VRX - Valeant Pharmaceuticals International Inc.

[original mungerville]

OM, before I answer your post let's take a step back and look at this Q&A from the last conference call:

 

David Risinger - Morgan Stanley

That's great. And then just separately, you discussed alternate fulfillment, could you just put that in perspective, maybe what percentage of the US brand Rx business alternate fulfillment is and how much of that is Philidor?

 

Mike Pearson - Chairman and CEO

Sure. It's really primarily our dermatology brands and then some of our specialty products like Ruconest, Arestin and some of the products that some of the other orphan drugs. For certain products it is quite larger, for Jublia it is probably 50%, for a lot of other dermatology it is much, much less. David, I am sorry I can't-- it's significant but I don't know the precise number but it is certainly of our US portfolio, so 10%, 20% maybe, maybe Tanya's nodding probably closer to 10%.

 

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.

 

So he said it was certainly significant, then said 10, maybe 20% of US branded portfolio of 43%. So at 20%, that's 8% of overall company. Then she misinterprets and assumes the question was the overall company, so she says closer to 10%. 

 

You are right though, you would think for that call he would have that number memorized. But sounds like they were up all night before the call. I don't think that on THAT call their intention was to withhold that info. On slide 10 and 11 they give the full break out relative to total company total revenue, net revenue, EBITDA including non-Philidor specialty pharma. Just because some lazy analyst wants to get the CEO to divide numbers into US branded or whatever when the CEO hasn't slept most of the last week and so fumbles the question/math...its not like they were holding back. If they were, the would have never provided the info on slides 10 and 11.

 

 In Q3 2015, Philidor represented 6.8% of total

Valeant revenue

 In Q3 2015, Philidor represented ~7% of Valeant

EBITA

 Prescriptions through Philidor are less profitable than

traditional channels due to lower copay rates, lower

cash pay rates and more cash pay scripts in Philidor

than in retail and other channels

11

Specialty Pharmacy - Q&A (1/6)

Question: What % of your YTD net revenues flow through

specialty pharmacies? What % of YTD net revenues is

through Philidor?

Answer:

▪ Specialty pharmacies account for 7.2% of Valeant net

revenue YTD

▪ Philidor accounts for 5.9% of Valeant net revenue YTD

 

 

[original mungerville]

I mean they are basically tailoring the price to meet your insurer's plan. Is that wrong? I don't think so. It's just a dysfunctional system. Isn't that standard practice as well?

 

 

 

That's what Philidor was doing and that part of the business will disappear, but even when it does its ridiculously cheap. 

 

And this is exactly why the gross sales would be growing significantly faster than net.

 

Yes it is wrong. Whether it's standard practice or not doesn't make it right either. What's this? The but ma he's doing it too approach to management?

 

Yes philidor was doing that and it was a tool valeant was using to grow. But what are the other tools? Will they get to keep them after they're made public?

 

Also Valeant may be cheap if you use valeant's opinion of how much money they're making i.e. cash eps. If you don't it's not necessarily that cheap. And there are many issues with cash eps. Just off the top of my head, they're backing out acquisition related professional fees. Since m&a is as much part of valeant's business as anything else aren't those just normal recurring operating costs?

 

Whether its wrong or right, I don't know. I think the whole industry is wrong, and exec compensation is wrong, and a lot of things are wrong. In any case, it does make a difference if it is industry practice or not, because if it is, and the music stops, the music stops for the whole industry, and so Valeant is less affected than otherwise would be the case if it was only a Valeant practice.

[original mungerville]

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.

 

Putting aside Philidor, I don't see how Valeant is gaming through normal pharmacies. Sure they probably give doctors coupons or whatever to provide to clients to cover the co-pay, but so does everyone else!

[original mungerville]

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.

 

I mean they are basically tailoring the price to meet your insurer's plan. Is that wrong? I don't think so. It's just a dysfunctional system. Isn't that standard practice as well?

 

Yes my understanding is this technique is common practice in the industry.

[original mungerville]

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.

 

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

 

I don't see how the whole model crumbles, can you explain? Taking out M&A, they are an average pharma company already, actually probably lower than average. Their differentiation is their ability to get 20% unlevered ROIs on acquisitions due to mgmt cost take out, R&D take out, and tax.

[original mungerville]

http://www.latimes.com/business/la-fi-1101-valeant-pharmacy-20151101-story.html

 

No question Philidor fucked this guy over. Option to buy without buying, use his licenses and number to funnel prescriptions through there while the guy retains legal liability because Philidor doesn't actually own it and therefore is shielded from legal liability. Pretty fuckin' dirty now that I think about it from this guys perspective. No wonder the guy withheld payment to Philidor/Valeant. And you have to know Valeant knew about this Philidor ownership structure once Valeant started suing the guy. Yet when this makes it to press, and benefit managers sever ties with Philidor, then only at that point Valeant severs ties?

 

The key question is did Valeant know that Isolani/Philidor did not own R&O outright? Or did they find out in the last month or so? You would think that if there was a lawsuit, they would have known via that lawsuit.

 

"R & O Pharmacy, an affiliate of Philidor, has sued Valeant saying it believes the drug giant may be the target of fraud or engaged in fraud itself."

 

Yup, its one or the other for sure. Either Valeant was engaged in fraud or the "target" of fraud. And I would say primary beneficiary of fraud instead of "target" of fraud. Valeant then sues R&O? Instead of Philidor? To keep the game going I guess.

[shalab]

So what is your thesis on VRX now? You think VRX guys played this all along or mgmt is innocent...

 

 

http://www.latimes.com/business/la-fi-1101-valeant-pharmacy-20151101-story.html

 

No question Philidor fucked this guy over. Option to buy without buying, use his licenses and number to funnel prescriptions through there while the guy retains legal liability because Philidor doesn't actually own it and therefore is shielded from legal liability. Pretty fuckin' dirty now that I think about it from this guys perspective. No wonder the guy withheld payment to Philidor/Valeant. And you have to know Valeant knew about this Philidor ownership structure once Valeant started suing the guy. Yet when this makes it to press, and benefit managers sever ties with Philidor, then only at that point Valeant severs ties?

 

The key question is did Valeant know that Isolani/Philidor did not own R&O outright? Or did they find out in the last month or so? You would think that if there was a lawsuit, they would have known via that lawsuit.

 

"R & O Pharmacy, an affiliate of Philidor, has sued Valeant saying it believes the drug giant may be the target of fraud or engaged in fraud itself."

 

Yup, its one or the other for sure. Either Valeant was engaged in fraud or the "target" of fraud. And I would say primary beneficiary of fraud instead of "target" of fraud. Valeant then sues R&O? Instead of Philidor? To keep the game going I guess.

[Picasso]

I'm reminded of the Buffett saying about 1) integrity, 2) intelligence, and 3) energy. The most dangerous combination is someone without integrity but lots of energy and intelligence. I think we've seen enough to know that they have a lot of intelligence and energy but lack some critical level of integrity.

 

The thing is, I think Pearson did this because he thought it would provide the most value for shareholders. It's not like he stole from the company or whatever. He genuinely pursued these methods thinking it was in the shareholders best interest and so no biggie. Well it's driving the company right off a cliff and we're still here trying to makes heads or tails out of various cues and trails left behind.

[original mungerville]

This is a tough one. I think they knew Philidor was going to be aggressive, however they might not have known the extent of it.

 

I no longer buy the speculation that the owner of R&O figured he sold his pharmacy too cheap and therefore started withholding money. He can't be that stupid. He was concerned for his legal liability given he was responsible for Philidor's use of his pharmacy.

 

I am surprised Valeant sued R&O, but I guess their hand was forced. When Valeant was suing R&O, they had to have known that Philidor was booking stuff from other pharmacies using R&O's number, etc etc. I don't know, its actually quite hard to tell what the hell Valeant knew or didn't...

 

[CONeal]

The question that keeps running through my head  Is everyone looking at The scripts filled at Philidor wrong and the impact to VRX?

 

Philidor had multiple pharmacy licenses they were using.  Is the %of scripts filled via Philidor wrong that VRX is reporting and they just don't know it yet?  When Philidor filled a script using another Pharmacy id (ex Wilshire) is that script fill recognized by VRX as being filled at Philidor or Wilshire? According to the insurance claim the script would have been filled by Whilshire. 

[tylerdurden]

It seems some people on this board think as long as Pearson did not know what was going on at Philidor, everything is ok. No it is not. If you are the CEO, you are supposed to know and if shit happens you will be kept accountable. We can ask the ex-VW CEO and bunch of others about their experiences about this knowing/not knowing issue.

 

Also, the way they responded to all of this do not give you the impression that they had lots of conviction in what they have been doing. Lack of PR, investor/government relations etc. argument kind of laughable. When Ackman was comparing VRX to Berkshire as the next compounding machine, everything was excellent but now PR sucks. come on. Even the CEO's answer to question about who the owners of Philidor was does not give any confidence. Whole world is collapsing because of this and you are giving really loose answers. If you want to give some confidence to investors and support your collapsing share price try to be a little bit more specific in your answers.

 

I agree that if this thing spreads to other pharma companies that would be a big salvation for VRX. If this stays as VRX specific you might say bye bye to your magic CEO. It might be small probability but no one knows exactly how this story keeps unfolding now...

 

 

[cmlber]

The question that keeps running through my head  Is everyone looking at The scripts filled at Philidor wrong and the impact to VRX?

 

Philidor had multiple pharmacy licenses they were using.  Is the %of scripts filled via Philidor wrong that VRX is reporting wrong and they just don't know it yet?  When Philidor filled a script using another Pharmacy id (ex Wilshire) is that script fill recognized by VRX as being filled at Philidor or Wilshire? According to the insurance claim the script would have been filled by Whilshire.

 

Either way the scripts would be part of "specialty pharmacies."

[tylerdurden]

 

Some people even do not call Philidor specialty pharmacy.

 

"A trade group for specialty pharmacies sought to distance itself from Philidor on Friday, pointing out that Philidor mostly dispensed drugs for common ailments that don’t require special handling. “Philidor is not a specialty pharmacy. They’re providing acne medicine—which you can get at your normal pharmacy—at a very high price,” Robert Fulcher, chief operating officer of the National Association of Specialty Pharmacy, said in an interview."

 

http://www.wsj.com/articles/valeant-to-sever-ties-with-philidor-1446197323

 

[CONeal]

The question that keeps running through my head  Is everyone looking at The scripts filled at Philidor wrong and the impact to VRX?

 

Philidor had multiple pharmacy licenses they were using.  Is the %of scripts filled via Philidor wrong that VRX is reporting wrong and they just don't know it yet?  When Philidor filled a script using another Pharmacy id (ex Wilshire) is that script fill recognized by VRX as being filled at Philidor or Wilshire? According to the insurance claim the script would have been filled by Whilshire.

 

Either way the scripts would be part of "specialty pharmacies."

 

Not exactly.  1) you have to know how VRX defines speciality pharmacy as there are grey areas in it.  2) you don't know what other pharmacy licenses Philidor was using to fill scripts.  They could just as easily been using a retail pharmacy license for the stuff that were not considered a speciality drug.

 

Have to admit this is becoming a fun exercise on critical thinking.

[ZenaidaMacroura]

The question that keeps running through my head  Is everyone looking at The scripts filled at Philidor wrong and the impact to VRX?

 

Philidor had multiple pharmacy licenses they were using.  Is the %of scripts filled via Philidor wrong that VRX is reporting wrong and they just don't know it yet?  When Philidor filled a script using another Pharmacy id (ex Wilshire) is that script fill recognized by VRX as being filled at Philidor or Wilshire? According to the insurance claim the script would have been filled by Whilshire.

 

Either way the scripts would be part of "specialty pharmacies."

 

Not exactly.  1) you have to know how VRX defines speciality pharmacy as there are grey areas in it.  2) you don't know what other pharmacy licenses Philidor was using to fill scripts.  They could just as easily been using a retail pharmacy license for the stuff that were not considered a speciality drug.

 

Have to admit this is becoming a fun exercise on critical thinking.

This is getting ridiculous.  Ok let's think about it critically -if you're philidor what's your angle?  You want to unlock further milestone payments?  Then are you going to hide the fact that you originated many of these scripts and let parent-valeant think they are attributable to someone else?  Why even risk breaking the law if some other Podunk pharmacy gets full credit (per your thought "what if valeant didn't know all the scripts attributable to philidor").

 

It's all about incentives right?  If that's the case then philidor is going to try and take credit for as much of the contribution as possible -At the expense of other channels.  The numbers that valeant hq has can only be high, not low.

[ERICOPOLY]

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.

[krazeenyc]

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.

 

+1

[rb]

OM,

 

I don't understand your obsession with what Mike Pearson knew exactly about Philidor. We can go in circles forever on this one. I don't think we'll ever know that and it may be that he didn't know the specifics on purpose. The structure of the Philidor deal screams of a structure set up to limit liability and maximize plausible deniability. Guess what, now that shit hit the fan Valeant is all over the deniability part.

 

So take 2 scenarios. 1: Mike Pearson meets with the head of Philidor and tells him to set up a network of phantom pharmacies to push Valeant drugs over generics and get maximum value and fills and all the details of how to do it (the cubicle 1301 version). 2: Valeant gives a bunch of money to Philidor people tells them to be resourceful, innovative, and entrepreneurial to generate the most value for Valeant. Oh and if you increase sales by a lot there's a whole bunch more money behind that. Don't worry about telling us how you do it. We're hands off people. But we'll have peter parker on the ground to make sure you don't mishandle foot cream.

 

Now some might say that there's a huge difference between 1 and 2. But reasonable people would not. Both scenarios lead to the same outcome. I am of the view that Valeant went with 2. That's the way you go when you set up a structure like they did. Then when it hits the headline you go out as say that Philidor went rogue (nevermind you financed that transition). To set up the structure like they did and go with 1 would be a monumentally stupid idea. Mike Pearson may be a lot of things but monumentally stupid is not one of them.

[original mungerville]

OM,

 

I don't understand your obsession with what Mike Pearson knew exactly about Philidor. We can go in circles forever on this one. I don't think we'll ever know that and it may be that he didn't know the specifics on purpose. The structure of the Philidor deal screams of a structure set up to limit liability and maximize plausible deniability. Guess what, now that shit hit the fan Valeant is all over the deniability part.

 

So take 2 scenarios. 1: Mike Pearson meets with the head of Philidor and tells him to set up a network of phantom pharmacies to push Valeant drugs over generics and get maximum value and fills and all the details of how to do it (the cubicle 1301 version). 2: Valeant gives a bunch of money to Philidor people tells them to be resourceful, innovative, and entrepreneurial to generate the most value for Valeant. Oh and if you increase sales by a lot there's a whole bunch more money behind that. Don't worry about telling us how you do it. We're hands off people. But we'll have peter parker on the ground to make sure you don't mishandle foot cream.

 

Now some might say that there's a huge difference between 1 and 2. But reasonable people would not. Both scenarios lead to the same outcome. I am of the view that Valeant went with 2. That's the way you go when you set up a structure like they did. Then when it hits the headline you go out as say that Philidor went rogue (nevermind you financed that transition). To set up the structure like they did and go with 1 would be a monumentally stupid idea. Mike Pearson may be a lot of things but monumentally stupid is not one of them.

 

I don't disagree with anything you said.

[original mungerville]

I am focusing on it because if #2, which I think is the case, the difference is likely that Pearson gets to learn never to do something like that again, and Valeant moves on.

[rb]

I am focusing on it because if #2, which I think is the case, the difference is likely that Pearson gets to learn never to do something like that again, and Valeant moves on.

Yes but you seem to assume that this was an isolated incident at VRX. from which they can learn and move on. That's a rather big assumption.

 

To me it seems like the Philidor situation was created by the culture at Valeant more than anything else. When you have a culture that lends itself to creating this type of issue it never results in just a singular problematic situation. Basically, it's very likely there's more than one cockroach.

 

I'm concerned about what's going on over there and I don't even have a financial stake in it. If I'd have a significant stake in it I'd go over my thesis back and forth and triple check everything the company put out with a very skeptical view and without making any assumptions.

[original mungerville]

No, I think he is going to be learning on multiple fronts how reputation is important, not just (shorter-term) shareholder value.

[cmlber]

There was absolutely nothing about the structure of the Philidor arrangement that incentivized illegal behavior.  If you think there was, you are just biased by hindsight. 

 

They got $100 million up front ($80 million after capital gains tax) and could get up to $133 million through earn out milestones (which btw would get taxed at an income rate probably, so after tax this would probably be another $80 million).

 

$80 million is a lot of f***ing money to lose.  Human beings are inherently risk averse.  Not many people would risk losing their $80 million fortune to gain $80 million. 

 

Sergio Marchionne has massive earn out payments if he hits his five year plan, $200 million in stock, and an immaterial salary compared to that.  Why don't people say he is perfectly incentivized to break the law and push every ethical boundary to make money? 

 

If I was Pearson, I would think this was the perfect comp structure for these guys.  If I think the regulatory environment is murky for specialty pharmacies and these guys know the laws better than I do, let me make them wildly rich up front, so they'll have an incentive to protect that fortune by not doing something stupid, and then give them earn outs so they are still motivated to grow the business.

 

But hindsight bias is powerful.

[merkhet]

There was absolutely nothing about the structure of the Philidor arrangement that incentivized illegal behavior.  If you think there was, you are just biased by hindsight. 

 

They got $100 million up front ($80 million after capital gains tax) and could get up to $133 million through earn out milestones (which btw would get taxed at an income rate probably, so after tax this would probably be another $80 million).

 

$80 million is a lot of f***ing money to lose.  Human beings are inherently risk averse.  Not many people would risk losing their $80 million fortune to gain $80 million. 

 

Sergio Marchionne has massive earn out payments if he hits his five year plan, $200 million in stock, and an immaterial salary compared to that.  Why don't people say he is perfectly incentivized to break the law and push every ethical boundary to make money? 

 

If I was Pearson, I would think this was the perfect comp structure for these guys.  If I think the regulatory environment is murky for specialty pharmacies and these guys know the laws better than I do, let me make them wildly rich up front, so they'll have an incentive to protect that fortune by not doing something stupid, and then give them earn outs so they are still motivated to grow the business.

 

But hindsight bias is powerful.

 

+1

 

I'm as cynical and suspicious about Valeant as anyone, but there's probably some hindsight creeping into the incentive structure discussion.

[original mungerville]

I am focusing on it because if #2, which I think is the case, the difference is likely that Pearson gets to learn never to do something like that again, and Valeant moves on.

Yes but you seem to assume that this was an isolated incident at VRX. from which they can learn and move on. That's a rather big assumption.

 

To me it seems like the Philidor situation was created by the culture at Valeant more than anything else. When you have a culture that lends itself to creating this type of issue it never results in just a singular problematic situation. Basically, it's very likely there's more than one cockroach.

 

I'm concerned about what's going on over there and I don't even have a financial stake in it. If I'd have a significant stake in it I'd go over my thesis back and forth and triple check everything the company put out with a very skeptical view and without making any assumptions.

 

My feeling is because Philidor was third-party the actions were worse there relative to anything within Valeant itself.