VRX - Valeant Pharmaceuticals International Inc.

[cmlber]

http://www.reuters.com/article/2015/10/30/us-valeant-pharmacies-expressscripts-exc-idUSKCN0SO2NE20151030

 

Is it absolutely clear Philidor did anything illegal?  Dropping them for non compliance with provider terms doesn't definitively mean fraud.  Why would express scripts be looking at Abbvie and Teva (per the article linked) captive pharmacies if the reason for dropping Philidor was outright fraud?  Would they think everyone in the industry was engaging in fraud?  More likely that Philidor was exploiting a loophole going unnoticed by the payers and now that attention was brought to the issue, they realized they are getting (legally) screwed and others might be doing the same thing.

[Picasso]

That might be a good best case scenario.  A good worst case scenario would be faking data presented to the FDA.

 

Andrew Left:  "Now I'm not saying Jublia isn't effective, but I'm not saying it's not Vic's VapoRub either."

[Picasso]

So question for the experienced investment bankers.... Is it too late to buy Salix with Valeant stock instead of debt?  Asking for a friend of a friend....

 

Looks like S&P just downgraded VRX debt to B+.  Now four notches from investment grade.  Going to be a while before they turn investment grade which seems to be part of Ackman's thesis.

[ERICOPOLY]

That might be a good best case scenario.  A good worst case scenario would be faking data presented to the FDA.

 

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.

[KCLarkin]

Place your bets, everyone. I hope to ignore this thread forevermore. Listening to others opine is dangerous to rational investing. Unfortunately, everyone has an opinion on this stock. Very few here have a rational thesis.

[Picasso]

Man, at this point what is there left to invest rationally here?  Management has proven completely inept at communications and providing clarity without pulling out teeth.  We have to read between every line to try and figure out what's real and what's not.  Do we really expect regular investors to dig in as much as we have to buy the stock?  It shouldn't be this hard.

 

Now that bagehot mentioned it, has anyone else looked at the past few years of net to gross sales?  I can't believe how much they've had to provision to get incrementally higher sales.  Now that Philidor is gone and you adjust back down to pre-Philidor levels...Ouch...  It's no surprise why the stock is getting killed aside from looking at penalties.  The potential fines are just noise in comparison.

[rb]

Liberty, you may believe whatever you want. It seems that whenever there's any question raised about Valeant you always come out strongly in favour of VRX management. A week or so ago you were sure that nothing wrong was going on at Philidor. Now you seem pretty sure that C-suite didn't know anything about the wrong doing. So I don't know if you are or can be objective in your view of Valeant.

 

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.

 

Valeant is a company that is ultra-aggressive in pushing their drugs and making numbers, always going right to the line of what they can do and what's legal. In an environment like that is very easy to go over the line. That's why it's not hard to believe that top management knew or sanctioned it as opposed to some rogue middle manager. Also this totally looks like something that Valeant would do.

 

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.

[ourkid8]

What is Valeant debt trading at? With the recent downgrade, this should be a priority to call to calm the market.

[feynmanresearch]

Liberty, you may believe whatever you want. It seems that whenever there's any question raised about Valeant you always come out strongly in favour of VRX management. A week or so ago you were sure that nothing wrong was going on at Philidor. Now you seem pretty sure that C-suite didn't know anything about the wrong doing. So I don't know if you are or can be objective in your view of Valeant.

 

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.

 

Valeant is a company that is ultra-aggressive in pushing their drugs and making numbers, always going right to the line of what they can do and what's legal. In an environment like that is very easy to go over the line. That's why it's not hard to believe that top management knew or sanctioned it as opposed to some rogue middle manager. Also this totally looks like something that Valeant would do.

 

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.

[rb]

What is Valeant debt trading at? With the recent downgrade, this should be a priority to call to calm the market.

Well sure, if you have anything to calm it with. They had a call after the initial citron report came out. It wasn't very effective at calming anything.

 

Also keep in mind that this is the bond market you're talking about here. It operates in different ways. As a stockholder you may get doubles or triples with VRX will be way more than you can get with something else. In the bond market they may pay 1% per year compared to something else. Why would bond investors take such risk for an extra 1%? Safety is number 1 priority in that market. After the recent performance they may be shut out of the bond markets for a while.

[walt373]

I keep seeing "$4 billion FCF" mentioned. Doesn't FCF overstate earnings power for a highly acquisitive company? When the focus was on drug pricing, it was argued that acquisitions are effectively the same as R&D, since the company is spending money to acquire drugs either way. However, R&D is expensed on the income statement. Acquisitions do not get accounted for in FCF at any point, and although they do show up on the income statement in amortization, VRX backs this out in their "cash earnings". So why can't you apply the same logic to other drug companies and just back out R&D expenses? That's ridiculous of course so I've never understood why VRX should not be valued based on their measly GAAP earnings just like other pharma stocks.

 

You will get FCF even if the acquisitions turn out to be uneconomical, that is, end up with a return lower than their cost of capital. But it's hard to tell if previous acquisitions are failures because they are dwarfed by new and ever-larger acquisitions, and VRX is not forthcoming with details when it comes to results of previous acquisitions, which was the focus of AZ Value's series of blog posts. That's just the classic roll-up game, isn't it? Of course, if a company pays for acquisitions using (overpriced) stock, it can "bootstrap" itself to real value. But VRX uses debt, and I think by the time this is over, shareholders will wish they used stock instead. It will be very interesting to see what the company looks like when they finally stop doing acquisitions.

[Picasso]

In case anyone missed the Ackman call:

 

[rb]

Man, at this point what is there left to invest rationally here?  Management has proven completely inept at communications and providing clarity without pulling out teeth.  We have to read between every line to try and figure out what's real and what's not.  Do we really expect regular investors to dig in as much as we have to buy the stock?  It shouldn't be this hard.

 

Now that bagehot mentioned it, has anyone else looked at the past few years of net to gross sales?  I can't believe how much they've had to provision to get incrementally higher sales.  Now that Philidor is gone and you adjust back down to pre-Philidor levels...Ouch...  It's no surprise why the stock is getting killed aside from looking at penalties.  The potential fines are just noise in comparison.

I'm totally with you on that one. I don't think anyone can perform independent rational research on VRX. I think I may have said this before here. Their financials may as well be written in ancient Egyptian. You can't get much out of them. Everyone was relying on management presentations.

 

I can't speak for others, but my investing experience has taught me to be somewhat cynical. Thus I prefer raw financials to management presentations and the words "adjusted non-gaap cash eps" always make me cringe.

[ni-co]

In case anyone missed the Ackman call:

 

 

… And it took him only an hour per point. Jesus, I think the Pershing Square standard  slide deck template has 100 slides.

[feynmanresearch]

In case anyone missed the Ackman call:

 

I wonder what amount of the decline today could be attributed to Ackman's presentation. If  I were to guess, I would say a decent portion of it

[ERICOPOLY]

Liberty, you may believe whatever you want. It seems that whenever there's any question raised about Valeant you always come out strongly in favour of VRX management. A week or so ago you were sure that nothing wrong was going on at Philidor. Now you seem pretty sure that C-suite didn't know anything about the wrong doing. So I don't know if you are or can be objective in your view of Valeant.

 

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.

 

Valeant is a company that is ultra-aggressive in pushing their drugs and making numbers, always going right to the line of what they can do and what's legal. In an environment like that is very easy to go over the line. That's why it's not hard to believe that top management knew or sanctioned it as opposed to some rogue middle manager. Also this totally looks like something that Valeant would do.

 

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.

 

[feynmanresearch]

"One of my favorite cases about the power of incentives is the Federal Express case. The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked.

 

Early in the history of Xerox, Joe Wilson, who was then in the government, had to go back to Xerox because he couldn’t understand how their better, new machine was selling so poorly in relation to their older and inferior machine. Of course when he got there he found out that the commission arrangement with the salesmen gave a tremendous incentive to the inferior machine.

And here at Harvard, in the shadow of B.F. Skinner -- there was a man who really was into reinforcement as a powerful thought, and, you know, Skinner’s lost his reputation in a lot of places, but if you were to analyze the entire history of experimental science at Harvard, he’d be in the top handful. His experiments were very ingenious, the results were counter-intuitive, and they were important. It is not given to experimental science to do better. What gummed up Skinner’s reputation is that he developed a case of what I always call man-with-a-hammer syndrome: to the man with a hammer, every problem tends to look pretty much like a nail. And Skinner had one of the more extreme cases in the history of Academia, and this syndrome doesn’t exempt bright people. It’s just a man with a hammer…and Skinner is an extreme example of that. And later, as I go down my list, let’s go back and try and figure out why people, like Skinner, get man-with-ahammer syndrome.

 

Incidentally, when I was at the Harvard Law School there was a professor,

naturally at Yale, who was derisively discussed at Harvard, and they used to say,

-2-

“Poor old Blanchard. He thinks declaratory judgments will cure cancer.” And that’s the way Skinner got. And not only that, he was literary, and he scorned opponents who had any different way of thinking or thought anything else was important. This is not a way to make a lasting reputation if the other people turn out to also be doing something important"- Charlie Munger

[NeverLoseMoney]

Why didn't she raise concerns with the huge position in Berkshire before it was reduced? Why didn't she have concerns over the summer on the size of the position?

 

Next, asking Buffett? Buffett has always taken concentrated bets, Amex/Geico and you can name many others. Come on guys, let's stop speculating on things that don't make much sense. 

 

About Sequoia Fund and possible redemptions: one of the two directors who resigned was Sharon Osberg. She's a bridge partner and close friend of Warren Buffett. According to the WSJ article she had expressed concerns about the size of Sequoia's VRX position in recent months.

I'm just saying that you don't let a member of Buffett's "inner circle" resign easily.

 

What were the concerns of the board members who resigned exactly? Was it purely about the size of the VRX position? When were these concerns first raised? Why did they decide to resign at this point in time and not earlier? It's up to Sequoia to explain this to their investors.

[CONeal]

Can someone please provide a link to the Hempton research/I think short thesis on VRX?  I don't know enough about the guy to find it.

 

Thanks you

[rb]

I do not dare to post a link to that guy on this site. Just google John Hempton blog and u'll get there.

 

Just keep in mind the dude tends to be quite aggressive in assertions and tends to see things which are not always there.

[CONeal]

I do not dare to post a link to that guy on this site. Just google John Hempton blog and u'll get there.

 

Just keep in mind the dude tends to be quite aggressive in assertions and tends to see things which are not always there.

 

Thank you for the info. I've seen a few people reference this but wanted to read it for myself.  The general outline of how the industry works from him is pretty correct but then it tails off into complete garbage when it gets to VRX specific material and allegations at least for the good amount of what I read.

[original mungerville]

That said, I am not convinced Valeant mgmt did not know what was going on a Philidor. I would be surprised if it made it all the way to the c-suite though. We have all said that the bet has been on Pearson being honest. If we are wrong on that, we will be wrong on this investment. If middle management at Valeant is involved, I maintain fines will not be larger than .5 billion and definitely not more than $1B with my most likely scenario low 100 millions.

OM, I don't see why it's hard to believe that the goings on at Philidor were known to the c-suite. It's obvious that the reason for Philidor was to be aggressive in filling prescriptions with Valeant drugs. Valeant paid 100 million for control of Philidor. That amount of money must get approval from the CEO. So it looks like the C-suite was aware.

 

Yes, I won't dispute that. Its just there is a whole gradation of awareness which can span aggressiveness (ie could be the reason for the option structure, or maybe they actually did not feel comfortable with regulations of the distribution business) all the way to illegalities. I am not ruling out that that deal was done with aggressiveness in mind, but the reason provided by the ex-CFO also seems plausible. Illegalities could have mushroomed over the course of the year with the mgmt incentive structure at Philidor. Think about how this thing went from nothing to $100M valuation plus another $133 in incentives. Certainly one could argue that the $100M was for the licenses, aggressiveness, and exclusivity (not all speciality pharmas offer exclusivity), then the other $133 incentive structure just sent the Philidor guys over the top and illegalities mushroomed quickly within months.

[original mungerville]

The issue isn't the fines.  The problem is the long-term affect on their operating business.  Medicis had big problems with Solodyn and other treatments because of the existing distribution method that Valeant likely has to go back to.  That's a bad thing because it's clear that was driving a lot of the organic growth.  The sell side is still saying they'll earn $16 of cash EPS. Throw those earnings out the window now that Philidor is gone.

 

The fines are irrelevant at this point.  What do you think the stock will do if they start showing negative growth?  All of a sudden the amortization is an expense and it's going to snowball.

 

How do you show negative growth when 7% of sales, at most, are gone. Ackman says only half of that 7% will be gone as Valeant drugs previously at Philidor will go through other channels. My take is, Philidor probably juiced things more than that, so I would say only one quarter of that 7% will remain, so about 2% remains and therefore a 5% loss in sales. Cash EPS declines to $14. (For example, Jublia is growing even without Philidor. Studies show it is at least 50% more effective than Lamisil (ie 15-20% effectiveness vs 10%) and so doctors like recommending it. If you ask me, none of those products work but at this point, they are the best options unless you want to shred your liver taking a pill along with applying these.) How do you get to negative cash EPS just because Philidor is gone?

 

It's not because Philidor is gone. It's because payors / insurers / governments get pissed. Price goes down. Volume possibly too. To the extent VRX was aggressive in non-Philidor sales, newly emboldened lawyers & compliance reigns in those practices. Volumes go down more. I'm still thinking this through, but you get the idea.

 

No, I don't get the idea, but keep thinking it through.

[Picasso]

Eventually we as shareholders have to stop excusing what management has led us to believe the last couple years. Either they are inept or intentionally misleading and neither of those two things reflect positively on Pearson. He's done a great job in different areas and perhaps some of this falls on the ex CFO, I'm not sure.

 

OM, have you looked at the gross versus net trend over the past two years?  Have you tried to calculate what it will take to incrementally grow profits from here?  It becomes fairly obvious that Philidor was a big part of the revenue growth along with something else I can't figure out. I can see why they didn't want to cut ties until the PBM's made the decision for them. They won't be able to make earnings without Philidor, period. That tailwind is gone and management has still not said anything about the effect to earnings. Cash EPS becomes useless if you see declines in the non Salix and B+L portfolio.

 

Start by assuming Pearson is not telling the truth and just look at the numbers and reallty. This stock becomes a lot harder to defend. Not that I know if he's lying or not, but at this point we need to verify everything.

[hyten1]

om and others, how confident are you guys at the way vrx selld its product? from what they say 7% is through specialty pharmacy.

 

my biggest concern is what about the other 82% of sales. is there a breakdown of product sales channel for vrx's products?

the ideal situation is all 82% are through pure demand from physicians and customers. meaning physician specifically ask for vrx's product and only their product. but we know that is most likely not the case. but is there some sort of breakdown of this somewhere?

 

also during the spat with allergan, vrx state most of their growth was obtain through non-traditional channels i.e. specialty pharmacy, here is what they state in one of their response to allergan:

 

"Chart does not capture all product sales as IMS Health does not capture all relevant distribution channels, including specialty pharmacy, physician dispensed sales, corporate accounts, and alternative fulfillment)"

 

sorry for my ignorance.