VRX - Valeant Pharmaceuticals International Inc.

[Picasso]

Here's the definition of gambling:

 

gambled gambling play \-b(ə-)liŋ\

intransitive verb

1

a :  to play a game for money or property

b :  to bet on an uncertain outcome

2

:  to stake something on a contingency :  take a chance

 

Investing your capital is gambling.  How is it not?  You stake your capital on uncertain outcomes in the hopes of achieving a positive return.  As I mentioned before, the difference between gambling in Vegas and the public markets is that you don't have to stay at the table with crappy odds.  You get to wait for good odds with a good payout in the public markets, if you're patient enough.

 

No matter what I invest in, I recognize there is a certain level of uncertainty.  Unless someone can point me to investors who invest in situations with only 100% odds, then you'll show me the first investor who never gambled.  Or maybe we should restrict the word "gambling" to anything that will lose money over time.  But that's not really the definition.  Anyway, semantics.

 

Maybe gambling is just a bad word in investing.  Everyone wants to act like they aren't gambling when they really are.  I can go buy a 10-year Treasury at 5%, but I'm taking the chance that inflation destroys the return.  I can drive through hundreds of thousands of intersections but eventually someone is going to run a red light and t-bone me.  There's always uncertainty and that always makes investing a gamble.

 

If there were a table in Vegas that laid out this simple game, would anyone want to play it? It included a roulette table where each number represented a stock that is trading for 3-4x FCF.  A 25-33% FCF yield.  One of the requirements of being on that table included a 15% spread between the debt of those companies and the equity.  In this case, VRX has debt yielding less than 9%.  So the spread here is 16-24%.  Every slot on that roulette table is also supremely hated with some kind of forced selling.  You then get to pick how much upside you want on your pick within one year.  Maybe 150-200%.  Because in the public markets it's not like you have to hold this forever.  Some of those slots are VRX others are [name your terrible busted equity here].  Is that a game worth playing?  It's probably a game you'll do well on over time.  Maybe some guys play the game in a bad way (they go 100% into a VRX or some other busted name when the odds don't favor a 100% allocation), but if you play it right it's not a bad thing to play. 

[Eye4Valu]

Well said Picasso. I think that is why they say investing is half art, half science. To say it isn't gambling is to say it's all science, which we know it is not. What is cool about investing and makes it worth the gamble is that even one or two investments that work out can move the needle in a big way. You don't need to bat 1,000. Of course, no one does.

[NBL0303]

 

Investing your capital is gambling.  How is it not?

 

 

If by gambling one means "uncertainty as to the outcome", then this is line of thought that gambling and investing are correct - then that is indeed correct but this is a mistaken conception of gambling.  If "uncertainty in the outcome" is the touchstone for the concept of gambling - then driving to work, each meal, and every other human endeavor would also be equivalent to gambling - because, after all, you never know if you'll make it to the office without being T-boned at an intersection and killed.  Thus, driving to work = gambling = investing = innovating = any human activity.

 

This, however, is not the conception of gambling that is relevant to this conversation about investing.  The concept of gambling relevant here means "betting money on a game of chance."  Roulette, slot machines, etc.  This is the interesting discussion - not is there some amount of inherent uncertainty in investing - but rather is there are difference between games of chance such as roulette and slot machines and the fundamental act of investing?

 

As previously stated, in my viewpoint, with these thoughts in mind, gambling and investing are not just dissimilar they are nearly in opposite corners.  Gambling is a negative-sum game with a negative return on investment, investing is positive-sum game with a positive return on investment.  There are, of course, examples of specific people who have a positive return from gambling and a negative return from investing - but those do not change the fundamental characteristics of these activities.

 

To consider this a bit further, if one played roulette continually their entire adult life - the certain eventual outcome is that they will lose all of their capital.  That is fundamentally different than a positive-sum game like investing.

[Picasso]

Maybe I'm in the minority but I also think all human decisions are gambling.  You're constantly taking a wager on your future with each decision you make and there is no certainty around your actions.  Also gambling doesn't mean you have to stick with crappy odds negative sum type games. 

 

People on this board like to fawn over Michael Burry and his credit swap trade.  Was that trade a gamble or a shrewd investment?  Had the crisis taken a little longer he would have been wiped out.  That was one of the uncertainties he had to take on as part of the bet.  What about if he took on that type of bet many times over his career?  Would the overall outcome look like a brilliant investor or that of a gambler?

 

Maybe we're just playing with the words here, but rb was saying that investing in something that long-term is a zero is like gambling at the roulette table.  If you step back for a minute, most things go to zero eventually.  Buffett regretted not buying FNMA/FMCC but now those are zeros.  Capitalism makes it so that most things go to zero.  Increasing your odds is about picking the right time frame (1 years, 5 years, 20 years) where you're playing against the idea of something turning into a zero.  But most things don't trade for 3-4x FCF unless everyone already thinks it will be going to zero, so by definition you aren't paying for stabilization or an improvement. 

 

Now guys that are trading intraday based on chart formations, those guys are gambling with crappy odds. 

[Peregrine]

 

Maybe we're just playing with the words here, but rb was saying that investing in something that long-term is a zero is like gambling at the roulette table.  If you step back for a minute, most things go to zero eventually.  Buffett regretted not buying FNMA/FMCC but now those are zeros.  Capitalism makes it so that most things go to zero.  Increasing your odds is about picking the right time frame (1 years, 5 years, 20 years) where you're playing against the idea of something turning into a zero.  But most things don't trade for 3-4x FCF unless everyone already thinks it will be going to zero, so by definition you aren't paying for stabilization or an improvement. 

 

Now guys that are trading intraday based on chart formations, those guys are gambling with crappy odds.

 

You make the best decision with the information that you have at that point in time. Buffett would not have bought Fannie or Freddie had he known about the company's plans to build what was in effect a massively leveraged hedge fund using the government's credit. In fact, he sold his shares shortly thereafter.

[Picasso]

How many investors would have sold Valeant had they known they were engaging in insurance fraud?  No information is ever perfect and the information is always changing.  It doesn't change that you're dealing with a varied set of outcomes with different probabilities and the one thing you can control is the price you pay for those odds.  It's always a gamble, but some gambles are just better than others. 

[alpha asset strategies]

Here's the definition of gambling:

 

gambled gambling play \-b(ə-)liŋ\

intransitive verb

1

a :  to play a game for money or property

b :  to bet on an uncertain outcome

2

:  to stake something on a contingency :  take a chance

 

 

Is it gambling if you make an investment into a stock with a positive expected value?  I guess it is - at least according to Picasso's definition (shown above). 

 

I think there is a huge distinction between investments with positive expected values and those with negative expected values.  Of course,

calculating expected values - at least with regard to stocks and securities - can be quite subjective given that the investor needs to "guess-stimate" numerous assumptions.  I guess that's what makes investing as much art as science.

[BeerBBQ]

Isn't gambling when you know for sure the odds are against you winning?  NPV = negative

 

Speculating is when you don't even know what the odds are. NPV=?

 

Investing is when the odds are in your favor.  NPV=positive

 

 

[Peregrine]

How many investors would have sold Valeant had they known they were engaging in insurance fraud?  No information is ever perfect and the information is always changing.  It doesn't change that you're dealing with a varied set of outcomes with different probabilities and the one thing you can control is the price you pay for those odds.  It's always a gamble, but some gambles are just better than others.

 

In that respect, you're absolutely right - value investing is basically finding mispriced bets.

 

With respect to Valeant, I don't think all of this completely came out of left field. Even with investor sentiment on the stock during its all-time high, a couple things were very knowable:

 

1) It was massively leveraged

2) Its aggressive acquisition strategy of drugs at pretty high premiums

3) Its aggressive increasing of prices shortly following acquisition

4) Its skimpy spending on R&D

5) Its peculiar and aggressive marketing of fairly rosey-looking accounting

[Oreo]

In addition, had one looked at certain web forums or spoke to (ex)insiders, one would have picked up on the aggressive "make your numbers" culture and questionable exec behavior (e.g. fondness for liquor at odd hours). These things were all there before Hillary, before Citron, before Philidor, and way before recent magazine "exposes" that seemed like they broke new ground but really didn't.

 

And of course, there's the cash flow statement. That's on EDGAR.

[Eye4Valu]

All fair points being reflected upon in hindsight. Some people intelligently saw the red flags before the collapse, and haven't hesitated to toot their own horn and wax poetic, while others were steady drinking the Cool-Aid. At this point in time, it's easy to criticize Valeant, its executives, culture, operating practices, etc. Many on this thread now claim the writing is on the wall and VRX will become a goose egg due to leverage, having to sell assets they overpaid for, and having to reformulate a business model that was flawed to begin with. Others believe VRX may be salvageable by selling non-core assets to pare down debt and reformulating distribution channels. They claim the pipeline is more robust than VRX is being given credit for. The ever enigmatic future will provide the answer in due time, so place your bets or get out of the casino.

[ZenaidaMacroura]

Maybe I'm in the minority but I also think all human decisions are gambling.  You're constantly taking a wager on your future with each decision you make and there is no certainty around your actions.  Also gambling doesn't mean you have to stick with crappy odds negative sum type games. 

 

 

 

Semantics, but you start to "dilute" the word when you broaden it to "all human decisions are gambling."

[vinod1]

Maybe I'm in the minority but I also think all human decisions are gambling.  You're constantly taking a wager on your future with each decision you make and there is no certainty around your actions.  Also gambling doesn't mean you have to stick with crappy odds negative sum type games. 

 

 

 

Semantics, but you start to "dilute" the word when you broaden it to "all human decisions are gambling."

 

+1

 

Choosing to get a college education is also gambling?

 

Vinod

[Jurgis]

Choosing to get a college education is also gambling?

 

Maybe you could have made $billions by going to American Idol instead?

 

;) ;)

[Guest roark33]

Maybe I'm in the minority but I also think all human decisions are gambling.  You're constantly taking a wager on your future with each decision you make and there is no certainty around your actions.  Also gambling doesn't mean you have to stick with crappy odds negative sum type games. 

 

People on this board like to fawn over Michael Burry and his credit swap trade.  Was that trade a gamble or a shrewd investment?  Had the crisis taken a little longer he would have been wiped out.  That was one of the uncertainties he had to take on as part of the bet.  What about if he took on that type of bet many times over his career?  Would the overall outcome look like a brilliant investor or that of a gambler?

 

Maybe we're just playing with the words here, but rb was saying that investing in something that long-term is a zero is like gambling at the roulette table.  If you step back for a minute, most things go to zero eventually.  Buffett regretted not buying FNMA/FMCC but now those are zeros.  Capitalism makes it so that most things go to zero.  Increasing your odds is about picking the right time frame (1 years, 5 years, 20 years) where you're playing against the idea of something turning into a zero.  But most things don't trade for 3-4x FCF unless everyone already thinks it will be going to zero, so by definition you aren't paying for stabilization or an improvement. 

 

Now guys that are trading intraday based on chart formations, those guys are gambling with crappy odds.

 

Buffett actually said he wished he had bought *more* Fannie/Freddie.  He did buy both of them, and sold them about a decade later.  I haven't found why he sold, but I believe it was in 2004/05, so presumably he say the borrow credit going down and that they were getting into riskier loans, he was just a few years early. 

[merkhet]

IIRC, he sold Freddie because they started doing stupid shit like fixed income arbitrage.

[JBTC]

Isn't gambling when you know for sure the odds are against you winning?  NPV = negative

 

Speculating is when you don't even know what the odds are. NPV=?

 

Investing is when the odds are in your favor.  NPV=positive

 

+1

 

This is my definition also.

 

[arbcon]

merkhet is right. Warren and Bill met with Raines as I recall to get him to stop using the government guarantee to invest in higher rate securities. They were basically told to get lost. They did.

[oscarazocar]

Here is a quote from Buffett on the Freddie Mac sale from the 2001 Berkshire meeting.

 

http://www.tilsonfunds.com/motley_berkshire_brkmtg01notes.php

 

Fannie Mae and Freddie Mac

 

In 2000, Berkshire Hathaway sold its large, long-term holding in Freddie Mac. When asked to explain why, Buffett said: "We felt uncomfortable with certain aspects of the business as they developed, though they may not hurt the company. We did not sell because we were worried about more governmental regulation -- the opposite if anything. We felt the risk profile had changed."

 

Munger added, "Maybe it's unique to us, but we're quite sensitive to financial risks."

 

Buffett continued, "There are many things you don't know by looking at a financial company's financial statements. We've seen enough to be wary. We can't be 100% sure that we like what's going on. With some types of companies, you can spot problems early, but you spot troubles in financial institutions late."

 

Munger: "Financial institutions make us nervous when they're trying to do well." [Think about that one for a while.]

 

At another point in the meeting, after a question about the underwriting risks in Berkshire Hathaway's portfolio, Buffett said, "the biggest risks are [assumed by] those who write lots of homeowner's policies. If you're Freddie Mac or Fannie Mae, guaranteeing mortgages for millions of people, what happens if an earthquake hits California? They're taking on enormous risk. I don't know if Freddie Mac and Fannie Mae are demanding that all homes with mortgages they guarantee have earthquake insurance."

[Graham Osborn]

Isn't gambling when you know for sure the odds are against you winning?  NPV = negative

 

Speculating is when you don't even know what the odds are. NPV=?

 

Investing is when the odds are in your favor.  NPV=positive

 

+1

 

This is my definition also.

 

Although it's a nice categorization, I don't think the common usage necessarily conforms to the system.  For example, Soros/ Rogers were often called "speculators" and yet in the majority of cases they had incredible odds.  Similarly, the term "investor" is massively overused (one of Graham's pet peeves as I recall).  Of every 20 people I interact with, I'd be surprised if one is an investor according to this definition.  So I think the system risks vernacular confusion.

 

The idea is a good one though.  Of the bookends I prefer the terms: "Strong positive" and "Strong negative" traders.  "Strong positive" traders make strong positive statements to justify a buy or sell (e.g. "I think companies X and Y will merge by Z date, so I will buy options that expire shortly after that").  The number of compound statements assures they lose most of the time.  "Strong negative" traders will identify "strong positive" traders and seek to profit from their miscalculation.

 

Incidentally, the terminology applies to companies too.  VRX was a "strong positive" company that relied on rising multiples for its portfolio, easy refinancing, acquisition accounting, tax leniency, and various other assumptions to keep the momentum.  This is why shorting the company might have been a good trade.  I also find the current bond market a fairly "strong positive" one, although I'm less confident betting against that exuberance is a good idea.  The lead-up to Brexit was also a "strong positive" since the Leave/ Remain divide was always pretty darn close to 50/50.

 

The process works in reverse during a prolonged selloff, when people reach the conclusion that every possible negative eventuality will come to pass.

[Guest roark33]

Many ways to make (and lose) money in the markets. I guess the question boils down to: when is it okay to put on a position that runs against your long-term fundamental view of the business (or even of the specific security in the capital structure)?

 

I don't think there's any one answer.  Obviously lots of folks doing it these days, and some making good money doing it (at least those are the ones we tend to hear from).  All I can tell you is that my personal experience has been this doesn't work for me.  Part of the reason is the times I have made real profits have required some level of interim adversity or at least uncertainty, and I don't think I would have had the resolve to stay in if I didn't have the strong fundamental view.  That's why Buffett likens buying a stock to getting married: if your wife is screaming at you and acting like a total * it will be awfully tempting to put up and leave, yet if she is a real keeper that is likely to be a defining moment in the relationship.  My strategy (adopted from Graham/ Buffett/ Jim Rogers) is basically a function of my tendency to experience emotion in proportion to my time spent trading.  My experience has been that winning trades require "sitting" time and some degree of pain.

 

To put this in practical terms, say you bought VRX yesterday and the stock dropped 5% today (which it did).  If I bought it for a bounce I'd be inclined to sell to manage risk.  Conversely if I bought because I thought the company was undervalued and growing I might tolerate that or even buy more.  You can see how a short term mindset forces you into an almost robotic, emotion-oriented trading strategy.  This is why Buffett described the market as an instrument that "transfers money from the impatient to the patient." Even great technical strategies require intensive preparation prior to going "live," so I believe this principle applies there as well.  Losing control is an antecedent to losing money.

 

I think the key is to understand that when you trade for a bounce that is a technical strategy, and everything you ever learned about fundamental analysis will suddenly fail you.  There are technical traders who make excellent and consistent profits but this is because they have a personal, highly specialized technical strategy.  Chances are you don't.  One thing that impressed me about the Market Wizards books was that TA and pattern trading really does work, but without free lunches - strategies that work take just as much sweat and blood to develop as a personal process for fundamental analysis.  When people who focus on fundamentals of businesses try to initiate a technical strategy (beyond some basics - like don't buy into a death slide) we'll generally fail over time simply because we don't know what the hell we are doing and we don't have a consistent process in place.  One corollary to a longer term holding strategy is it discourages us from venturing into an art we are not master of.

 

This is such a great thought and even more important when looking at this a few weeks later.  The stock is down over 20% since the date of this post, so the question for the buy the dip trading crowd is whether you are mentally/emotionally able to hold on during this period when you don't have a strong view on the fundamentals. 

[Picasso]

http://www.bloomberg.com/news/articles/2016-06-27/valeant-dips-below-20-as-brexit-exacerbates-investor-worries

 

Now it's a Brexit stock. 

 

“The most significant risk to Valeant is the currency risk,” Rodman & Renshaw analyst Ram Selvaraju said. Turmoil in exchange rates could hurt Valeant’s sales outside the U.S., decreasing total revenue. Last year, 32 percent of the company’s sales were overseas.

 

It seems so silly to say that their most significant risk is the currency risk.  I can name at least five other things worse than the currency issues. 

[Mephistopheles]

http://www.bloomberg.com/news/articles/2016-06-27/valeant-dips-below-20-as-brexit-exacerbates-investor-worries

 

Now it's a Brexit stock. 

 

“The most significant risk to Valeant is the currency risk,” Rodman & Renshaw analyst Ram Selvaraju said. Turmoil in exchange rates could hurt Valeant’s sales outside the U.S., decreasing total revenue. Last year, 32 percent of the company’s sales were overseas.

 

It seems so silly to say that their most significant risk is the currency risk.  I can name at least five other things worse than the currency issues. 

 

Lol, forget the accounting misstatements, price gouging, SEC investigation, congressional investigation and political risk, topped with a monstrous debt load. That currency risk scares the shit out of me

[Graham Osborn]

http://www.bloomberg.com/news/articles/2016-06-27/valeant-dips-below-20-as-brexit-exacerbates-investor-worries

 

Now it's a Brexit stock. 

 

“The most significant risk to Valeant is the currency risk,” Rodman & Renshaw analyst Ram Selvaraju said. Turmoil in exchange rates could hurt Valeant’s sales outside the U.S., decreasing total revenue. Last year, 32 percent of the company’s sales were overseas.

 

It seems so silly to say that their most significant risk is the currency risk.  I can name at least five other things worse than the currency issues.

 

I couldn't agree more.  The levered beta on this one and ENDP is huge.  It's easy to overthink these things.  I've been watching VRX/ ENDP/ AGN/ TEVA as a group.  The interesting thing is the market is acting like the AGN/ TEVA leverage is divided between the 2 - interesting but not unexpected.

[LongHaul]

For those interested in a company that could be similar to Valeant, see my post on the board on XPO.  Especially the last bullet point.  Uncanny similarities.