VRX - Valeant Pharmaceuticals International Inc.

[original mungerville]

The Roddy Boyd site which is being referenced by Bronte and Citron.

 

Ya, OK, that guy is an idiot and/or unethical in my view.

[Picasso]

So basically this is what Citron is calling the smoking gun:

 

Valeant inventory ==> Sent to sit at a specialty pharmacy, still in inventory ==>  (nothing changes yet on any revenue recognition) ==> patient recieves product ==> booked into accounts receivable, inventory finally changes (drops) ==> Valeant eventually receives cash and books the revenue.

 

There’s nothing unusual there at all.  The issues become 1) potential conflicts of interest, 2) Philidor reimbursing for Medicare, 3) ownership structure breaking the law in places like California.  There is no evidence of any of that.  Doctors are prescribing the drugs, there’s no evidence of Medicare copay reimbursement, and nothing I’ve seen which indicates R&O is breaking the law.

 

The question is how R&O doesn’t know they have several tens of millions of inventory.  Seems pretty hard to not know whether that much product is sitting on your shelves. 

[Guest roark33]

Southern Investigative Reporting Journal.  They wrote the first piece on Monday about Philidor.  (google it:)....)

[original mungerville]

So basically this is what Citron is calling the smoking gun:

 

Valeant inventory ==> Sent to sit at a specialty pharmacy, still in inventory ==>  (nothing changes yet on any revenue recognition) ==> patient recieves product ==> booked into accounts receivable, inventory finally changes (drops) ==> Valeant eventually receives cash and books the revenue.

 

There’s nothing unusual there at all.  The issues become 1) potential conflicts of interest, 2) Philidor reimbursing for Medicare, 3) ownership structure breaking the law in places like California.  There is no evidence of any of that.  Doctors are prescribing the drugs, there’s no evidence of Medicare copay reimbursement, and nothing I’ve seen which indicates R&O is breaking the law.

 

The question is how R&O doesn’t know they have several tens of millions of inventory.  Seems pretty hard to not know whether that much product is sitting on your shelves.

 

Where are you getting this R&O doesn't know they have millions of inventory from? I think this stuff is on consignment at R&O from Philidor/Valeant. I think Pearson said that on the call. Look this isn't necessarily pretty, Valeant may be pushing the boundaries here big time relative to others - I don't know, that would be my guess. But my thinking is they have vetted with external legal counsel before proceeding - and its legal. This is probably the reason for the option to buy these VIEs rather than just own them.

[Picasso]

R&O stated they didn't know they had done business with Valeant.  Valeant is saying the product was sold (so not really inventory anymore) and is demanding payment.  I mean do they not know they are a specialty pharma selling Jublia?  It wouldn't be that hard to connect the dots.

 

Edit:  They have to know they are part of the network that Philidor utilizes in California. 

[original mungerville]

R&O stated they didn't know they had done business with Valeant.  Valeant is saying the product was sold (so not really inventory anymore) and is demanding payment.  I mean do they not know they are a specialty pharma selling Jublia?  It wouldn't be that hard to connect the dots.

 

Yes, R&O should know they are selling say Jublia and that say Jublia is a Valeant product. I think Valeant products are on consignment at Philidor/R&O, R&O sold product but did not pay Philidor so Philidor did not pay Valeant. Given Valeant has a bigger legal budget and team, Valeant is going after R&O for it. R&O is getting cute and saying look, who are you, we don't even have a business relationship with you. This is, legally, correct. In practice, however, as you note, R&O knows damn well they have Valeant product on consignment.

[doughishere]

Oh, VRX thread on CoBF. "I wish I knew how to quit you." (Unfortunately, there's just so much interesting stuff happening with Valeant land recently that it's tough.)

 

In any case, I decided to do a little bit a research during some of my downtime on some of the stuff that has come out recently. So, as far as I understand it, VRX sent R&O a letter demanding payment. R&O sent back a letter basically saying "we have no idea who you are." Okay, that's a bit weird, but it turns out that VRX "owns" Philidor which "owns" R&O. I'm using air quotes for reasons that will be obvious pretty soon. I'll even use this * to indicate that I'm going to come back to it.

 

Now, Zenaida has pointed out that it's a little weird for a "subsidiary" to sue its ultimate "parent," but I have no comment on that one way or the other. It's definitely weird, but it's unclear how or why it's playing out. I suspect it's playing out this way because something hanky is going on. ** We'll come back to this in a second as well.

 

What's significantly more interesting is that VRX had a presentation today indicating that they were consolidating Philidor's financials (revenue and balance sheet) onto their consolidated financials based on a Variable Interest Entity (VIE) assessment under ASC 810. (Note: In the presentation today, they did not specifically call out that they also consolidated R&O's financials, e.g. revenue and balance sheet, into their consolidated financials. The presentation only talks about Philidor.)

 

Why is this important? Here's where the * gets interesting. If you pull up ASC 810, you'll see that on page 13, you have a stupidly complicated chart. Alternatively, you could read the following page which is slightly more comprehensible. Now, someone with more knowledge on this might want to review this to make sure that I'm not getting this wrong, but basically it says that a VIE assessment results in consolidated financials when (A) you've determined that you're dealing with a VIE and (b) the reporting company has the power to direct the actions of the VIE that most significantly impact the VIE's economic performance. (There's one other step, but since VRX says they're consolidating things, then we assume that last step is fulfilled, and it's irrelevant for this discussion, IMO.) In essence, the reporting company must "control" the VIE.

 

Why is this important? Well, now we're back to **. If VRX has effective control (for consolidation purposes) over Philidor and Philidor has effective control (for consolidation purposes) over R&O, then if R&O or Philidor is doing something hanky, then I'm wondering whether, under regulatory scrutiny or a court of law, VRX is going to be able to argue their independence. I mention this only because someone either on Twitter or CoBF mentioned that it's possible that R&O and/or Philidor was doing something wrong, but it doesn't mean you can impute such knowledge to VRX or Pearson. Except, that might not actually be true.

 

Disclaimer: I have never had any position in VRX. I'm really just here for the popcorn.

 

 

Merk..hard as *! Sorry, I'm 5 fingers into some Irish Whiskey tonight.Maybe more.

 

Basically what it boils down to is is VRX responsible for the fuck-ups at phil or RSO?

 

 

* = fuck.

[berkshire101]

Man, this thread is lighting up like a Christmas tree right now!

[giofranchi]

Days like today are always humbling, because you can have a lot of confidence in an idea, but when the price is moving against you a percent a second, your reptilian brain kicks in and it's really easy to want to join the panic. I didn't do anything, and maybe not joining the panic will later be revealed to be a mistake, but time will tell once the dust has settled.

 

I agree 100%.

 

Cheers,

 

Gio

[kirkomi]

For a value investing board, trying to emulate Warren Buffett, this thread is becoming really disheartening. Speculative/emotional posts trump the posts with some facts in them by a wide margin.

 

I am willing to admit that I did follow some board members into a few positions taken from this board (like AIQ, QIWI, NWH, PKX) -- after some small book-keeping kind of research from my side. But, it seems that I was wrong to not do my own research as thoroughly as I would have if I had gone solo. This thread has been a big learning experience for me. Suffice is to say that I would be filtering the idea from this board quite aggressively.

 

I really have a great amount of respect for some members who are willing to take the pummeling and not give up on their conviction. It really does take an immense amount of confidence to have that kind of capacity to suffer.

[ScottHall]

For a value investing board, trying to emulate Warren Buffett, this thread is becoming really disheartening. Speculative/emotional posts trump the posts with some facts in them by a wide margin.

 

I am willing to admit that I did follow some board members into a few positions taken from this board (like AIQ, QIWI, NWH, PKX) -- after some small book-keeping kind of research from my side. But, it seems that I was wrong to not do my own research as thoroughly as I would have if I had gone solo. This thread has been a big learning experience for me. Suffice is to say that I would be filtering the idea from this board quite aggressively.

 

I really have a great amount of respect for some members who are willing to take the pummeling and not give up on their conviction. It really does take an immense amount of confidence to have that kind of capacity to suffer.

 

You must understand that this board is more for amusement than investment insight. Use it that way and it's a lot more amusing.

[giofranchi]

You must understand that this board is more for amusement than investment insight. Use it that way and it's a lot more amusing.

 

I don’t think I agree with this, Scott.

Imo there are a lot of good ideas on this board. Just because the investment in VRX is giving us much trouble lately, it doesn’t mean the work done by many good investors on this board is to be completely disregarded and thrown away. Any single investment, even a “high conviction” idea, can turn out to be a wrong bet: of course there might be lessons to be learnt, but it doesn’t mean there is nothing good with this board anymore.

 

Cheers,

 

Gio

 

[LongHaul]

I liked your post Kirkomi.

 

Philidor

Take a careful look at their website.

http://www.philidorrxservices.com/

 

Why is the website 1996 ish?  Do they even want more clients?  Why is Valeant the only client?  Why is there not electronic ordering when that would be more efficient?  Why are there reports of document destruction at Philidor?  Go read the Cali Permit license denial and tell me what type of character the Davenports have?  And Pearson is partnering with the Davenports?  What type of character does he have then?  Why is their aggresssive refilling by Philidor?  Why do they seem to be using other pharmacies to bill with? 

 

Why are many, many employees of VRX comparing VRX to Enron and Tyco way before all this news hit?

See cafepharmamessage boards for this. 

 

Why does Pearson tell people what he thinks they want to hear  (Investors and employees)?

Why do short seller and investigative reporters have to dig out these relationships before Pearson issues disclosures? 

 

Why would R&O (related to Philidor) sue Valeant?  That was deliberate act.

 

Do you trust the Russian and other emerging markets revenues?

 

Did I mention the old CFO resigned in July?

 

Do you still believe Pearson?  Everyone thought he was a financial genius.  Total cult of personality and they followed him. 

 

The entire thing points in one direction, very bad.  Every time I keep digging and get more info it seems to get worse and worse.  There is still a lot more dirt to come out. 

 

If any of you were my brothers I would tell you to immediately sell.

 

 

 

 

 

 

 

 

 

 

 

 

 

[Sionnach]

Thanks everyone for the insightful comments, this thread is a very interesting read

 

I think what some analyst on the street (and any bulls) are missing is that VRX's explanation saying that it doesn't recognize revenue until the customer receives it, as opposed to when it is sent to the distributor, is totally meaningless.

 

I think a story from a bronte capital commenter describes the situation perfectly. Basically he used a foot ointment made by VRX and was pushed to receive more and more foot ointment even after the foot was healed until he had like a two year supply of foot ointment. Why would VRX want to give away the product? well because the insurer is willing to pay for it. I can't say I understand it completely, but from what I tell VRX will basically give away product until it hits the "limit" on what the insurer is willing to pay. So if the distributor gives someone a two year supply of foot ointment, its paid for by the insurer and VRX books it as revenue. Once the insurer won't pay for it, they stop pushing the product on the customer (this is what VRX describes as "taking on the risk" because they have to pay for it if the insurer doesn't), but its worth it to test the limit of the insurer.

 

This isn't illegal per say, but it does explain a lot. I remember listening to a conference call where an analyst was saying that every other company's eye contact sales declined whereas VRX's increased like 20% or something. Looking back, it seems hard to explain this through "great execution", but the fraud explanation actually makes some sense. I saw B+L contacts at CVS the other day and they are just average contacts. No reason it should grow at a significantly higher rate than any other contacts.

 

 

What surprises me most about the situation, and what gave me confidence in the company was having ubben (or a VA partner) on the board. Especially because his whole investment philosophy is based on having a good reputation. But I remember he said he doesn't think the 3% tax rate VRX pays is "unpatriotic" because its not his fault the US tax system is so messed up. I think he might say the same about this product pushing. Its not his fault the whole US healthcare system is messed up.

 

 

[merkhet]

I think they are going to argue that Philidor doesn't control R&O.

In press release they say it's an outsourcing relationship.

 

So, the press release says that Philidor has an option to acquire R&O. However, at some point, Valeant stated that they also consolidated R&O's sales & inventory. If that's true, then they've also done an ASC 810 VIE assessment on R&O otherwise they wouldn't consolidate.

[Liberty]

I'll just say one thing for now: Be careful about trusting 'evidence' that comes from anonymous forums like Cafepharma and other customer complaint sites when it is used by shorts who have obviously been working on this for a long time (and can have planted stories over months and weeks) and have millions and millions of dollars on the line. Very easy to plant these posts to create a certain impression to back up their claims. How convenient that over the past month almost all their talking points popped up on cafepharma...

 

I'm sure all pharmacies out there have some real complaints against them, but it's something else entirely to go from: anonymous messages -> this is systematic widespread practice done on purpose with the knowledge of the supplier

[KCLarkin]

Sionnach, is it fraud or just aggressive sales. I don't see how it can be both. The evidence clearly shows there isn't fraud, at least in the way Citron claims. There might be insurance fraud or Medicare fraud but there is no evidence of this.

[original mungerville]

I think they are going to argue that Philidor doesn't control R&O.

In press release they say it's an outsourcing relationship.

 

So, the press release says that Philidor has an option to acquire R&O. However, at some point, Valeant stated that they also consolidated R&O's sales & inventory. If that's true, then they've also done an ASC 810 VIE assessment on R&O otherwise they wouldn't consolidate.

 

Yes, that is probably correct. And don't forget, you are talking accounting, its probably still legally an outsourcing relationship between R&O and Philidor. They do seem to be pushing boundaries though (but I would assume exercising an option to buy would need to clear some sort of regulatory hurdle if regulators care about big pharma owning these pharmacies, no?).

[original mungerville]

Sionnach, is it fraud or just aggressive sales. I don't see how it can be both. The evidence clearly shows there isn't fraud, at least in the way Citron claims. There might be insurance fraud or Medicare fraud but there is no evidence of this.

 

This is my view, but its probably pretty damn aggressive and a public relations nightmare for a while.

[Sionnach]

Yeah larkin, youre right. Fraud isn't the right word here. And it might be all Philador and not have anything to do with valeant (although they appear to be in bed together). they are just taking advantage of bad economics in the US healthcare system. not illegal, but not ethical either.

 

maybe someone who know insurance better can clear this up - but from what I can see they only do this if you have employers insurance, not a government program. I think somewhere along the line price signals aren't responding and philador is able to charge insurance companies as much as they want. maybe this is also good for insurance companies too because they can pass it along and charge the employer.

[KCLarkin]

but I would assume exercising an option to buy would need to clear some sort of regulatory hurdle if regulators care about big pharma owning these pharmacies, no?.

 

“Philidor does not currently have a direct equity ownership in R&O Pharmacy or the affiliated pharmacies, but does have a contractual right to acquire the pharmacies now or in the future subject to regulatory approval.”

 

 

[merkhet]

Merkhet,

 

Glad we don't have to talk about IRRs anymore!

 

lol, me too

 

I will generally agree with you here, this smells weird and I would note the following:

 

1. I would caution on your VIE explanation because if my memory serves me correctly, its a lot more complicated than that in terms of the accounting test, and I would not be in a position to correct you myself. You said as much and I agree. My vague recollection is that you can also consolidate a VIE if you control it OR if you received the majority of the variable economic interest from the business of the VIE, but I could be wrong. Valeant could be receiving the latter.

 

I believe that the test is that you have to have "control" AND (1) absorb losses OR (2) receive a majority of the economic upside. In other words, under all circumstances, you must have control. Of course, I skimmed it last night, so it's possible that I may have missed something.

 

2. The definition of control for tax purposes can be different than the definition of control for accounting purposes which can be different than control as determined by courts - as you would probably know. Its important to not mix these in this type of situation. Of course one of these definitions can influence another or be a partial input into another however we should understand and be clear that control for accounting purposes does not equal control as determined by the courts.

 

Totally agree. The thing that stuck out to me is that the reporting company must make its own determination that it has "control" over the VIE defined as the "the power to direct the actions of the VIE that most significantly impact the VIE's economic performance." Now, you're right that the definition of control under both legal and accounting rules is going to differ, but the important thing to me is that the company had to make a determination that is has some significant influence over the VIE.

 

Whether that rises to the level of legal control is something that is up to the courts and/or the regulatory commission. However, a half decent government lawyer and/or plaintiffs lawyer and/or whoever, is going to hammer this point in, and I figure most determining authorities (judges, juries, regulatory people) are going to have serious cognitive dissonance trying to reconcile VRX having control for accounting purposes but not having control for legal purposes.

 

Another thing that stuck out was that a VIE is basically an undercapitalized entity. It's part of the accounting definition that they don't have enough at-risk equity or something. I recall a legal case from way back during my first year in law school about taxi companies that dealt with this. A taxi company basically put each of its taxis into a separate legal structure but didn't put very much money into each of those accounts so that if the taxi got into an accident, only the shell was responsible for the accident. The courts pierced the corporate veil in that case because of the fact that the companies were undercapitalized. Not entirely sure how undercapitalized the companies are here and/or whether there was future precedent that nullified that decision though.

 

3. Valeant has an option to acquire this Philidor, but does not have an equity stake, similarly Philidor has an option to acquire R&O Pharmacy but does not have an equity stake. Why? Probably to legally get around regulatory hurdles. You don't start setting up these complicated relationships for no reason. Its most often a regulatory or tax reason.

 

That's what makes this interesting. Basically, you don't set up a structure like this on accident. So there's a reason it's done this way -- and if getting around regulatory hurdles is the reason, then that's potentially problematic. People outside of the legal field like to think that the law is cut and dry. In some cases, it is. However, in other cases, it's very murky and sometimes evolving. (Think about the whole spinoff w/ a small business situation w/ Alibaba & Yahoo recently. Used to be fine for Liberty companies. Is it still fine? Unclear!)

 

4. Valeant has an option to buy, and similarly Philidor, but this does not mean they are the "parent" or currently "control" R&O legally - until they exercise that option. As such, a dispute on a payment doesn't seem that crazy to me. Maybe a little weird, but not out of question that this could arise.

 

Sort of agree, that's why I put it all in quotes because it's as yet not determinative. The weird possibility that I floated to Zenaida yesterday was that it's possible that something along these lines happened. (Again, this is basically pulled out of my ass, so keep that in mind.) VRX set up Philidor and then Philidor or VRX set up R&O. This structure was set up to get around the California issue. At some point, there was a lot more money flowing through this structure than initially anticipated and R&O basically realized they could hold VRX up at gunpoint. They sent a letter to VRX that demanded that they get to keep the money because otherwise VRX has to drag this whole regulatory evasion thing into the light. It fits the facts, but, of course, as we all know, the mind creates narratives to fill holes in our fact patterns.

 

As per my prior post, my view is worst case there is no fraud, nothing illegal by Valeant in any major way, but after broad public debate, this practice could eventually be banned or curtailed in the pharma industry over the next couple of years. (Multiple pharma companies are using these speciality pharma outfits, its unlikely they are all committing fraud. I should add that Valeant potentially has set-up what looks to be a captive network with the option to buy; but if this complicated web was set up for regulatory purposes, you would think the option to buy would need prior regulatory approval.)

 

Yea, so that's the thing I meant about the law being murky at times. Not all regulatory commissions have something like the IRS where you can get a "comfort letter" that what you're doing is perfectly legal. Occasionally, you have to just get a legal opinion from a reputable law firm and hope for the best. Think about it this way. Every M&A transaction I've ever seen has gotten a fairness opinion. I have never seen (or heard of) a single M&A transaction get turned down for a fairness opinion. Statistically, that's unlikely.

 

Basically what it boils down to is is VRX responsible for the fuck-ups at phil or RSO?

 

It seems like a pretty decent possibility -- but as I stated before, it's not 100% clear. And, it's also not clear at this point that anything illegal and/or fraudulent has been done. It's all just a little hanky, as I like to put it.

[jay21]

Oh, VRX thread on CoBF. "I wish I knew how to quit you." (Unfortunately, there's just so much interesting stuff happening with Valeant land recently that it's tough.)

 

In any case, I decided to do a little bit a research during some of my downtime on some of the stuff that has come out recently. So, as far as I understand it, VRX sent R&O a letter demanding payment. R&O sent back a letter basically saying "we have no idea who you are." Okay, that's a bit weird, but it turns out that VRX "owns" Philidor which "owns" R&O. I'm using air quotes for reasons that will be obvious pretty soon. I'll even use this * to indicate that I'm going to come back to it.

 

Now, Zenaida has pointed out that it's a little weird for a "subsidiary" to sue its ultimate "parent," but I have no comment on that one way or the other. It's definitely weird, but it's unclear how or why it's playing out. I suspect it's playing out this way because something hanky is going on. ** We'll come back to this in a second as well.

 

What's significantly more interesting is that VRX had a presentation today indicating that they were consolidating Philidor's financials (revenue and balance sheet) onto their consolidated financials based on a Variable Interest Entity (VIE) assessment under ASC 810. (Note: In the presentation today, they did not specifically call out that they also consolidated R&O's financials, e.g. revenue and balance sheet, into their consolidated financials. The presentation only talks about Philidor.)

 

Why is this important? Here's where the * gets interesting. If you pull up ASC 810, you'll see that on page 13, you have a stupidly complicated chart. Alternatively, you could read the following page which is slightly more comprehensible. Now, someone with more knowledge on this might want to review this to make sure that I'm not getting this wrong, but basically it says that a VIE assessment results in consolidated financials when (A) you've determined that you're dealing with a VIE and (b) the reporting company has the power to direct the actions of the VIE that most significantly impact the VIE's economic performance. (There's one other step, but since VRX says they're consolidating things, then we assume that last step is fulfilled, and it's irrelevant for this discussion, IMO.) In essence, the reporting company must "control" the VIE.

 

Why is this important? Well, now we're back to **. If VRX has effective control (for consolidation purposes) over Philidor and Philidor has effective control (for consolidation purposes) over R&O, then if R&O or Philidor is doing something hanky, then I'm wondering whether, under regulatory scrutiny or a court of law, VRX is going to be able to argue their independence. I mention this only because someone either on Twitter or CoBF mentioned that it's possible that R&O and/or Philidor was doing something wrong, but it doesn't mean you can impute such knowledge to VRX or Pearson. Except, that might not actually be true.

 

Disclaimer: I have never had any position in VRX. I'm really just here for the popcorn.

 

If you have the option to buy the company, you probably have control because you can acquire the whole thing. It's analogous to kick out rights in securitizations. If you can just fire the GP (mgmt), then you effectively control the entity.

 

IMO obviously. There's interpretations in everything

[cogitator8]

Mike Pearson=Aubrey Mcclendon, this sound like chesapeake all over again. I think Bill Ackman should have talked to a doctor before investing so much money in VRX, we could have told him all the details, it was quite apparent to me, hence I never invested in this company. So next step for VRX will be, Pearson will be gone, it will not be able to suddenly become a growth company out of thin air and it will not be able to cover interest on that $ 30 B it has borrowed. So one can imagine the carnage.

[ScottHall]

You must understand that this board is more for amusement than investment insight. Use it that way and it's a lot more amusing.

 

I don’t think I agree with this, Scott.

Imo there are a lot of good ideas on this board. Just because the investment in VRX is giving us much trouble lately, it doesn’t mean the work done by many good investors on this board is to be completely disregarded and thrown away. Any single investment, even a “high conviction” idea, can turn out to be a wrong bet: of course there might be lessons to be learnt, but it doesn’t mean there is nothing good with this board anymore.

 

Cheers,

 

Gio

 

Ah, man, you misunderstand me Gio. I don't care that VRX is going down; check my post history. This forum is just a shell of what it used to be, in general.