It’s been a catastrophic week for Valeant (VRX, Financial). In the past few days, the $40 billion serial acquirer has been slashed to ribbons by a leading presidential candidate, seen its stock plunge by nearly half and been likened to Enron by a leading short-selling firm.
Now, Valeant is facing a set of menacing questions concerning its corporate growth strategy. Fund managers can’t get rid of bonds quick enough, and investors seem to think the firm’s disastrous falter has proven beyond a reasonable doubt that M&A should no longer have a leading role in the pharmaceuticals industry.
In the long term, this herd mentality may prove costly for skittish investors.
Since 2008, Canadian firm Valeant has effectively redefined how Big Pharma pursues growth – guiding an industrywide transition from expansion through R&D to consolidation through M&A. However, as highlighted in last week’s report by Citron Research, several of Valeant’s acquisitions are now proving more than toxic – and nondisclosure over the ownership of one company in particular has now led to the claim that Valeant may be engaging in sham transactions to inflate sales. Valeant CEO Michael Pearson has denied that accusation wholeheartedly, but the damage has already been done.
What’s more, even if it turns out there are perfectly reasonable answers that refute these claims of shady accounting, Valeant still has an image problem to address – namely because there are brands within the Valeant stable whose growth can be almost entirely attributed to unpopular drug price hikes. For example, in the two years since Valeant purchased heart medication Isuprel, the drug’s price has increased eightfold. The public backlash surrounding these hikes will inevitably bring those street prices crumbling back down in the near future – along with the corporate growth of the multibillion-dollar firms backing them.
At least, that’s the theory – which is why shares in Valeant dropped by up to 40% on Wednesday. Yet frantic fund managers would do well to try and discern the toxicity of certain acquisitions from Valeant’s wider success as an M&A giant. The truth is, Valeant has proven the only way forward for Big Pharma is through consolidation. The only real alternative, R&D, simply cannot compete.
For years and years, research and development was the way to post revenues within the pharmaceuticals industry and land big returns for investors. But thanks to shrinking production costs, more and more of the globe’s biggest-selling products have completely lost their market exclusivity. In other cases, advances in biotechnology are eradicating the need for certain drugs almost entirely. According to experts at Tufts University, it now costs in the realm of $2.5 billion to roll an original drug out onto the market. Bearing in mind that few drugs are able to post even $1 billion in annual sales, this means the vast majority of pharmaceutical companies simply can’t afford to go meddling in R&D without risking an exodus of short-term investors. So, in order to develop the new, blockbuster drugs that consumers and investors so crave, firms have got to minimize risk by tracking down major backers. That’s where M&A comes in.
Over the past decade, firms like Valeant and Activis have swiftly proven the only cost-effective way to produce new drugs is to expand one’s pocketbook and maximize commercialization. Ever since the passing of the Hatch-Waxman and Bayh-Dole acts, the C-level at Valeant has proven particularly efficient in acquiring, licensing and protecting R&D property without sacrificing growth. In turn, new markets have been created, more drugs have been pushed out into stores and competition has flourished. The only real drawback from the industry’s transition to M&A has been a more unreliable jobs market; however, investors and consumers are relatively unaffected by the shifting sands.
At the end of the day, there’s nothing wrong with M&A. Believe it or not, there’s nothing wrong with Valeant, either – or, rather, it shouldn’t be too difficult for CEO Michael Pearson to remove the pesky thorns in his company’s side. After all, the vast majority of Valeant’s $40 billion worth of acquisitions have been nothing but gold. The firm’s two biggest buys to date, Bausch & Lomb and Salix Pharmaceuticals (SLXP, Financial), which together cost Valeant a cool $25 billion, aren’t even remotely dependent upon price hikes. Right now, Valeant is embroiled in a case of nasty political PR. That doesn’t mean the ride is over, and it doesn’t mean Valeant’s corporate strategy has been wrong.
Despite fierce political rhetoric from the likes of Hillary Clinton, no one wants Valeant to fail. Not only do countless individuals rely on the specialty drug company’s unique position in which to fund R&D for provision of new, life-saving drugs, but Valeant’s financial success also has serious knock-on effects for other industries. For example, Valeant has grown to become the globe’s fifth-highest payer of investment banker fees. So long as Valeant continues to hurt, the investment banking sector is going to hurt, too.
Fortunately, that pain will be short-lived.
Last Wednesday, this huge political controversy surrounding Valeant brought share prices down by 40%, losing hedge fund manager Bill Ackman (Trades, Portfolio) $2 billion on paper. How did he respond to a loss that would leave lesser managers ready to jump off a very tall bridge? Ackman bought 2 million additional shares for peanuts. A quick glance at Valeant’s Q3 results explains why.
It’s hardly made headline news, but Valeant has actually just posted a stellar quarter that should be the envy of every other pharmaceutical company on the planet. Revenue is up 36% year on year to $2.79 billion, beating previous forecasts. On a non-GAAP basis, Valeant posted an earnings jump of 30% per share (amounting to $2.74 per share). Organic sales growth and same-store sales are up, and drugs like Xifaxen have witnessed huge sales jumps since Q2. Despite last week’s drama, Valeant has not only readjusted its Q4 revenue guidance from a range of $3.2 billion to $3.4 billion to $3.25 billion to $3.45 billion but also bumped up its Q4 adjusted earnings guidance to $4.00 to $4.20 per share.
Once Valeant has successfully distanced itself from these toxic price hike firms and politicians have found a new axe to grind, investors will be changing their tune about the firm embarrassingly quickly.
Make no mistake: this will be another stressful week for Michael Pearson. Monday’s investor call was a little painful, and shares very well might take another tumble before stabilizing. The company undeniably has some questions to answer regarding its relationship with a couple of hugely toxic acquisitions, brands may need to be cut loose, and a few individuals will be asked to fall on their swords. But long-term investors should definitely stay the course – because when it comes to growth in Big Pharma, there’s no way but M&A, and nobody is better at M&A than Valeant.
