VRX - Valeant Pharmaceuticals International Inc.

[muscleman]

You have become soft huh...

 

Position size is about 25%.  I don't do really crazy sizing anymore.

 

The "problem" is that I don't have access to our RothIRA funds anymore.  I can only invest what's in my taxable account.

 

VRX anyhow is best suited to a taxable account.  So no worries and isn't 25%+ enough if it triples in a couple of years?  Okay, it's not enough but my hands are tied.  Oh well!

 

Eric---Did you build this entire position over the past week since the decline or have you been a long term holder?

 

I didn't buy any before this week.

 

What made you decide to buy this week? Do you now have a good grasp of Citron's claims vs VRX's explanation and felt like it is FFH 2006 all over again?

[ERICOPOLY]

You have become soft huh...

 

Position size is about 25%.  I don't do really crazy sizing anymore.

 

The "problem" is that I don't have access to our RothIRA funds anymore.  I can only invest what's in my taxable account.

 

VRX anyhow is best suited to a taxable account.  So no worries and isn't 25%+ enough if it triples in a couple of years?  Okay, it's not enough but my hands are tied.  Oh well!

 

Eric---Did you build this entire position over the past week since the decline or have you been a long term holder?

 

I didn't buy any before this week.

 

What made you decide to buy this week? Do you now have a good grasp of Citron's claims vs VRX's explanation and felt like it is FFH 2006 all over again?

 

Citron doesn't really have any claims. 

 

I decided to buy this week because I hadn't heard the Valeant story ever before.  I had never read any of the thread until this past week. 

 

I had been ignoring the thread completely because it had "Pharmaceuticals" in the name and I thought I knew nothing about that industry and never would.  But then once I started reading about the name, I realized it's actually really easy to understand the Valeant investment case.  Then I got to somewhere around April 2014 in this thread and Original_Mungerville said exactly the same thing!  He was ignoring Valeant until then because he thought pharma was worth ignoring.  I think we both assumed pharma was about wildcatting and thus too hard.

[sswan11]

Not so positive video by accounting prof:

 

http://www.bnn.ca/Video/player.aspx?vid=736200

 

http://elitzu.blogspot.ca/2015/10/valeant.html

[Guest roark33]

http://www.wsj.com/articles/pharmacys-sales-tactics-disclosed-1446075817

 

This is a good article and what most independent observers thought was happening.  VRX was "gaming" the insurance companies in the same way that insurance companies "game" their customers to deny the claims.  This is the US healthcare system, whether we like it or not.  I cannot speak to all the technicalities, but I would lean to all of the activities being aggressive and not illegal.  This is important because it furthers narrows the range of fines, fees, and impact to the business. 

 

I hope and pray this drops on this "news" tomorrow, even better if IV spikes...

 

 

[kevin4u2]

Eric, what you are saying is true but I think you know what the difference is. The earnings stream at VRX is not an growing earnings stream or a flat earnings stream. It is a declining earnings stream. That is important because unlike a conventional company whose goodwill is never impaired, it truly is an asset. The asset at VRX will decline just like it's earnings. That means the company must always make acquisitions to make up for the declining asset that is never expensed.

 

At the end of the day, a dollar of earnings at VRX is not a dollar of owner earnings. You cannot payout the VRX earnings to shareholders, it is not free cash flow, it must be retained to sustain the earnings power of the company.

 

Now, the biggest risk to VRX is a low stock price. That will make its acquisition currency less valuable. Image management is crucial for VRX.

 

Back to the sidelines.

 

You can take control of the company for a day and in a special press release, writed-down the goodwill to zero.

 

Be my guest, just be sure to leave the company immediately and return control to Pearson so he can keep on reporting earnings as they are.

 

And your reign of earnings will be remembered as THE ONE where it was necessary to ignore the one-time item in order to see what the real earnings are.

 

And that would accomplish... absolutely fucking nothing.  It would make absolutely no difference whatsoever to their earnings power.

[Picasso]

My favorite is this:

 

The PowerPoint, which isn't dated, gave step-by-step instructions on what to do when an insurance company electronically rejected a prescription because the drug cost too much. It advised rechecking the submission for any mistakes, and calling the insurance company for an override.

 

“If override is successful…Great!!!” the PowerPoint said.

 

I wouldn't exactly label that as aggressive.

 

One would assume that if the WSJ got their hands on the handbook and this was the worst they found, it looks like the narrative will have to shift yet again to some other wacky claim.

[Guest roark33]

The fund I worked for in a previous life owned a home health/hospice company and I worked with them in their billing. We went through so many billers until we found one that was amazing.  I asked her how she did it, and she said, Well, I just keep changing things until something works" and then she created this huge spread sheet with all the different quirks of the various insurance companies we worked with.  The spreadsheet was massive, and if I can find it I will post it.  There were so many stupid differences that had no substantive impact on the chart or coding, but would get rejected if you didn't do it right...So if this is the worst that VRX is doing, it will be an absolute boon for buyers at these levels...

[ERICOPOLY]

Eric, what you are saying is true but I think you know what the difference is. The earnings stream at VRX is not an growing earnings stream or a flat earnings stream. It is a declining earnings stream.

 

The earnings stream is declining?  By this you mean organic earnings growth is actually negative, I presume?

 

In what quarter has that happened?  You should be able to easily point to it if what you say is true, and why wouldn't it be true if you are saying it?

[ERICOPOLY]

You invest X in a company, and you get paid back X in cash earnings over first 6 years.

 

Now you have your "X" back plus whatever earnings are still being produced by the asset acquired in that initial outlay 6 years earlier.

 

So you invest X once again...  Now you have growth because you've got a brand new X invested, plus some remaining income from the first iteration.

 

Then rinse and repeat.

 

That is real growth in earnings and it is sustainable. It is enough to merely value it based on the earnings and ignore all the goodwill bullshit.

 

[Picasso]

The fund I worked for in a previous life owned a home health/hospice company and I worked with them in their billing. We went through so many billers until we found one that was amazing.  I asked her how she did it, and she said, Well, I just keep changing things until something works" and then she created this huge spread sheet with all the different quirks of the various insurance companies we worked with.  The spreadsheet was massive, and if I can find it I will post it.  There were so many stupid differences that had no substantive impact on the chart or coding, but would get rejected if you didn't do it right...So if this is the worst that VRX is doing, it will be an absolute boon for buyers at these levels...

 

It would be awesome if you found it.  That might help explain some of the issues Medicis had when distributing Solodyn through other channels.

[giofranchi]

Eric, what you are saying is true but I think you know what the difference is. The earnings stream at VRX is not an growing earnings stream or a flat earnings stream. It is a declining earnings stream.

 

The earnings stream is declining?  By this you mean organic earnings growth is actually negative, I presume?

 

In what quarter has that happened?  You should be able to easily point to it if what you say is true, and why wouldn't it be true if you are saying it?

 

This is what I have always said: as long as there is organic growth, no need to worry. If and when organic growth starts to falter, I’ll take notice.

 

Cheers,

 

Gio

 

[KCLarkin]

Not so positive video by accounting prof:

 

http://www.bnn.ca/Video/player.aspx?vid=736200

 

http://elitzu.blogspot.ca/2015/10/valeant.html

 

Ha ha. Is this a joke? He finds a 0.6% probability of manipulation in 2014, the year Philidor really starts going? I am not a statistician, but that sounds like it might not be statistically different than zero. What is the confidence interval?

 

Then he says that it is highly suspicious that AR is highly correlated with sales. I am no professor, but wouldn't the problem be sales growth that wasn't correlated with ar growth?

 

And how does factor in inventory destocking at Salix?

[ERICOPOLY]

http://www.forbes.com/sites/stephenbrozak/2015/10/29/ackman-to-the-rescue-can-he-make-the-case-for-valeant/?utm_campaign=yahootix&partner=yahootix

 

The topic of this Forbes piece is to explain that Philidor/Valeant cozy relationship is just basically a vertical integration.

 

Hopefully this will help to settle things down -- Philidor is Citron's "smoking gun"... which is funny because you can't "stuff the channel" with Philidor due to the consolidation.

 

[giofranchi]

I've got some new cash this morning and I have just bought more.

 

Cheers,

 

Gio

[KJP]

You invest X in a company, and you get paid back X in cash earnings over first 6 years.

 

Now you have your "X" back plus whatever earnings are still being produced by the asset acquired in that initial outlay 6 years earlier.

 

So you invest X once again...  Now you have growth because you've got a brand new X invested, plus some remaining income from the first iteration.

 

Then rinse and repeat.

 

That is real growth in earnings and it is sustainable. It is enough to merely value it based on the earnings and ignore all the goodwill bullshit.

 

Kevin can speak for himself, but I think the only point is that in the scenario you describe "cash earnings" is not the same as "free cash flow," if "free cash flow" means the amount you can put in your pocket after making the investments necessary to maintain current profits.  This kind of disconnect between (operating cash flow - cap ex) and the real underlying economics of the business often happens with companies that have lumpy capital expenditures, e.g., hotels, or companies that are operating relatively new, long-lived assets, e.g., Seaspan. 

 

In these kinds of situations, to get a better sense of the underlying economics, I usually try to estimate a true maintenance capex number.  With something like Seaspan, it may make sense to look at actual depreciation to get that number. I assume that's the thinking behind looking at amortization for Valeant.  I have no opinion on Valeant or whether that type of thinking makes sense here.  But if the assets Valeant is buying are finite-lived (as the scenario above suggests), doesn't it make sense to include some kind of capital charge, if what you're trying to do is estimate true free cash flow, owner earnings, or whatever you want to call it?       

 

[cmlber]

At best absolutely nothing illegal happened and the business goes on with no changes, at worst this looks like a repeat of the salad oil scandal.  In that case, there was fraud at a small warehousing subsidiary of Amex, in this case, it's at Philidor.  If Philidor is 10% of EBITDA, and if that completely disappeared (which it won't), you'd still get $6.75 billion in EBITDA in 2016, less $300 million for capex & stock comp, less $1.4 billion interest, taxed at 5%, divided by 340 million shares, you still get $14/share cash EPS in 2016. 

[KCLarkin]

Kevin can speak for himself, but I think the only point is that in the scenario you describe "cash earnings" is not the same as "free cash flow," if "free cash flow" means the amount you can put in your pocket after making the investments necessary to maintain current profits.  This kind of disconnect between (operating cash flow - cap ex) and the real underlying economics of the business often happens with companies that have lumpy capital expenditures, e.g., hotels, or companies that are operating relatively new, long-lived assets, e.g., Seaspan. 

 

In these kinds of situations, to get a better sense of the underlying economics, I usually try to estimate a true maintenance capex number.  With something like Seaspan, it may make sense to look at actual depreciation to get that number. I assume that's the thinking behind looking at amortization for Valeant.  I have no opinion on Valeant or whether that type of thinking makes sense here.  But if the assets Valeant is buying are finite-lived (as the scenario above suggests), doesn't it make sense to include some kind of capital charge, if what you're trying to do is estimate true free cash flow, owner earnings, or whatever you want to call it?     

 

This is completely valid BUT the accounting amortization provides absolutely no value in this approach. Start with normalized cash earnings and make your own adjustments to get to your own estimate of Owner's Earnings.

 

Some of the optimists believe that the capital charge is $0 if there is organic growth. The pessimists think you should charge all acquisitions + restructuring against FCF.

[merkhet]

The fund I worked for in a previous life owned a home health/hospice company and I worked with them in their billing. We went through so many billers until we found one that was amazing.  I asked her how she did it, and she said, Well, I just keep changing things until something works" and then she created this huge spread sheet with all the different quirks of the various insurance companies we worked with.  The spreadsheet was massive, and if I can find it I will post it.  There were so many stupid differences that had no substantive impact on the chart or coding, but would get rejected if you didn't do it right...So if this is the worst that VRX is doing, it will be an absolute boon for buyers at these levels...

 

So my questions on this would be:

 

(A) How common is this?

(B) Is this practice sustainable over the long-term?

© What keeps health insurance companies from stopping people from gaming the system?

 

I realize that last question seems to insinuate some moral component to what various companies are doing, but I don't know how to phrase it in a more neutral way.

[Liberty]

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

[ERICOPOLY]

But if the assets Valeant is buying are finite-lived (as the scenario above suggests), doesn't it make sense to include some kind of capital charge, if what you're trying to do is estimate true free cash flow, owner earnings, or whatever you want to call it?     

 

No, it doesn't make sense to do that.

 

Similarly, it makes no sense to announce a big charge to Microsoft's present quarterly earnings simply because the Windows franchise has a finite life. 

 

You can't assume that they are going to develop another similarly fantastic Windows franchise to replace the current one simply because they did so decades ago with entirely different people in an entirely different competitive landscape.  They might try to acquire the next one, in which case today's free cash flow isn't really free cash flow by your argument.  So that means they have no earnings today?

[KCLarkin]

So my questions on this would be:

 

(A) How common is this?

(B) Is this practice sustainable over the long-term?

© What keeps health insurance companies from stopping people from gaming the system?

 

I realize that last question seems to insinuate some moral component to what various companies are doing, but I don't know how to phrase it in a more neutral way.

 

What happens when the specialty pharmacy doesn't help with reimbursement (this is my interpretation, someone with more knowledge correct me if I am wrong):

- The doctor who prescribes the medicine has no clue whether it is covered by insurance. Every patient has different insurance and different insurance has different coverage for every drug. You need IBM's Watson to prescribe any drugs. So the doctor can either prescribe the medicine she thinks most appropriate and risk it getting denied by insurance. Or he can try to guess which drug will be reimbursed.

- The patient takes the prescription to the pharmacy. The pharmacist has no motivation to get the drug reimbursed. The coverage is denied. The patient can either pay out of pocket or have his doctor write a script for a different drug. Or try to battle with the insurance company to get coverage.

 

As Liberty mentions, it looks like the insurers are trying to game the system too (to deny claims). No wonder doctors and patients like Philidor.

 

 

[giofranchi]

Some of the optimists believe that the capital charge is $0 if there is organic growth.

 

To get satisfactory organic growth, they spend for R&D (not much, but very focused on ROI), they spend for marketing, they spend for their sales force, etc. … just because those costs are not defined as maintenance expenditures, it doesn’t mean they are less effective. And they are already accounted for!

 

Cheers,

 

Gio

 

[Liberty]

Sequoia letter on VRX situation:

 

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

[mcmaaaaath]

Guys, no dog in this fight, just an interested observer.

 

VRX says Philidor is 6% of revenues and Specialty Pharmacies overall is 7%. Is it possible that Valeant is doing something similar with regular pharmacies? Their products aren't injectables that actually have a reason to be distributed by specialty pharmacies, right?

 

Jublia in particular (44% distributed through Philidor) is a topical foot anti-fungal, exactly the type of medication that does not appear to fall into the industry definition of a specialty pharmaceutical.

 

http://www.pharmacist.com/specialty-pharmacy-unique-and-growing-industry

 

So I guess my question is: do we have reason to think Valeant ISN'T playing these sorts of games with regular old pharmacies?

 

I'd love to know what % of Valeant's sales flow through a pharmacy in which they had any: actual ownership, option to purchase, profit sharing agreement, ability to influence or appoint management, etc.

 

 

[KCLarkin]

I'd love to know what % of Valeant's sales flow through a pharmacy in which they had any: actual ownership, option to purchase, profit sharing agreement, ability to influence or appoint management, etc.

 

They went through this in detail on the call (not the ownership option but a breakdown of sales channels). You seem to assume all sales go through pharmacies, which is not true.