VRX - Valeant Pharmaceuticals International Inc.

[LongHaul]

I am following the drama from a distance. I presume some holders here initially got involved knowing plenty of investment luminaries were long.

 

Can we put together some hypotheses why all these smart and experienced people got it wrong together?

 

I start with -

 

1) The CEO was a top guy at McKinsey. The CFO was a top guy at Goldman. So the money mangers were dazzled.

2) These people actually clone each other secretly, but we assume they do independent work.

3) ?

 

This is a really great question - the funds who invested generally had great track records, presumably did a lot of research and have high IQ types running around.  Here is my list:

 

1. Mckinsey and Goldman - totally agree.  Mckinsey and Goldman are the elite of the elites.  Investors could not believe that individuals from these places and schooling pedigree (Duke/Wharton) could be possible frauds.  The investors often went to those schools or their cousins.  There is a lot of prestige and authority with all these brands. 

 

Reality - lots and lots of highly unethical people go to Wharton and other Ivy's.  Wharton is full of sleazy types - Skilling and Milken are two who went to jail.  Trump went to Wharton too. 

 

 

2.  Mike Pearson Cult - Pearson was not an articulate talker but told value investors exactly what they wanted to hear.  He had a great story that sounded plausible.  Long term shareholder value, cut out 3,000 basis points of expenses as fat (kernel of truth to it as pharma was a bit fat), R&D didn't make sense, etc.  Buy, gut, create value - repeat.  Adjusted EPS went up a lot.  A powerful cult of personality developed around the CEO as on Outsider awesome CEO. 

 

Reality - Pearson doesn't know anything about business and his actions make no long term sense for customers, employees, suppliers or stockholders.  Pharma had great ROE on tangible equity.  His actions destroyed companies but only over the long run and evidence would only come out over time.  Pearson is indeed an “Outsider” – he runs his businesses Outside accounting and Legal rules.

 

3.  Valeant was it's own little bubble as the stock rose and rose and rose.  Longs made a fortune - and there is nothing like making a lot of fast, easy money to gum up your brain.  Everyone got creamed who was negative and short early.  A lot of powerful psychological forces took form. 

 

4.  Tons of smart funds owned it - this triggers Social Proof, Association, Envy, Group think and authority, etc.  And with the stock going up it must be a smart investment.  All those smart guys could not be lazy and wrong - could they?  These investors were gods and gods cannot be wrong.  They wouldn't just be riding a bubble wave of sorts and cheering on a fraud - no way right?

 

Reality - every single human has human problems and bias'.  They all take a shit most days.  It doesn't matter their IQ or schooling or track record.  Most of the investors were just gamblers when Valeant was very high.  40x FCF is bonkers for VRX.  It is also interesting to think that people thought they were smart because they had great track records but how much of their track records were from VRX going up?  Circular evidence to an extent.  The small speculators and the large speculators were the same because both groups failed to grasp ultimate realities of VRX.  I personally think that many investors were lazy with their research, thinking and willfully blind to the bad ethics.  In investing you have to do your own research and thinking and stick by your analysis even if the world disagrees in the short term.

 

5.  Reality Avoidance - Initially there was VRX gutting companies, paying a lot of for deals, jacking up prices, the Allergan claims - let's just ignore those things.  Oh yeah, and the fact that Pearson had a few super expensive corporate jets although he was a fan of long term shareholder value.  Al Dunlap flew 1st class and stayed at the 4 seasons.  See the pattern?  Sam Walton doubled up in cheap motel however.

 

Then the serious disconfirming evidence started to come out in August 2015.  AZ VAlue, Philidor, Norma Provencio, R&O and a lot of funds doubled down even more.  Again reacting and blaming rather than thinking and analyzing and weighing the evidence.  Rationalizing it all away as small potatoes rather than the poop it was.  Denial and Delusion ruled.  There was stress too.  "It is just a bunch of bears and a PR problem".  The only people that cared about the bears on the way up were the bears families because of personal bankruptcy if any had a big position.  Convenient scapegoats on the way down though.       

 

6.  Frauds can be tough to spot even for people with years of experience in investing.  Short selling is its own craft and spotting frauds can be tricky and a lot of hard work.  Who wants to wade through all those footnotes and details and figure out the accounting – it is hard mental work.  I have owned a few companies cooking the books - ouch.  I have also shorted a bunch.  You have to have patterns in your head to pick up on bad character in people and how that translates into their exhibited behavior when they run businesses.  You have to know and understand business and the industry.  The backgrounds of the people involved can help as character is constant.  Then you have to know accounting really well.  Well enough to know all the levers a shady CEO can pull.  And there are a lot.  I have seen very smart people miss these very frequently so it is not easy.  Then there are off balance sheet games and related party stuff that occurs to continue the fraud.  Also complex and this can be tricky to figure out.  Then there can be intensive field research to figure out the culture of the company.       

My hats off to Roddy Boyd, Chanos, Hempton and Left.  They are masters at their craft.

 

Sometimes you just have to have the hard experience with frauds to really learn about them.  If you lost money on VRX then on the bright side you have just learned a ton that will serve you well over time if you choose to learn from it.

 

Right now I sense a lot of hindsight bias from many who knew it all along.  That is not how the environment was in August 2015 when VRX was riding high. 

 

Conclusion:

 

At the end of the day we are all human and all have made mistakes and will continue to make more.  I think a large degree of humility is good to keep us all in check and we should not take pleasure in those (even high profile rich, etc.) that have lost money in Valeant as any of us could have been in their shoes.   

 

 

 

 

 

 

[sleepydragon]

i just noticed goldman suspended coverage of vrx.

They sometimes do this when they are advising companies on issues such as restructuring, share issue etc.

 

[premfan]

Enjoyed the Dorsia and Roark analysis and commentary of VRX. 

 

I wouldn't even touch Valeant at $15.  Here is why.  The more I learn about the company the more negative I get. 

At this point I think there is a good chance of a wipeout on the equity.  What I don't know is what the earnings power of the business is - levered or unlevered because I don't trust the accounting at all.  In my opinion Pearson is a bottom 1% type character wise.  It is so extreme it is not even funny and will make for interesting reading in a book and perhaps a movie.  I think it is more extreme than the Enron guys.  Look who the head of the Audit committee is - Norma Provencio and her background association with a Heartronics which was a total pump and dump fraud. 

 

Back to earnings power.  I have had the impression for at least the last 6 months that the board of Valeant is compromised and pathetic.  They still have not gotten out a report on Philidor ( which I heard from field research that VRX actually set up from the beginning). Where is the report?  Unacceptable.  So you have some very unsavory executives and the only thing they do is an aggressive accounting transaction for ~$60m that front loads profits in the 4Q 2014?  I don't believe that for a second.  The 10-K is not out and the committee mentioned other accounting issues.  The FCF sucks vs what it should be.  I think VRX has been pushing out their current liabilities to enhance FCF also.  With a bad 1Q 16 and 4Q 15 and Philidor gone and the insurance companies tightening on VRX drugs FCF is probably negative now.  In addition VRX is apparently not paying a lot of suppliers.  The prepaids are massively out of line, they changed Salix's reserving and the list goes on.   

See Cafe pharma for Supplier posts and accounting.

 

Oh yeah the Europe channel seems stuffed too.  What about the US channel? 

And a lot of Valeant's answers to tough allegations in their rebuttal is not clear - I wonder why that is?

It is highly humorous to me that anyone can say that Valeant has or ever had a PR problem.  They had an ethics problem and a fundamental slimy way of doing business problem.  The speculators who were long this thing and rationalized Valeant's disgusting behavior got an expensive lesson in ethics. 

 

But now with the Schiller/Tanya Carro factions out we finally have dissent and a breaking up of the likely charade.  Now it is every man for himself with possible criminal indictments and the truth will come out.  I am sure Schiller likes Pearson putting all the blame on him. 

 

Then you get the the most aggressive tax rate and all other liabilities.  It is beyond a mess and the risk is probably much more on the downside.  Frankly it could be even worse than what I am thinking now - I just don't know.  Probably better odds at Las Vegas.

 

I am very glad Pearson will be out shortly and he can no longer gut pharma companies that help improve the lives of humans.  Maybe he will open up a fudge shop on the NJ shore after his likely "vacation". 

 

It will also be very interesting what the New CEO finds.  Everything will get flushed out as he will not want to take any blame.

 

You made a great point about the lack of empathy in the business model. Humans depend on the evolution of medicine and science to improve lives. To even save lives. Cutting research and development for the sake of eps gain seems like a culture that lacks empathy. For the pure bred capitalist thinking running a bloated business is bad. I would use context in that thinking. There is a difference in cutting operating expenses in a retail business vs a pharma business. 

[Rasputin]

Yeah, the underlying value of the assets is a tricky question. And Valeant certainly hasn't made it easier with all of the bolt-on acquisitions.

 

I will note one thing on Salix that I found interesting. Last quarter, Xifaxan had about 200 million of revenue. That's a run rate of 800 million.  Now, it appears there were still some inventory issues being worked through, but back in 2013, Xifaxan had yearly revenue of 635 million, and then there was the lost year of channel stuffing. 

 

The fact that Salix felt the need to stuff the channel to show growth, and the fact that even with inventory levels stabilizing, Xifaxan is struggling to grow much above where it was in 2013, shows there may not be tremendous organic demand for the product. If it stabilizes at about 1 billion (and it's been on the market for 6 years, so it may be reaching stabilization), then I don't think it's worth 15 billion, even if the patent extended to 2029 (and I think at best it ends in 2024).  But hey, people do seem entranced by gut guy, so there's still hope.

 

(For comparison, Regeneron trades at a 9 price/sales, Celgene at an 8 price/sales, and Gilead at a 4 price/sales, and each of those companies (Gilead somewhat less so) have far more robust R&D platforms. Salix is basically Xifaxan, under these valuations, it would trade somewhere in the 8-9 billion range, probably less because of the no R&D.)

 

Another note on valuing - I've been looking at some other pharmas 10-ks recently, (such as Salix) and it is remarkable how much better the disclosure of unit-by-unit results are in every other pharma I've looked at. (Here's Salix's 10k for reference - http://cdn.salix.com/salix/assets/pdf/investors/2014_10K.pdf?id=790422).  Valeant for the last several years has done everything in just two segments, based on geography. But I know that is kicking a man while he's down. The point is that it's tough to break out and do a sum of the parts valuation when there's so little audited sum of the parts info. Like Valeant just paid 800 million for Amoun. Does anyone have any idea what Amoun looks like? The only glimpse we've ever gotten was AZ on Sanitas, and that looked like a very agressive purchase.

 

I've found it strange that everyone now agrees (or almost everyone) that Pearson and Schiller were not the greatest at accounting. And yet, people still largely accept that they were good at M&A and synergies. I think it may be turtles all the way down, but that's me.

 

Salix is not basically just Xifaxan.  In 2015, Xifaxan sales under VRX (Q2, Q3, Q4 2015) was $578 million.  Total GI franchise sales in 2015 was $1.3 Billion.  Apriso, Uceris, Relistor, Cycloset, Moviprep were part of Salix (now VRX GI).  Beyond GI, VRX got Ruconest from Salix. 

[arcube]

I am following the drama from a distance. I presume some holders here initially got involved knowing plenty of investment luminaries were long.

 

Can we put together some hypotheses why all these smart and experienced people got it wrong together?

 

I start with -

 

1) The CEO was a top guy at McKinsey. The CFO was a top guy at Goldman. So the money mangers were dazzled.

2) These people actually clone each other secretly, but we assume they do independent work.

3) ?

 

This is a really great question - the funds who invested generally had great track records, presumably did a lot of research and have high IQ types running around.  Here is my list:

 

1. Mckinsey and Goldman - totally agree.  Mckinsey and Goldman are the elite of the elites.  Investors could not believe that individuals from these places and schooling pedigree (Duke/Wharton) could be possible frauds.  The investors often went to those schools or their cousins.  There is a lot of prestige and authority with all these brands. 

 

Reality - lots and lots of highly unethical people go to Wharton and other Ivy's.  Wharton is full of sleazy types - Skilling and Milken are two who went to jail.  Trump went to Wharton too. 

 

 

2.  Mike Pearson Cult - Pearson was not an articulate talker but told value investors exactly what they wanted to hear.  He had a great story that sounded plausible.  Long term shareholder value, cut out 3,000 basis points of expenses as fat (kernel of truth to it as pharma was a bit fat), R&D didn't make sense, etc.  Buy, gut, create value - repeat.  Adjusted EPS went up a lot.  A powerful cult of personality developed around the CEO as on Outsider awesome CEO. 

 

Reality - Pearson doesn't know anything about business and his actions make no long term sense for customers, employees, suppliers or stockholders.  Pharma had great ROE on tangible equity.  His actions destroyed companies but only over the long run and evidence would only come out over time.  Pearson is indeed an “Outsider” – he runs his businesses Outside accounting and Legal rules.

 

3.  Valeant was it's own little bubble as the stock rose and rose and rose.  Longs made a fortune - and there is nothing like making a lot of fast, easy money to gum up your brain.  Everyone got creamed who was negative and short early.  A lot of powerful psychological forces took form. 

 

4.  Tons of smart funds owned it - this triggers Social Proof, Association, Envy, Group think and authority, etc.  And with the stock going up it must be a smart investment.  All those smart guys could not be lazy and wrong - could they?  These investors were gods and gods cannot be wrong.  They wouldn't just be riding a bubble wave of sorts and cheering on a fraud - no way right?

 

Reality - every single human has human problems and bias'.  They all take a shit most days.  It doesn't matter their IQ or schooling or track record.  Most of the investors were just gamblers when Valeant was very high.  40x FCF is bonkers for VRX.  It is also interesting to think that people thought they were smart because they had great track records but how much of their track records were from VRX going up?  Circular evidence to an extent.  The small speculators and the large speculators were the same because both groups failed to grasp ultimate realities of VRX.  I personally think that many investors were lazy with their research, thinking and willfully blind to the bad ethics.  In investing you have to do your own research and thinking and stick by your analysis even if the world disagrees in the short term.

 

5.  Reality Avoidance - Initially there was VRX gutting companies, paying a lot of for deals, jacking up prices, the Allergan claims - let's just ignore those things.  Oh yeah, and the fact that Pearson had a few super expensive corporate jets although he was a fan of long term shareholder value.  Al Dunlap flew 1st class and stayed at the 4 seasons.  See the pattern?  Sam Walton doubled up in cheap motel however.

 

Then the serious disconfirming evidence started to come out in August 2015.  AZ VAlue, Philidor, Norma Provencio, R&O and a lot of funds doubled down even more.  Again reacting and blaming rather than thinking and analyzing and weighing the evidence.  Rationalizing it all away as small potatoes rather than the poop it was.  Denial and Delusion ruled.  There was stress too.  "It is just a bunch of bears and a PR problem".  The only people that cared about the bears on the way up were the bears families because of personal bankruptcy if any had a big position.  Convenient scapegoats on the way down though.       

 

6.  Frauds can be tough to spot even for people with years of experience in investing.  Short selling is its own craft and spotting frauds can be tricky and a lot of hard work.  Who wants to wade through all those footnotes and details and figure out the accounting – it is hard mental work.  I have owned a few companies cooking the books - ouch.  I have also shorted a bunch.  You have to have patterns in your head to pick up on bad character in people and how that translates into their exhibited behavior when they run businesses.  You have to know and understand business and the industry.  The backgrounds of the people involved can help as character is constant.  Then you have to know accounting really well.  Well enough to know all the levers a shady CEO can pull.  And there are a lot.  I have seen very smart people miss these very frequently so it is not easy.  Then there are off balance sheet games and related party stuff that occurs to continue the fraud.  Also complex and this can be tricky to figure out.  Then there can be intensive field research to figure out the culture of the company.       

My hats off to Roddy Boyd, Chanos, Hempton and Left.  They are masters at their craft.

 

Sometimes you just have to have the hard experience with frauds to really learn about them.  If you lost money on VRX then on the bright side you have just learned a ton that will serve you well over time if you choose to learn from it.

 

Right now I sense a lot of hindsight bias from many who knew it all along.  That is not how the environment was in August 2015 when VRX was riding high. 

 

Conclusion:

 

At the end of the day we are all human and all have made mistakes and will continue to make more.  I think a large degree of humility is good to keep us all in check and we should not take pleasure in those (even high profile rich, etc.) that have lost money in Valeant as any of us could have been in their shoes. 

 

+ 1. Thanks for a great summary!

[rpadebet]

The truly smart investors are the ones that had the popcorn, entertained themselves and left with a lesson to boot.

 

PS: Did Pearson really have corporate jets? How did I miss that one? Would have reconsidered my long if I knew that :P

[LongHaul]

The truly smart investors are the ones that had the popcorn, entertained themselves and left with a lesson to boot.

 

PS: Did Pearson really have corporate jets? How did I miss that one? Would have reconsidered my long if I knew that :P

 

Yes, had jets.  One was the G650 which is apparently a super expensive jet.

http://sirf-online.org/2016/02/22/valeant-pharmaceuticals-howard-schiller-up-in-the-air/

[rpadebet]

The truly smart investors are the ones that had the popcorn, entertained themselves and left with a lesson to boot.

 

PS: Did Pearson really have corporate jets? How did I miss that one? Would have reconsidered my long if I knew that :P

 

Yes, had jets.  One was the G650 which is apparently a super expensive jet.

http://sirf-online.org/2016/02/22/valeant-pharmaceuticals-howard-schiller-up-in-the-air/

 

Actually stories like these are why shorts like SIRF didn't seem credible to me. This is tabloid gossip level stuff, not research. They may have been right on their call but for wrong reasons.

 

AZ_Value on the other hand backed up some of his research with facts and didn't indulge in this kind of stuff.

 

[plato1976]

Hi, Rasputin:

 

Given the recent drama (finger pointing among board, ceo, cfo, controller) and the potential of more accounting problems, do you still feel comfortable with the numbers you rely on in your analysis?

 

Thanks!

/plato

 

Yeah, the underlying value of the assets is a tricky question. And Valeant certainly hasn't made it easier with all of the bolt-on acquisitions.

 

I will note one thing on Salix that I found interesting. Last quarter, Xifaxan had about 200 million of revenue. That's a run rate of 800 million.  Now, it appears there were still some inventory issues being worked through, but back in 2013, Xifaxan had yearly revenue of 635 million, and then there was the lost year of channel stuffing. 

 

The fact that Salix felt the need to stuff the channel to show growth, and the fact that even with inventory levels stabilizing, Xifaxan is struggling to grow much above where it was in 2013, shows there may not be tremendous organic demand for the product. If it stabilizes at about 1 billion (and it's been on the market for 6 years, so it may be reaching stabilization), then I don't think it's worth 15 billion, even if the patent extended to 2029 (and I think at best it ends in 2024).  But hey, people do seem entranced by gut guy, so there's still hope.

 

(For comparison, Regeneron trades at a 9 price/sales, Celgene at an 8 price/sales, and Gilead at a 4 price/sales, and each of those companies (Gilead somewhat less so) have far more robust R&D platforms. Salix is basically Xifaxan, under these valuations, it would trade somewhere in the 8-9 billion range, probably less because of the no R&D.)

 

Another note on valuing - I've been looking at some other pharmas 10-ks recently, (such as Salix) and it is remarkable how much better the disclosure of unit-by-unit results are in every other pharma I've looked at. (Here's Salix's 10k for reference - http://cdn.salix.com/salix/assets/pdf/investors/2014_10K.pdf?id=790422).  Valeant for the last several years has done everything in just two segments, based on geography. But I know that is kicking a man while he's down. The point is that it's tough to break out and do a sum of the parts valuation when there's so little audited sum of the parts info. Like Valeant just paid 800 million for Amoun. Does anyone have any idea what Amoun looks like? The only glimpse we've ever gotten was AZ on Sanitas, and that looked like a very agressive purchase.

 

I've found it strange that everyone now agrees (or almost everyone) that Pearson and Schiller were not the greatest at accounting. And yet, people still largely accept that they were good at M&A and synergies. I think it may be turtles all the way down, but that's me.

 

Salix is not basically just Xifaxan.  In 2015, Xifaxan sales under VRX (Q2, Q3, Q4 2015) was $578 million.  Total GI franchise sales in 2015 was $1.3 Billion.  Apriso, Uceris, Relistor, Cycloset, Moviprep were part of Salix (now VRX GI).  Beyond GI, VRX got Ruconest from Salix.

[Rasputin]

Hi, Rasputin:

 

Given the recent drama (finger pointing among board, ceo, cfo, controller) and the potential of more accounting problems, do you still feel comfortable with the numbers you rely on in your analysis?

 

Thanks!

/plato

 

Yes, I still feel good about the business and the numbers I relied on.  That will change if they uncover billion dollars fraud.  So far, magnitude of error is small vs VRX 2014/2015 revenue. 

[abcd]

If anyone is following the hedge fund wonder "kid" Nehal Chopra

 

http://blogs.wsj.com/moneybeat/2016/03/21/big-valeant-hedge-fund-booster-got-out-just-in-time/

 

[doughishere]

Hi, Rasputin:

 

Given the recent drama (finger pointing among board, ceo, cfo, controller) and the potential of more accounting problems, do you still feel comfortable with the numbers you rely on in your analysis?

 

Thanks!

/plato

 

Yes, I still feel good about the business and the numbers I relied on.  That will change if they uncover billion dollars fraud.  So far, magnitude of error is small vs VRX 2014/2015 revenue. 

 

 

I completely agree right now.

 

Valeant released a 8-K on March 21st of this year. In it it restated earnings for prior periods in which it has "preliminary determined that approximately $58 million in net revenues relating to sales to Philidor during the second half of 2014 should not have been recognized upon delivery of product to Philidor."

 

Further they state that they "should have been recognized on a sell-through basis (i.e., record revenue when Philidor dispensed the products to patient)" and not "on a sell-in basis (i.e., recorded when the Company delivered product to Philidor)." I believe this to be the proper recognition. Revenues are recognized when product or service is delivered.

 

This seems like a small "drop" in the bucket of revenues which for 2014 $8,264 million of revenue was booked. Misstatements of Phildor revenue recognition only represent .7% of revenues.This along with the "channel stuffing" regarding Wellbutrin XL, as described in your post dated February 24th of this year, You yourself state that Wellbutrin XL is accounted for $93M. I assume, perhaps wrong, that this figure of $93M is for 2014.this time 1.12% of revenues.  Again seems to me to be a small "drop" in the bucket or revenues.

 

 

The company in question may make further "readjustments" to revenue recognition but I just fail see the significance of these two individual cases. Perhaps, I am missing something. I guess my final question is this...is this indicative of a more material portion of the revenues booked?

[dorsiacapital]

Hi, Rasputin:

 

Given the recent drama (finger pointing among board, ceo, cfo, controller) and the potential of more accounting problems, do you still feel comfortable with the numbers you rely on in your analysis?

 

Thanks!

/plato

 

Yes, I still feel good about the business and the numbers I relied on.  That will change if they uncover billion dollars fraud.  So far, magnitude of error is small vs VRX 2014/2015 revenue. 

 

 

I completely agree right now.

 

Valeant released a 8-K on March 21st of this year. In it it restated earnings for prior periods in which it has "preliminary determined that approximately $58 million in net revenues relating to sales to Philidor during the second half of 2014 should not have been recognized upon delivery of product to Philidor."

 

Further they state that they "should have been recognized on a sell-through basis (i.e., record revenue when Philidor dispensed the products to patient)" and not "on a sell-in basis (i.e., recorded when the Company delivered product to Philidor)." I believe this to be the proper recognition. Revenues are recognized when product or service is delivered.

 

This seems like a small "drop" in the bucket of revenues which for 2014 $8,264 million of revenue was booked. Misstatements of Phildor revenue recognition only represent .7% of revenues.This along with the "channel stuffing" regarding Wellbutrin XL, as described in your post dated February 24th of this year, You yourself state that Wellbutrin XL is accounted for $93M. I assume, perhaps wrong, that this figure of $93M is for 2014.this time 1.12% of revenues.  Again seems to me to be a small "drop" in the bucket or revenues.

 

 

The company in question may make further "readjustments" to revenue recognition but I just fail see the significance of these two individual cases. Perhaps, I am missing something. I guess my final question is this...is this indicative of a more material portion of the revenues booked?

 

Two things.

 

First, the 8k contains a caveat that means the accounting issues are not just limited to Philidor

 

"While the Ad Hoc Committee believes it is nearing completion of its review of accounting and financial reporting matters, it has not concluded its work, there remains a possibility that additional accounting adjustments may be identified that further impact prior periods and that additional remediation actions may be recommended."

 

Second, as a matter of logic, if the accounting issues in the 10K were just limited to Philidor, and they have been fully identified at this point, why doesn't Valeant just release the 10k with those changes. Right now, by not releasing the 10k, Valeant is causing investors to become very concerned and, perhaps more importantly, is breaching various debt covenants. Yet, despite the fact that the issue is supposedly just limited to Philidor, Valeant is still unsure whether it can release the 10k by April 29th, and is negotiating with creditors for an extension. An extension, apparently, for which creditors will extract various concessions such as interest rate increases and etc., according to various news reports.

 

I simply don't think it's plausible that Valeant would be holding up the 10k just because of this 58 million in net revenues, since they've apparently fully identified the problem. I think, and again, this is speculation, that there must be things in the 10k that are worse than tripping your covenants for not releasing the 10k.  The thing that most easily comes to mind is that releasing the 10k will trip debt covenants even worse than not releasing the 10k. I've heard others say that it's more a matter of contingent liabilities and risk factors. That may be true, I generally have erred on the side of cynicism with Valeant and so far have been rewarded.

 

Now, Valeant does say "The Company believes that after giving effect to the restatement it will have remained in compliance with all of the financial maintenance covenants in its credit facility at

the end of each affected quarterly period." but I'd be more assured if the auditor was saying it, and so far we aren't hearing anything from the auditor at all, even though, I think PwC must be prepared with its audit by March 15th.

 

 

 

[doughishere]

Ohhh I read the 8k and clearly get that there could be a larger cancer that has metastasized...i just dont see it as having metastasized yet.

 

 

 

I think PwC must be prepared with its audit by March 15th. 

 

You mean April 29th? Agreed. This needs to be nipped in the butt. However, im still of the opinion that i have no opinion. Perhaps i should be more skeptical.

[dorsiacapital]

Yeah, the underlying value of the assets is a tricky question. And Valeant certainly hasn't made it easier with all of the bolt-on acquisitions.

 

I will note one thing on Salix that I found interesting. Last quarter, Xifaxan had about 200 million of revenue. That's a run rate of 800 million.  Now, it appears there were still some inventory issues being worked through, but back in 2013, Xifaxan had yearly revenue of 635 million, and then there was the lost year of channel stuffing. 

 

The fact that Salix felt the need to stuff the channel to show growth, and the fact that even with inventory levels stabilizing, Xifaxan is struggling to grow much above where it was in 2013, shows there may not be tremendous organic demand for the product. If it stabilizes at about 1 billion (and it's been on the market for 6 years, so it may be reaching stabilization), then I don't think it's worth 15 billion, even if the patent extended to 2029 (and I think at best it ends in 2024).  But hey, people do seem entranced by gut guy, so there's still hope.

 

(For comparison, Regeneron trades at a 9 price/sales, Celgene at an 8 price/sales, and Gilead at a 4 price/sales, and each of those companies (Gilead somewhat less so) have far more robust R&D platforms. Salix is basically Xifaxan, under these valuations, it would trade somewhere in the 8-9 billion range, probably less because of the no R&D.)

 

Another note on valuing - I've been looking at some other pharmas 10-ks recently, (such as Salix) and it is remarkable how much better the disclosure of unit-by-unit results are in every other pharma I've looked at. (Here's Salix's 10k for reference - http://cdn.salix.com/salix/assets/pdf/investors/2014_10K.pdf?id=790422).  Valeant for the last several years has done everything in just two segments, based on geography. But I know that is kicking a man while he's down. The point is that it's tough to break out and do a sum of the parts valuation when there's so little audited sum of the parts info. Like Valeant just paid 800 million for Amoun. Does anyone have any idea what Amoun looks like? The only glimpse we've ever gotten was AZ on Sanitas, and that looked like a very agressive purchase.

 

I've found it strange that everyone now agrees (or almost everyone) that Pearson and Schiller were not the greatest at accounting. And yet, people still largely accept that they were good at M&A and synergies. I think it may be turtles all the way down, but that's me.

 

Salix is not basically just Xifaxan.  In 2015, Xifaxan sales under VRX (Q2, Q3, Q4 2015) was $578 million.  Total GI franchise sales in 2015 was $1.3 Billion.  Apriso, Uceris, Relistor, Cycloset, Moviprep were part of Salix (now VRX GI).  Beyond GI, VRX got Ruconest from Salix.

 

Where are you getting total GI sales from? I don't see GI broken down in the most recent presentation, and I'm not sure if prior presentations are worthwhile at this point. 

 

But in any case, I'm focusing on Xifaxan because I'm trying to forecast what somebody would offer for Salix now.  In the merger document, Xifaxan constitutes about 90% of the revenue after 2022 and about 60-75% of the revenue from 2017-2022. Xifaxan is the key to Salix.  And, Salix doesn't have much of a pipeline at this point. There's relistor oral and then 4 compounds that are still in early stage.  Plus, I think Salix was acquired before Valeant's reinvention, so I have to assume that it's R&D was slashed to the absolute bone.  Therefore, the vast majority of the future cash flows from Salix will be from Xifaxan.

 

Also on Salix, Uceris and Apriso constitute the bulk of the other Salix revenue from 2017-2022. The merger document projects that Uceris would do 167 million in 2015 and then 253 million in 2016.  Uceris in its 3 quarters under Valeant has done q2-24, q3-46, q4-39 for a total of 109 million. Furthermore, revenue was actually decelerating last quarter from 46 to 39 million, which is concerning since it was supposed to grow about 50 percent in 2016 and then peak at around 400 million in 2018/19. (I think summing based on 3 quarters is fair because I think Salix devoted all of q1 to drawing down the inventory from the channel, you could argue that artificially suppresses the numbers). 

 

On Apriso, the merger document projects that it will do 95 million in 2015 and 180 million in 2016.  Apriso in its 3 quarters under Valeant has done q2-31, q3-35, and q4-31.  Now that is on track with the merger document but the revenue growth has been completely static so far, which is not great because it's supposed to double next year. 

 

Now, on Glumetza, the merger document porjects that it will do 105 million in 2015. Glumetza actually did q2-26, q3-53, q4-86 so it actually substantially exceeded the merger document. But, of course, Glumetza's patent ends this year, and Express Scripts has completely blocked it.

 

So the other main components of Salix appear to be under performing the merger document at this point.

 

One other great note on Valeant's q4 presentation, in classic Valeant fashion, they only showed the quarterly revenues for q4 2015 and not the prior quarters revenues (i.e. q3, q2, q1, etc.,) even though that had been their standard for the last several years. Obviously the comparison can be easily made with a little toggling and then you see the deterioration even , but it's just so typical of them that it's almost charming.

 

By the way, earlier you dismissed Allergan's ANDA challenge to Xifaxan. Fair enough, Allergan does file a lot of ANDA challenges. But in this case, Allergan also just brought to market its own IBS-D drug, Vibrezi, so it may be extra incentivized to challenge the Xifaxan patent and undercut a competitor. And litigation is never predictable. I don't think Gilead just expected to lose a jury trial to Merck on the Hep C drugs.

 

[dorsiacapital]

Ohhh I read the 8k and clearly get that there could be a larger cancer that has metastasized...i just dont see it as having metastasized yet.

 

 

 

I think PwC must be prepared with its audit by March 15th. 

 

You mean April 29th? Agreed. This needs to be nipped in the butt. However, im still of the opinion that i have no opinion. Perhaps i should be more skeptical.

 

Fair enough, it may not have metastasized although all the language about deficient internal controls appears to be Valeant saying we're not entirely sure if it's metastasized.

 

I meant that I think, and people have disagreed about this with far more knowledge than I here (http://cafepharma.com/boards/threads/glossary-of-hostile-takeover-terms-with-discussion.559657/page-44)  that PWC, as a large auditing firm, must have been ready with its audit on March 15th and that it is Valeant who is choosing to sit on the audit rather than release it and is using the "work of the ad hoc committee" as an excuse for the delay.

 

The alternative is that PWC hasn't been able to complete their audit because they're waiting for the ad hoc committee. I don't understand why PWC's financial audit is dependent on the Ad Hoc committee work, especially because the Ad Hoc mandate appears to have been limited to Philidor and the primary Philidor audit issue appears to be clear at this point (the 58 million in revenue).

[jay21]

Ohhh I read the 8k and clearly get that there could be a larger cancer that has metastasized...i just dont see it as having metastasized yet.

 

 

 

I think PwC must be prepared with its audit by March 15th. 

 

You mean April 29th? Agreed. This needs to be nipped in the butt. However, im still of the opinion that i have no opinion. Perhaps i should be more skeptical.

 

Fair enough, it may not have metastasized although all the language about deficient internal controls appears to be Valeant saying we're not entirely sure if it's metastasized.

 

I meant that I think, and people have disagreed about this with far more knowledge than I here (http://cafepharma.com/boards/threads/glossary-of-hostile-takeover-terms-with-discussion.559657/page-44)  that PWC, as a large auditing firm, must have been ready with its audit on March 15th and that it is Valeant who is choosing to sit on the audit rather than release it and is using the "work of the ad hoc committee" as an excuse for the delay.

 

The alternative is that PWC hasn't been able to complete their audit because they're waiting for the ad hoc committee. I don't understand why PWC's financial audit is dependent on the Ad Hoc committee work, especially because the Ad Hoc mandate appears to have been limited to Philidor and the primary Philidor audit issue appears to be clear at this point (the 58 million in revenue).

 

This doesnt make any sense:

 

1) Why would VRX "sit on" their 10-K and risk tripping their covenants?

2) An audit depends on mgmt sign off

3) PwC has to comment on internal controls so they kinda need the committee to conclude

4) If things are coming to light that would affect PwC's opinion on the fairness of the accounts, then they will delay and not sign off

 

Neither party is just "sitting on it". There's actual work that they need to finish.

 

[VersaillesinNY]

Another head is falling: Goldfarb to Retire From Sequoia Fund After Valeant Losses

 

Edit: I guess the Valeant tesis is not working for now; Sequoia is bleeding redemptions and facing angry shareholders.

The board met and executed a bright mind in order to save the rest of the ship. I would expect Greg Alexander to play a growing role in the fund.

 

“There is only one cure for grey hair. It was invented by a Frenchman. It is called the guillotine.”

― P.G. Wodehouse

 

----------------------

Dear Shareholder,

After an extraordinary 45-year career in investing, Bob Goldfarb, our Chief Executive Officer

and Sequoia Fund co-manager, is retiring. David Poppe, who has served as the co-manager of

Sequoia for the past 10 years alongside Bob, will replace him as Ruane, Cunniff & Goldfarb’s

CEO and will now serve as the lead manager of Sequoia, as part of an investment process that

will showcase the talents of one of the best research teams in our industry. The board of Sequoia

Fund fully supports these changes.

 

A uniquely brilliant student of business, Bob played an important and valued role in producing

the outstanding long-term investing record of which we now become the stewards. Over 45

years through the end of 2015, Sequoia Fund has returned 14.0% per annum versus 10.8% for

the S&P 500 index, with $10,000 invested at Sequoia’s inception worth $3.9 million, versus $1.0

million for the same amount invested in the index. Over the last twenty years, we have returned

10.2% per annum, versus 8.2% per annum for the index. Perhaps most meaningfully, over the

36 rolling ten-year periods since inception, Sequoia has only underperformed the index twice—

for the decade ended 1994 and the decade ended 1999.

 

We owe these achievements to immense talents like Bill Ruane, Rick Cunniff and Bob Goldfarb,

but we believe that we owe our success first and foremost to a simple but powerful strategy: The

careful selection of a focused portfolio comprised of intensively researched investments,

purchased with a margin of safety. While we have beaten the market over the past decade,

through the end of 2015, our investment in Valeant has diminished a record that we have built

over two generations and in which we take great pride. We are a loyal, dedicated and intensely

driven group, and to the extent that we have lost any of our investors’ confidence, we are

determined to win it back.

 

While our commitment to a value-oriented strategy grounded in extensive primary research

remains as strong as ever, the Valeant experience has spurred a period of reflection. Going

forward, we have resolved to take a more collaborative approach to constructing the portfolio

that will feature a more significant role for our senior analysts, including Greg Alexander,

Jonathan Brandt, Arman Gokgol-Kline, John Harris, Trevor Magyar, Terence Paré, David

Poppe, Chase Sheridan and Greg Steinmetz. Our team boasts a combined tenure at Ruane

Cunniff of more than 125 years, and several members have successfully managed significant

sums of client capital for more than a combined 50 years.

 

As we have noted many times over our history, it is inevitable that from time to time, our

concentrated approach to portfolio construction will cause us to diverge from the market

averages. In 1999, Sequoia underperformed the S&P index by 37 percentage points. Over 1972

and 1973, we underperformed by 23 percentage points. Though past performance is obviously

no guarantee of future results, and though different factors admittedly drove each of these rough

patches, we have every expectation that we will recover from this one by staying focused on our

core principles of outstanding investment research, thoughtful security selection and stringent

price discipline.

 

We are grateful for your patience during a disappointing period. We are profoundly fortunate to

have attracted over the years a client and shareholder base possessed of a uniquely long-term

perspective that aligns with our own. We realize we have a special relationship with our

investors that is unusual in the investment industry. We have earned it by delivering strong

investment results over a long period, and we are confident that we will continue to prove

ourselves worthy of it in the future.

 

We think often about our founders Bill Ruane and Rick Cunniff—their values, their

achievements and their legacy. The challenge of living up to the example they set for us is a

constant one that we embrace, and as we take it up under the next generation of our firm’s

leadership, we find ourselves energized.

If you have any questions, please call our Director of Client Services Jonathan D. Gross at 212-

832-5280.

 

Sincerely,

 

David M. Poppe and the Ruane, Cunniff & Goldfarb Team

Sequoia_clientletter.pdf

[doughishere]

Another head is falling: Goldfarb to Retire From Sequoia Fund After Valeant Losses

 

March 23, 2016

 

Dear Shareholder,

After an extraordinary 45-year career in investing, Bob Goldfarb, our Chief Executive Officer

and Sequoia Fund co-manager, is retiring. David Poppe, who has served as the co-manager of

Sequoia for the past 10 years alongside Bob, will replace him as Ruane, Cunniff & Goldfarb’s

CEO and will now serve as the lead manager of Sequoia, as part of an investment process that

will showcase the talents of one of the best research teams in our industry. The board of Sequoia

Fund fully supports these changes.

 

Ya man that shit was plastered all over the front page of the WSJ this morning.

[arbcon]

Know him well and have since the 1980's. Still a great investor in my mind. One miss in 45 years..ok by me.

[dorsiacapital]

Ohhh I read the 8k and clearly get that there could be a larger cancer that has metastasized...i just dont see it as having metastasized yet.

 

 

 

I think PwC must be prepared with its audit by March 15th. 

 

You mean April 29th? Agreed. This needs to be nipped in the butt. However, im still of the opinion that i have no opinion. Perhaps i should be more skeptical.

 

Fair enough, it may not have metastasized although all the language about deficient internal controls appears to be Valeant saying we're not entirely sure if it's metastasized.

 

I meant that I think, and people have disagreed about this with far more knowledge than I here (http://cafepharma.com/boards/threads/glossary-of-hostile-takeover-terms-with-discussion.559657/page-44)  that PWC, as a large auditing firm, must have been ready with its audit on March 15th and that it is Valeant who is choosing to sit on the audit rather than release it and is using the "work of the ad hoc committee" as an excuse for the delay.

 

The alternative is that PWC hasn't been able to complete their audit because they're waiting for the ad hoc committee. I don't understand why PWC's financial audit is dependent on the Ad Hoc committee work, especially because the Ad Hoc mandate appears to have been limited to Philidor and the primary Philidor audit issue appears to be clear at this point (the 58 million in revenue).

 

This doesnt make any sense:

 

1) Why would VRX "sit on" their 10-K and risk tripping their covenants?

2) An audit depends on mgmt sign off

3) PwC has to comment on internal controls so they kinda need the committee to conclude

4) If things are coming to light that would affect PwC's opinion on the fairness of the accounts, then they will delay and not sign off

 

Neither party is just "sitting on it". There's actual work that they need to finish.

 

I was responding to doughishere and Rasputin saying that they tend to believe that there are not any other accounting problems besides Philidor.  I think it is very difficult although certainly not impossible to square that position with Valeant’s failure to release a 10k.

 

1) Why would VRX “sit on their 10-K and risk tripping their covenants.

 

Yes, why would they. The optimistic interpretation is that VRX just wants to be very, very sure that this Philidor issue is the only problem.  The pessimistic interpretation is that there are monsters in the 10k that they don’t want to let out.  So far, the pessimistic interpretation for VRX has been right every time, and usually it’s been too optimistic.  Remember when Schiller coming back to be the interim CEO showed there were no accounting problems? Although they didn’t flag it, VRX admitted there could be other accounting problems in the most recent 8k. And they also included this language about leadership’s aggressiveness causing problems. Do you think that aggressiveness was just cabined to Philidor. Could it have spread to other areas? (i.e. treatment of tax assets, channel stuffing in Europe, sales of Wellbutrin XL through Direct Success, charitable foundations/Medicare).  Or, conversely, could PWC be worried about the Arthur Andersson example and not be yielding an inch on various things, including  issues such as going concern language.  Especially since they may be a bit frosty about not catching Philidor last audit.  (I understand going concern is a stretch, my personal guess is that either PWC is demanding massive writedowns in goodwill and intangible assets and that this may trip covenants or there are further adjustments, besides Philidor, like European revenue, that would trip covenants.)

 

2) An audit depends on mgmt. sign off

Yes it does.  I think that just begs the question. Why hasn’t mgmt. signed off?

 

3) PWC has to comment on internal controls so they kinda need the committee to conclude.

Well Valeant just put out an 8k saying there was a failure of internal controls. And up until this month, the audit and the ad hoc committee were not linked. Can’t PWC make that independent assessment?  In general, auditors determine whether or not internal controls are sufficient without needing ad hoc committees to do the job for them.

 

4) If things are coming to light that would affect PwC's opinion on the fairness of the accounts, then they will delay and not sign off

 

Yes, exactly. Although why are things just coming to light now. Both PWC and the audit committee have been working for months and months.  If it’s so difficult to resolve, then that would imply the accounting issues are not just limited to Philidor/58 million of revenue There’s some interesting comments on this Cafepharma thread, such as

 

“Yes, Mike and Howie openly asked for more sales, often beyond possibility for that quarter. They knew it, we all knew it. There were no secrets; it required a push. So, they pushed loading or fake sales or whatever one chooses to call it. They said whatever it takes and said so openly to every division, every country / region. They asked to your face or on the phone. We were amazed about how open it all was; it seemed oddly unprofessional. Because it will now be shown to be criminal. Security fraud. They will be charged; that is inevitable.

 

And

 

“On the Finance organization side, until Howie showed up and did part of the dirty work for him, Mike systematically played musical chairs with Finance, moving people around, keeping very few people from having the big picture. He placed his own loyalists in key finance positions across the company. In fact, he did not even include CFOs before Howie in any of the big or small M&A deals he did, etc. It was all, always, Mike. For the Board to blame Howie now for improper conduct (which is great, appropriate and about time) and not to finger Mike beggars belief. The other shoe there must drop.

 

In the end, this all is coming out and will seem painfully obvious before long, if not already..... it was Mike, it was Howie, it was all the senior guys, it was all the Finance guys, it was Chai-Onn, it was the Board, it was the guys in Phoenix, in Europe and in LatAm and in Asia, they were all doing it. The Board knew all this or were so stupid not to see it that they should be fired. They will all have to go. Better sooner than later. The new CEO should hold no illusions; he needs to get rid of the bastards at the top and down into mid-level senior management; they've all been corrupted and have sins on their hands and are only used to pushing the business by cheating.” (http://cafepharma.com/boards/threads/reorganization-of-finance-accounting.593177/) - and yes, I know, it's Cafe Pharma, but it's been surprisingly accurate so far.

 

“Neither party is just "sitting on it". There's actual work that they need to finish.”

 

This again goes back to how dependent PWC is on the ad hoc committee. Maybe you’re right and PWC was unable to timely finish their audit because/while they’re waiting for Valeant to conclude, after a six month investigation (like half the time that Philidor was in operation) that the problems, including a failure of controls, was just limited to Philidor. That is an optimistic interpretation. But at this point, assuming the worst is far ahead of trusting management as a predictive heuristic.   

 

I could be totally wrong. It could just be a double revenue issue with Philidor. And on the cafepharma thread I linked in the prior post, there’s a very detailed and well-reasoned argument that the ad hoc and PWC issues are very closely linked in the manner you described. I hope though that you would be patient and forgiving of my speculation. As you yourself know, it’s very, very easy to get Valeant wrong: 

 

jay21 on August 29, 2015, 06:45:37 AM

I've always looked at VRX skeptically and never really got interested in the company. AZ Value's posts were the first time I started doing some digging beyond reading BBG articles and tweets.

 

I have to say, I am leaning towards initiating a long. I've spent some time thinking about how they generate high teen IRRs and you can explain a lot by changing the tax structure and eliminating wasteful R&D. Deliotte published reports showing R&D returns are around 5%. That's huge destruction of value. Those two points alone can count for a substantial part of their acquisition outperformance.

 

Next step is getting more familiar with the actual products and organic growth

 

 

jay21 on August 16, 2015, 10:21:15 AM

 

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

 

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

 

 

jay21 on October 22, 2015, 07:48:32 AM

I bought a little more at $150 and will take another bute sub $80. After which the position still won't exceed more than 3% of capital from a cost basis.

 

Always looked at this as an option.

 

TBH - I don't really understand this whole Philidor thing. So there's some obscure relationship in a huge international company that MAY impact a small segment of US sales? I guess it's the implication that they may be channel stuffing or booking inappropriate revenue in this one instance and then extrapolating to the entire company. But the first one is a leap of faith in and of itself.

 

 

Post by: jay21 on October 24, 2015, 10:03:23 AM

People keep bringing up the Munger quote but I remember reading that someone actually asked him to expand on it after the meeting. The person reported that Munger said he doesn't know much about VRX or Pearson and that a few people that he respects reached out to him after and said complimentary things about Pearson.

 

 

Post by: jay21 on October 26, 2015, 05:49:52 AM

I have been following this from about 10,000ft. Can I try to distill the facts:

 

1) Philidor is an un-owned distributor of VRX products

2) Philidor is not licensed in California and uses R&O to sell into California

3) R&O refused to pay VRX and VRX sues

 

I can see how 2 might be an issue if they are circumventing the law somehow (I would assume liability would rest solely with Philidor though). The rest seems pretty normal.

 

Anything I am missing?

 

 

[jay21]

Im not sure if posting my old comments in this thread are meant to discredit me? They seem pretty tame. I generally try to stick with facts and I dont see too much inaccurate there.

 

And Im points above were meant to help you think through the delayed 10-k. On some of your pts, you know that when scoping an audit you place reliance on the clients internal controls, which in part determines your sample size and materiality thresholds? If you have information that contradicts your initial reliance, you have to rescope the work, increase the sample size, and audit more.

 

Also, this company probably got put on their "at risk" client list, which means more auditing.

[PhatKing]

http://www.valuewalk.com/wp-content/uploads/2016/03/Sequoia_clientletter.pdf

 

A sad but real casualty of the Valeant saga.... Though some level of arrogance and hubris is a coda to this story. I have attended the sequoia fund meetings for a couple of decades, and Mr. Goldfarb was a eloquent articulator of his craft. It is a ironic that the fund has had so much turmoil within 5 years of the passing of the last of the founders. Hopefully these (much needed) Portfolio manager changes will allow the fund to regain a modicum of its past glory. But it is likely to be an uphill struggle.

[arcube]

http://ww2.kqed.org/stateofhealth/2016/03/22/pharmaceutical-companies-hiked-price-on-aid-in-dying-drug/

[Guest Grey512]

http://www.ft.com/cms/s/0/0fa7d92a-f149-11e5-9f20-c3a047354386.html

 

See last sentence of the article. Sequoia indirectly blaming the Valeant fiasco on junior team members of Sequoia. Such BS...

 

I remember vividly Sequoia Q&A calls with LPs where it was the senior Sequoia people who jumped in to defend their Valeant pick. The junior Sequoia analyst guy was far more self-effacing.

 

Sequoia's credibility is shot and done.