players and probably have their own measures to deal with this, and some insurers might on their side be very aggressive with trying to reject (valid) claims. This is a case of two sophisticated players doing battle, not quite the same as if one side was sophisticated and the other wasn't.

Great stuff by Ben Thompson: https://stratechery.com/2015/stop-doubting-the-iphone-the-macintosh-company-2/

Charter Q3 is out: http://ir.charter.com/phoenix.zhtml?c=112298&p=irol-newsArticle&ID=2104101

Pfizer and AGN looking at merger, apparently. http://www.wsj.com/articles/pfizer-allergan-considering-combining-1446079506

Meanwhile... Samsung is not doing too hot: http://www.bloomberg.com/news/articles/2015-10-28/samsung-misses-estimates-as-new-phones-fail-to-revive-growth

6% hit from FX on organic growth, so at least they would be positive without that. Not great, but that has always been lumpy, and they have no control over FX. Last Q had -4% organic growth with same 6% FX impact. Margins are up, adjusted net income up 43%.

More ruminations on VRX's model. Similar to stuff I've written earlier in the thread, but I don't think I quite put it this way before, and we have a lot of new readers these days... In the pharma industry, if you pull on the string long enough and go back to the source, all assets come from R&D. But there are different ways to get those assets, some of which are higher risk but higher reward, and some which are lower reward, but also lower risk... You can position yourself at different points in the value chain, even if ultimately the money all flows back to the same place. Traditional pharma places bigger bets earlier in the chain, which leads to a profile that is: Higher risk, higher reward. So if you are good and/or lucky, you can find a blockbuster and have huge upside. But if you are not too good and/or unlucky, you can pour a lot of money down the drain without much to show for it. Because of this high risk profile, you can't use much leverage because your future cashflows are not predictable enough. Valeant has decided to instead focus on just the R&D that they know they are good at (and they seem to be getting good returns there -- the pipeline is producing good stuff) and for the rest, buy a highly diversified portfolio of assets that aren't too susceptible to competition (drugs too small to be worth copying, already off patent, in categories where generics have a hard time (skin creams, contact lenses), where doctor recommendation matter, etc). When you buy rather than build, your potential upside is more limited (usually no surprise blockbusters), but your risk is also a lot lower because you know what you're getting and have more control over how you tailor it (certain therapeutic areas, certain countries, buying opportunistically assets that you find underpriced, etc). So they built a portfolio of assets that are lower reward by themselves, but lower risk too, and more predictable and durable in the aggregate. That's why they feel they can use leverage, which is enough to juice those lower returns into superior ones. Combine that with very lean operations in an industry that has a lot of fat (zero-based budgeting, decentralized model, etc), and a very good tax rate and you push those superior returns into even higher gear. Maybe time will show that this structure doesn't work, but it certainly sound like a valid experiment.

Are senior miners who buy assets from more nimble and efficient juniors leeches? ??? Who's talking about reducing R&D in the pharma industry? Pearson is just moving dollars around to where they are more effective, but if you follow those dollars, the termination point is R&D. It's the journalists who write that "valeant doesn't believe in R&D", but if you listen to the actual company's strategy, you'll find that's not what they're saying, they just don't have a "not invented here" hangup. When they buy Sprout or Dendreon or Salix, the money is to pay for the R&D that was done at those companies. What's the difference with spending it in an internal lab, except the risk/reward profile and the ability to pick assets that you think are undervalued? And to keep these companies growing in the future, what's the difference between allocating all capital into internal R&D and allocating some internally and some of it for other acquisitions? Not everyone has to be good at everything. Some can specialize at R&D and be really good and efficient at it, but not everyone has to have the same model. Others can be better at distribution and identifying good assets; their money is just as good and ends up in R&D in the end. In short: R&D <-> pharma assets When you buy assets, you pay for that R&D retroactively. Just like when you buy a house, you pay for the construction of that house. Another annoying thing is measuring R&D by inputs rather than outputs. This just encourages waste.If VRX contracts some of its R&D to an external lab that has overcapacity and costs a lot less than having a high fixed cost internal lab, the % of revenue spent on that project is lower even if the actual work being done is the same. So for optics, VRX is be penalized in that specific case because they got the same thing done more cheaply..

http://mashable.com/2015/10/28/apple-phil-schiller-mac/#cFHpyHjLkkqR Good piece. More and more access inside Apple under Cook, less secrecy about process.

I saw the Alcon link on Twitter. Huge conflict of interest that wasn't disclosed. Alcon has been losing share to the newly invogorated Bausch & Lomb.. See here: https://twitter.com/CaraOriel/status/657544115257778176 And he's not just a 2-bit player at Alcon either: http://www.alcon.com/docs/BioJeffGeorge.pdf I think Valeant really is bad at PR. If I was them, from day 1 I'd have repeated again and again that when you make an acquisition, the vast majority of the price isn't going to employees and real estate and computers and desks, it's a way to pay for assets that are basically embedded R&D. So whether you spend money on internal or external R&D, the money is still making its way to people in labs creating new assets. Like how larger miners will buy juniors when they find something; the money is still going into exploration, even if indirectly. To be fair, VRX has been saying that, but not in a way that people understood. Certainly not in a way that is as catchy as the "they just slash R&D" headlines. They phrase it as "we are agnostic about where we source innovation, it doesn't have to be internal", but that doesn't make the idea clear to most observers.

CHTR is a great example of a company that if someone just quickly looks at it, the leverage may seem high, the GAAP numbers are crap, the FCF is low, capex elevated, etc.. But you have to look at where they are going, understand what's actually going on underneath the numbers, go to the real economics, and what the normalized earning power of the business could be. Then you have the M&A picture making things even less clear... Not for everyone either.

To paraphrase Malone, it's better to pay interest and restructuring charges than tax.

Because the real earning power isn't $6.75.