VRX - Valeant Pharmaceuticals International Inc.

[original mungerville]

The non-weighted growth rate was a negative for me too. I thought about it some more, and I don't necessarily think they should have put only the weighted though. Best approach would be to put both. A non-weighted approach would mean management believes that size is not a driver of future growth. So, let us think of Salix - which if it works out perfectly, would dwarf many of the previous acquisitions and really skew a weighted approach. As such, it is not clear a weighted approach is the best approach. So even this is not a "smoking gun" from my perspective.

 

In terms of disclosing the revenues to year-end of new acquisitions under the Valeant fold only in the year of acquisition. One argument to not disclose these during the next year is that some product lines are probably cut down, others expanded, countries abandoned, others increased, sales forces synergies, etc. There are a lot of reasons for not making this comparison. Another reason might be that revenue growth is not really needed at all to make Valeant attractive - assuming they can get the IRR they have been getting historically on acquisitions (an IRR which itself, I know, is an estimate because it has to include an assumed future growth rate).

 

The write-up does make me think though - which is very helpful. I would say I have questioned all managements (Berkshire, Fairfax, Malone - all these guys I have felt at one point or another were talking, to a degree depending on the subject, out of both sides of their mouths). I don't know, I am looking forward to the next posts of the sections which follow. Let us understand all the other possible negative arguments.

 

 

[Travis Wiedower]

It's easy to say the non-weighted CAGR is one small issue but I view things like that as big red flags. Management knew perfectly well what they were doing and if they're going to be deceptive about something that small it's a bad sign for the bigger, more important things. If the management team is both unethical and smart, those small red flags are probably all we'll get until everything blows up (but of course then it's too late).

[KCLarkin]

The non-weighted growth rate was a negative for me too. I thought about it some more, and I don't necessarily think they should have put only the weighted though. Best approach would be to put both.

 

The key is transparency. If they are showing the average, they should clearly indicate this. This is not a smoking gun for me but it is difficult to analyze the company when key information is not clear. I assume we'll learn more in the next installment, but I have no idea what methodology they are using for IRR.

 

 

[Picasso]

In my mind there is no excuse. Why not throw in a small acquisition of 10 million with a 200% CAGR and say they're doing deals at 30%?

 

This is one of those things where the bull case is so vague and it's easy to come up with excuses. I'm just waiting for someone to say they lose their competitive advantage by disclosing details.

 

There's more to VRX than just revenue growth but I don't think a levered situation like this should involve any kind of monkey business. The margin of error is not wide enough to warrant that behavior.

[original mungerville]

Any thoughts on all the hedge funds (like valueact and persian who are highly respected with solid track record) on the board?  The bulls are basically riding off their insights.

 

and Sequoia Fund's largest position by far, and a large Lou Simpson position...so also very well-respected long-only longterm value investors, not just hedge funds.

 

We can do a lot of digging to put together a rough idea of what the business/acquistions actually looks like but no matter what information we find, Jeff can just ask a pointed question at a Board meeting and get way more information than us. Also, I believe that Mason was involved heavily in the due diligence of all early acquisitions.

 

I know the counter to this point (and respect it), but the information asymmetry makes me trust their analysis over whatever I can do on my own. However, I have no position.

 

 

Buffett bought and sold XOM/COP in less than a year, both times buying at high oil prices and selling at decade-lows. He admitted another major mistake with Tesco. Lots of value investors completely missed the housing bubble and bought WAMU days/weeks before bankruptcy (including Parabai). And, of course, the mighty Hank Greenberg managed to destroy a 6+ decade long reputation by being mislead by CCME. Everyone makes mistakes, they just make far fewer. However, even Buffett still regularly makes major mistakes.

 

I don't understand the hero worship in the face of conflicting evidence just because they are presumably experts. It's CNBC-syndrome to me. I think we'd all agree that Lou Simpson or collectively, Sequoia, are better investors on the whole than AZ_Value (without knowing anything about AZ). However, it seems possible that AZ_Value is the expert on this extremely specific topic. I don't mean to pick on you personally, just a pet-peeve about relying on expert opinions when their actual expertise is more broad and only partially related. Lou Simpson may be an expert in capital allocation and equity valuation. We have no idea and it's almost impossible to know if that expertise extends to VRX's business, regardless of his investment status.

 

http://brontecapital.blogspot.com/2011/03/what-demise-of-china-media-express-says.html

 

Old timers on this site might get a little agitated when they see a link to Bronte Capital as there is a long history between Bronte Capital and the Corner of Berkshire & Fairfax. You should ask little John Hempton to give you a history lesson on it, or Sanjeev or Ericopoly or Uccmal, or Cardboard, etc. I won't because I'll get too pissed off.

[original mungerville]

It's easy to say the non-weighted CAGR is one small issue but I view things like that as big red flags. Management knew perfectly well what they were doing and if they're going to be deceptive about something that small it's a bad sign for the bigger, more important things. If the management team is both unethical and smart, those small red flags are probably all we'll get until everything blows up (but of course then it's too late).

 

I don't disagree, like I said, I think they should have used both weighted and non-weighted.

[KCLarkin]

For me, this is the real red flag and the reason I didn't buy in size:

 

So the way it works for Mike and Howard, the CEO and the CFO of the company, if over the period of their long-term incentive compensation grant, which are typically long-term periods, the company's share price, the total return does not equal or exceed 15%, they get no long-term incentive compensation. If it's above 15%, they get 100% of their PSUs vest. If it's above 30% compounded, they get 200%. If it's 45% compounded, they get 300%. At 60%, they get 400% of their PSU grant. So that, again, focused on IRR on a long-term basis.

 

I don't see how that doesn't go spectacularly wrong.

 

[ZenaidaMacroura]

 

In terms of disclosing the revenues to year-end of new acquisitions under the Valeant fold only in the year of acquisition...

Quick take on that -I haven't verified it by examining each of the acquisitions but Pearson says in the calls that they break out revs not only in the year of the acquisition but as long as they are taking significant integration charges.  So presumably some like B&L get reported longer while Sanitas or Medicis may have revs broken out for a much shorter period.

[original mungerville]

For me, this is the real red flag and the reason I didn't buy in size:

 

So the way it works for Mike and Howard, the CEO and the CFO of the company, if over the period of their long-term incentive compensation grant, which are typically long-term periods, the company's share price, the total return does not equal or exceed 15%, they get no long-term incentive compensation. If it's above 15%, they get 100% of their PSUs vest. If it's above 30% compounded, they get 200%. If it's 45% compounded, they get 300%. At 60%, they get 400% of their PSU grant. So that, again, focused on IRR on a long-term basis.

 

I don't see how that doesn't go spectacularly wrong.

 

Yes, agree. I am not sure that is the best compensation plan to foster conservative thinking. I think that causes you to get quite aggressive - which they are with acquisitions and debt. That plan will go very right or very wrong, not much in between - this is why I own the call LEAPs rather than the common.

 

[mateo999]

 

Old timers on this site might get a little agitated when they see a link to Bronte Capital as there is a long history between Bronte Capital and the Corner of Berkshire & Fairfax. You should ask little John Hempton to give you a history lesson on it, or Sanjeev or Ericopoly or Uccmal, or Cardboard, etc. I won't because I'll get too pissed off.

 

Wait... now you've piqued my interest.  At the risk of you getting pissed off, do tell...

[EliG]

Wait... now you've piqued my interest.  At the risk of you getting pissed off, do tell...

 

C'mon, you can google it.

 

http://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/collection-of-e-mails-john-hempton-wrote-regarding-accounting-issues-at-fairfax/

[Guest JoelS]

At the risk of adding something inflammatory, there is a good book called 'The seven signs of ethical collapse' by Marianne Jennings, a professor of business ethics. Here is her list:

 

1. Make the numbers

2. Fear/intimidation and Silence

3. Young un's and a bigger than life CEO.

4. Weak board of directors.

5. Conflicts of interest at executive level (e.g. stock options)

6. Innovation like no other

7. Goodness in some areas atones for bad in others.

 

I am not suggesting Valeant is fraudulent (who knows), but I find this checklist interesting to think about in relation to Valeant. There are too many incentives skewed in one direction. In particular, no 5: innovation like no other - e.g. you can cut R&D costs dramatically at a drug company, without negative consequence. Another is becoming a top five pharmaceutical company by market cap in three years…

 

I think the Outsider blueprint is fundamentally sound, but taken too far, can be dangerous. I will watch from the sidelines and learn something either way.

[LongHaul]

Loved the analysis AZ Value.  Wonderful dissection of VRX.  Thanks for putting it out there.

 

If mgmt is highly deceptive about a simple sales growth slide what else are they hiding? 

The limits are endless with a smart and energetic person who is willing to deceive. 

 

Every time I try and understand VRX organic growth rate from their 10-K I get a headache and cannot figure it out clearly.

The business model makes no sense to me.  Pay a lot for deals then cut growth expenses and create value. 

 

Here is something to think about - if VRX is really shrinking by -2% a year then with all the debt what P/E is it worth?

 

The "smart" investors who own VRX is just noise. 

[Liberty]

Hey AZ, I just want to point out that I haven't had a chance to read your piece yet. You caught me in one of the rare times of the year when I can't do much more than glance at a few articles each day, so the novella is on the list for later. Cheers!  :)

[Bagehot]

For me, this is the real red flag and the reason I didn't buy in size:

 

So the way it works for Mike and Howard, the CEO and the CFO of the company, if over the period of their long-term incentive compensation grant, which are typically long-term periods, the company's share price, the total return does not equal or exceed 15%, they get no long-term incentive compensation. If it's above 15%, they get 100% of their PSUs vest. If it's above 30% compounded, they get 200%. If it's 45% compounded, they get 300%. At 60%, they get 400% of their PSU grant. So that, again, focused on IRR on a long-term basis.

 

I don't see how that doesn't go spectacularly wrong.

 

Yes, agree. I am not sure that is the best compensation plan to foster conservative thinking. I think that causes you to get quite aggressive - which they are with acquisitions and debt. That plan will go very right or very wrong, not much in between - this is why I own the call LEAPs rather than the common.

 

That's only half of it, the other half (where the teeth are) is that Pearson can't really sell any shares except for taxes and some charitable giving until he retires, and even then he's required to hold 1M shares for another 2 years after retirement. Even noted corporate governance gadfly Lucian Bebchuk likes the pay package, saying "it goes a substantial distance towards addressing my concerns about executive pay arrangements."

[ZenaidaMacroura]

For me, this is the real red flag and the reason I didn't buy in size:

 

So the way it works for Mike and Howard, the CEO and the CFO of the company, if over the period of their long-term incentive compensation grant, which are typically long-term periods, the company's share price, the total return does not equal or exceed 15%, they get no long-term incentive compensation. If it's above 15%, they get 100% of their PSUs vest. If it's above 30% compounded, they get 200%. If it's 45% compounded, they get 300%. At 60%, they get 400% of their PSU grant. So that, again, focused on IRR on a long-term basis.

 

I don't see how that doesn't go spectacularly wrong.

 

Yes, agree. I am not sure that is the best compensation plan to foster conservative thinking. I think that causes you to get quite aggressive - which they are with acquisitions and debt. That plan will go very right or very wrong, not much in between - this is why I own the call LEAPs rather than the common.

 

That's only half of it, the other half (where the teeth are) is that Pearson can't really sell any shares except for taxes and some charitable giving until he retires, and even then he's required to hold 1M shares for another 2 years after retirement. Even noted corporate governance gadfly Lucian Bebchuk likes the pay package, saying "it goes a substantial distance towards addressing my concerns about executive pay arrangements."

Pearson also takes a $1 salary if I correctly recall. 

 

Edit: he was required to buy $3million USD worth of shares upon assuming the helm initially but he went further and bought $5million. I assume that would be a considerable amount even for someone who "lifed" at McKinsey.  He was super aligned and it's not likely he would risk the money given that the 120k share incentive was worth A fraction of the buy-in...

 

 

Edit2: he originally received a 1.75mm base salary, the $1 is more recent.  Still if you had someone wanting a free moonshot they would have bought the minimum shares required and not up the ante.

[KCLarkin]

You are probably right. I'm just a sucker for the Law of Unintended Consequences.

[original mungerville]

Loved the analysis AZ Value.  Wonderful dissection of VRX.  Thanks for putting it out there.

 

If mgmt is highly deceptive about a simple sales growth slide what else are they hiding? 

The limits are endless with a smart and energetic person who is willing to deceive. 

 

Every time I try and understand VRX organic growth rate from their 10-K I get a headache and cannot figure it out clearly.

The business model makes no sense to me.  Pay a lot for deals then cut growth expenses and create value. 

 

Here is something to think about - if VRX is really shrinking by -2% a year then with all the debt what P/E is it worth?

 

The "smart" investors who own VRX is just noise.

 

Well over 15x owner earnings. Negative growth of 2%, or flat revenues, or 2% growth is nothing, IF they have an IRR on acquisitions north of 25%. AZ_Value has promised some interesting facts on the IRR estimates - let us see what he has.

[giofranchi]

I have already commented on Twitter and I am commenting here as well.

 

The basic and only idea on that post is: Pearson is a liar and Valeant is a fraud.

 

I would like to know who among you has listened to the Q2 2015 conference call.

 

In it Pearson reviews IRR and cash payback time for all 140 acquisitions so far, and he clearly divides them between large, medium, and small deals. Therefore, I think he adresses the previuos mistake quite satisfactorily. He also discloses organic growth both for the whole company and for its top 20 products. Therefore, I think I have all the information I require about how acquired businesses are doing.

 

But AZ_Value shifted the discussion on another level: he has told us that what Pearson tells belongs to the garbage can... He cannot be trusted at all!

 

Of course, if the information we receive from Pearson is fraudolent, I am lost...

 

But... The fact Pearson is telling lies to everyone doesn't make business sense to me:

 

In my experience you lie when you are in trouble and you don't know how to make a profit. VRX instead is in the best industry in the world and has the best strategy in the industry.

 

When you are in their position, to do something dishonest is the last thing you want to do! Why to risk such a strong business over the long term? For what? AGN is a 9x since 2007... PRGO is a 10x since 2007... VRX is a 45x since 2008! Even their strongest competitors have grown much slower! If you were Pearson, would you risk losing everything for a rate of growth that's utterly unnecessary? I would not. And it doesn't make any sense to me. What's the point for Pearson to earn $billions... If he later ends up in jail? Especially given the fact his business is very sustainable and could build wealth for a very long time.

 

Some of you have said VRX's business model is flawed... Of course we disagree, but if VRX's business model weren't as strong and unique as I think it is, I would understand why Pearson might be telling lies much more easily!

 

This being said, the fact imo remains:VRX's management is giving us all the information I would like to know about their business... If they can be trusted, those results are great... If they are telling lies, VRX is a fraud.

 

I will read AZ_Value's part two on VRX, but I seriously doubt we will get beyond this question: is Pearson reliable, or is he telling lies to everyone?

 

Cheers,

 

Gio

[frommi]

Well over 15x owner earnings. Negative growth of 2%, or flat revenues, or 2% growth is nothing, IF they have an IRR on acquisitions north of 25%. AZ_Value has promised some interesting facts on the IRR estimates - let us see what he has.

 

The trouble is finding enough targets to move the needle for the company and they need access to cheap capital. Debt levels are now near the maximum possible, so growth via aquisitions will surely slow down. When you just look at reported operating cashflow - deprecation as owner earnings, it trades only at a 2-3% FCF yield which is pretty low for a pharma company, so at the current price i don`t think VRX is a good investment. But maybe when the momentum investors have no interest in this stock anymore and it trades 50% lower.

Looking at Salix, it looks a bit like they are reducing revenues in the year before the aquisition to post higher growth rates after the aquisition, but of course i have no evidence for that. I sold my position because of AZValue`s report after realizing that i know pretty much nothing about VRX and i was just chasing performance.

[Andy Dufresne]

I have already commented on Twitter and I am commenting here as well.

 

The basic and only idea on that post is: Pearson is a liar and Valeant is a fraud.

 

I would like to know who among you has listened to the Q2 2015 conference call.

 

In it Pearson reviews IRR and cash payback time for all 140 acquisitions so far, and he clearly divides them between large, medium, and small deals. Therefore, I think he adresses the previuos mistake quite satisfactorily. He also discloses organic growth both for the whole company and for its top 20 products. Therefore, I think I have all the information I require about how acquired businesses are doing.

 

But AZ_Value shifted the discussion on another level: he has told us that what Pearson tells belongs to the garbage can... He cannot be trusted at all!

 

Of course, if the information we receive from Pearson is fraudolent, I am lost...

 

But... The fact Pearson is telling lies to everyone doesn't make business sense to me:

 

In my experience you lie when you are in trouble and you don't know how to make a profit. VRX instead is in the best industry in the world and has the best strategy in the industry.

 

When you are in their position, to do something dishonest is the last thing you want to do! Why to risk such a strong business over the long term? For what? AGN is a 9x since 2007... PRGO is a 10x since 2007... VRX is a 45x since 2008! Even their strongest competitors have grown much slower! If you were Pearson, would you risk losing everything for a rate of growth that's utterly unnecessary? I would not. And it doesn't make any sense to me. What's the point for Pearson to earn $billions... If he later ends up in jail? Especially given the fact his business is very sustainable and could build wealth for a very long time.

 

Some of you have said VRX's business model is flawed... Of course we disagree, but if VRX's business model weren't as strong and unique as I think it is, I would understand why Pearson might be telling lies much more easily!

 

This being said, the fact imo remains:VRX's management is giving us all the information I would like to know about their business... If they can be trusted, those results are great... If they are telling lies, VRX is a fraud.

 

I will read AZ_Value's part two on VRX, but I seriously doubt we will get beyond this question: is Pearson reliable, or is he telling lies to everyone?

 

Cheers,

 

Gio

 

Gio,

 

AZ Value drew a very important distinction between misrepresentations in any documents filed with the SEC compared with anything else. Mess up on the former, and you go to prison; mess up on the latter, consequences aren't that severe. So YES, there is a large incentive for management to disclose as little as possible on the 10Ks and 10Qs and then perform "creative story-telling" as AZ has shown. Sadly, with the amount of information and limited time, managements KNOW that 99.9% of analysts will not have the time and patience to look for inconsistencies between the SEC filings and the rest (=marketing).

 

You ask why would a billionaire CEO do this? Well, in short, out of control ego. May I remind you of another McKinsey alumnus, Jeff Skilling of Enron, who had no need to fabricate? He was already a wealthy man, but shaping your own cult-like company proved to be too great a lure for him.

 

I am in no way suggesting that either VRX or its CEO are anything like Enron - this remains to be seen, but I think the least we owe AZ for his wonderful effort is to examine his findings objectively (I have no position in VRX, so for me its easier I guess) and make sure that tough questions are asked both via VRX's IR and on the next quarterly call.

 

Il bugiardo deve avere buona memoria!

 

Andy

[jschembs]

I have already commented on Twitter and I am commenting here as well.

 

The basic and only idea on that post is: Pearson is a liar and Valeant is a fraud.

 

I would like to know who among you has listened to the Q2 2015 conference call.

 

In it Pearson reviews IRR and cash payback time for all 140 acquisitions so far, and he clearly divides them between large, medium, and small deals. Therefore, I think he adresses the previuos mistake quite satisfactorily. He also discloses organic growth both for the whole company and for its top 20 products. Therefore, I think I have all the information I require about how acquired businesses are doing.

 

But AZ_Value shifted the discussion on another level: he has told us that what Pearson tells belongs to the garbage can... He cannot be trusted at all!

 

Of course, if the information we receive from Pearson is fraudolent, I am lost...

 

But... The fact Pearson is telling lies to everyone doesn't make business sense to me:

 

In my experience you lie when you are in trouble and you don't know how to make a profit. VRX instead is in the best industry in the world and has the best strategy in the industry.

 

When you are in their position, to do something dishonest is the last thing you want to do! Why to risk such a strong business over the long term? For what? AGN is a 9x since 2007... PRGO is a 10x since 2007... VRX is a 45x since 2008! Even their strongest competitors have grown much slower! If you were Pearson, would you risk losing everything for a rate of growth that's utterly unnecessary? I would not. And it doesn't make any sense to me. What's the point for Pearson to earn $billions... If he later ends up in jail? Especially given the fact his business is very sustainable and could build wealth for a very long time.

 

Some of you have said VRX's business model is flawed... Of course we disagree, but if VRX's business model weren't as strong and unique as I think it is, I would understand why Pearson might be telling lies much more easily!

 

This being said, the fact imo remains:VRX's management is giving us all the information I would like to know about their business... If they can be trusted, those results are great... If they are telling lies, VRX is a fraud.

 

I will read AZ_Value's part two on VRX, but I seriously doubt we will get beyond this question: is Pearson reliable, or is he telling lies to everyone?

 

Cheers,

 

Gio

 

Gio,

 

AZ Value drew a very important distinction between misrepresentations in any documents filed with the SEC compared with anything else. Mess up on the former, and you go to prison; mess up on the latter, consequences aren't that severe. So YES, there is a large incentive for management to disclose as little as possible on the 10Ks and 10Qs and then perform "creative story-telling" as AZ has shown. Sadly, with the amount of information and limited time, managements KNOW that 99.9% of analysts will not have the time and patience to look for inconsistencies between the SEC filings and the rest (=marketing).

 

You ask why would a billionaire CEO do this? Well, in short, out of control ego. May I remind you of another McKinsey alumnus, Jeff Skilling of Enron, who had no need to fabricate? He was already a wealthy man, but shaping your own cult-like company proved to be too great a lure for him.

 

I am in no way suggesting that either VRX or its CEO are anything like Enron - this remains to be seen, but I think the least we owe AZ for his wonderful effort is to examine his findings objectively (I have no position in VRX, so for me its easier I guess) and make sure that tough questions are asked both via VRX's IR and on the next quarterly call.

 

Il bugiardo deve avere buona memoria!

 

Andy

 

+1

[Bagehot]

Well over 15x owner earnings. Negative growth of 2%, or flat revenues, or 2% growth is nothing, IF they have an IRR on acquisitions north of 25%. AZ_Value has promised some interesting facts on the IRR estimates - let us see what he has.

 

The trouble is finding enough targets to move the needle for the company and they need access to cheap capital. Debt levels are now near the maximum possible, so growth via aquisitions will surely slow down. When you just look at reported operating cashflow - deprecation as owner earnings, it trades only at a 2-3% FCF yield which is pretty low for a pharma company, so at the current price i don`t think VRX is a good investment. But maybe when the momentum investors have no interest in this stock anymore and it trades 50% lower.

Looking at Salix, it looks a bit like they are reducing revenues in the year before the aquisition to post higher growth rates after the aquisition, but of course i have no evidence for that. I sold my position because of AZValue`s report after realizing that i know pretty much nothing about VRX and i was just chasing performance.

 

Salix's growth this year is due to former management's channel stuffing, which was well-known and the reason the former CEO was fired and the stock was down 45% in late 2014. VRX is working through the elevated inventory levels and expects to have them normalized by end of year, leading to a normalized year in 2016. It is possible that Valeant "spring loaded" Medicis and B+L to some degree, but not Salix, that happened before VRX was on the scene. And in any event, whatever benefit they got from (potentially) doing so with MRX and B+L has long since washed through the P&L.

 

On finding enough acquisitions, it is true that they will likely slow down, but even still the consensus revenue estimate for next year is ~$13.5B against a $2-$3T pharma and device industry. Another sanity check is that even crusty old Pfizer has consensus revenue estimates of $50B next year, Merck $40B, Bayer $54B, etc. So VRX could triple to quadruple its revenue base before catching the industry leaders on the top line. And at ~15x '16E cash EPS, you aren't paying for Herculean growth assumptions at $245/sh, particularly for a business that has been growing double-digits organically for the past year.

[original mungerville]

+1.

[giofranchi]

Andy,

It makes no difference at all.

 

Enron?! Come on... You MUST think about business! First of all it is business! Than come SEC filings and all the rest!

 

I have read a lot about Enron... And I have never understood how they made money!!

 

This is the thing you should always think about: how does a business make money?

 

In my experience, if you figure that out, everything else follows.

 

Now I repeat: VRX imo has the best strategy in the best industry in the world. This century imo will be the century of biotech and its only weakness are R&D costs that too often are out of control.

 

That's why VRX makes lots of money.

 

As far as "character" is concerned, Pearson has always given me the impression of being very humble and dedicated to what he is doing. The exact opposite of the guys that ran Enron!

 

Cheers,

 

Gio