Question:
Howard Schiller has resigned as the chief financial officer at Valeant Pharmaceuticals (NYSE:VRX) after four years. The Financial Times joked that he may be exhausted from ‘‘all this fiddling.’’ With Valeant’s lofty stock price likely bringing its percentage of our fund’s assets to upwards of 20% and with the company’s accelerated growth likely to be impacted by the specter of rising interest rates, have you been reevaluating our position?
Rory Priday:
He has done quite a bit of fiddling. The market cap since Howard Schiller joined Valeant went from less than $15 billion to over $70 billion today. But I think some people get burned out at the company just because of the number of deals that they do and the number of products that they manage. Some people refer to their time at Valeant as a tour of duty. It was a little concerning for us that he left, but he is going to be on the board hopefully for a long time. He told us that he would be there as long as investors wanted to have him. So I do not think he is going anywhere.1
David Poppe:
The fact that Howard is staying on the board is a pretty strong sign that there are no disagreements or unhappiness. Not so long ago, he was telling us that Valeant closed a deal at eight o’clock at night on New Year’s Eve. It is a very intense pace. Sometimes you make a lot of money and that pace is too much. I think it is more about that than it is about anything else.2
...
Question:
If I could ask about Valeant as well.... Being students of the family of Berkshire, can you discuss your views and perhaps comment on what Mr. Munger insinuated about Valeant recently?
Bob Goldfarb:
After reading about Mr. Munger’s comments, Rory looked for all the books on Harold Geneen that he could find. I think he is the man to answer your question. Rory?
Rory Priday:
We were not at the Daily Journal meeting, where Mr. Munger made the remark comparing Valeant and ITT. So we do not know exactly what he said. But it was something to the effect that Valeant was like ITT, except that Mike Pearson was worse than Harold Geneen, who became CEO of ITT in 1959. ITT was one of a number of serial acquirers that were active particularly in 1960s. Geneen bought a raft of companies — some of the names you will recognize today like Sheraton and Avis. Bob can provide more context than I can because he is pretty familiar with the company as well. But Geneen bought a lot of disparate businesses in different industries. I recall from the books I read that ITT’s sales went from $700 million to $17 billion over eighteen years and the earnings went from $29 million to $550 million. But ITT also issued a lot of equity and was prone to issue equity in order to buy these companies. By the time Geneen stepped down from the CEO’s spot, ITT’s share count had increased tenfold.
One of the big differences is that Valeant is focused on the healthcare sector. Last year, 57% of sales came from pharmaceuticals. The company is not really going outside the healthcare space, and it is not going far outside pharmaceuticals. There are plenty of pharma companies that operate in different therapeutic areas, and the main ones for Valeant today are dermatology, ophthalmology, and gastroenterology. Another difference is that Mike does not like to issue equity. Even though the Bausch & Lomb and Salix acquisitions required him to issue some equity, the share count has not really moved that much.
If you adjust for the dividend that Valeant paid out before the Biovail merger, earnings per share have gone from 81 cents to probably close to $27 this year. Next year’s EPS will be close to $38 a share. So the earnings will have gone up over 45 times in seven years.
Bob Goldfarb:
My guess, when I saw the comments, was that Charlie might have been targeting Valeant’s accounting. If I were going to question the accounting, the principal issue I would have would be with the accounting for the restructuring charges after Valeant makes a large acquisition. The company and the analysts who follow it add back these restructuring charges to derive the company’s cash earnings. What we do is add back the restructuring charges to the purchase price; so that if Valeant buys a company for $9 billion and there are $500 million of after-tax restructuring charges, the company effectively paid $9.5 billion rather than the $9 billion that it announced initially.
If you deduct the restructuring charges associated with significant acquisitions from a given year’s earnings, I do not think that is accurate accounting even though it does conform to GAAP. When we look at a company’s reported earnings in a given year, we are always searching for a sense of what the true earning power of that company is relative to the stock price. If you deduct the large restructuring charges in a given year, you are not going to get an accurate number for the earning power. Heinz — Berkshire acquired 50% of the company — is an example. Jonny, Heinz had very low earnings last year, right, because of the restructuring charges?
Jon Brandt:
Yes, it did.
Bob Goldfarb:
That was GAAP accounting. Heinz’s earning power is clearly very substantial but it was masked in the accounting by that huge restructuring charge. So when we looked at Berkshire in the year Heinz was acquired, we just added back those restructuring charges to get a better idea of what Heinz was earning, half of which Berkshire3 was earning as well.
Question:
I guess it is no surprise that most of the questions are about Valeant. So I will add one more. A few weeks ago in the papers it was reported that Valeant raised the price on a particular drug by 400% − 500%, within a very short period of time after purchasing the rights to that drug from another company. I was troubled by reading that. I am curious to hear your reaction.
Rory Priday:
I understand why reaction to that could be negative. Obviously, Sequoia and our clients that own Valeant are benefiting from those price increases. But in general, the capitalistic approach to pricing is to charge what the market will bear. Valeant believes that when it buys a drug and it is underpriced, it should charge a price that will maximize the company’s long term cash earnings. Some people maybe feel differently about healthcare. It is obviously a more sensitive topic.
Bob Goldfarb:
Embedded in the asking price for Marathon — which is the company that sold these drugs to Valeant — embedded in the sale price was a significant increase in the price of those drugs. In fact, Rory, what had Marathon’s management been advised to do with its prices?
Rory Priday:
We were told that Marathon had hired a consulting firm that advised it to take huge price increases. So Valeant was following the advice of the consulting firm, not that Mike would shy away from taking a price increase if he saw an opportunity. We are not really sure why the company decided to sell these drugs, but I think part of the reason was that management was looking at selling another asset. So Marathon needed to get this deal done. That is the one that David mentioned earlier when Valeant was working at 8:00 p.m. on New Year’s Eve.
Bob Goldfarb:
A point that the article missed, and I am not faulting the Wall Street Journal, is that either those prices or the volumes at those elevated prices are going to be very short-lived because both of those drugs are subject to genericization and Valeant management expects that they will be genericized within a couple of years. So Valeant had to recoup its investment and more within that short window of time in order to achieve the returns that management was expecting.
From Ruane, Cunniff & Goldfarb Investor Day 2015 Transcript Part I.
