Valeant Pharmaceuticals International Inc. (VRX, Financial) has been a hot topic recently with high-profile investors and short sellers both involved in one of the most interesting dramas ever. Valeant's shareholder base includes some of the most admired investors including Bill Ackman (Trades, Portfolio), Jeff Ubben (Trades, Portfolio), the Sequoia Fund, Lou Simpson (Trades, Portfolio) and Wallace Weitz. It is really fascinating to watch on the sideline as the events unfold.
This is not intended to add any personal thoughts on whether or not Valeant’s business is legitimate or not as I don’t know enough about the business to have useful insights. But over the past year, I’ve been exposed to Valeant in a few incidents, which I think may be worthwhile to share with the readers.
I had never heard of Valeant until last year when the news that Bill Ackman (Trades, Portfolio) and Valeant were teaming up to bid for Allergan (AGN, Financial) in a hostile takeover. Then on CNBC Ackman briefly walked through Valeant’s business model, which is simple – raise debt to buy other pharmaceutical companies and once they acquire the companies, they cut the R&D, lay off workers and raise the price of the drugs. They use the cash generated to pay off debt and make more acquisitions. Initially it reminded me a bit of Bill Stiriiz from Post Holdings (POST, Financial) so it was interesting. But I thought it sounded too good to be true. Since then I have followed the news but never got deeply involved.
Later I was on a trip to visit some companies in the Northeast region. Of the companies I met, there were a few healthcare companies whose name I shall not disclose here. During the meeting with these healthcare companies, I always ask the question, “So what do you think of Valeant’s business model?” Interestingly enough, the answers were uniformly negative. Everyone thought that what Valeant had achieved was great but how they did it fell under the grey area and was not likely to be sustainable in the long run. This was fascinating.
Then earlier this year I had the pleasure to attend the Daily Journal (DJCO, Financial) shareholder meeting. I was appalled at Charlie Munger (Trades, Portfolio)’s comments on Valeant. Munger likened Valeant’s business to “the worst abuses in for-profit education. Valeant is like ITT (ITT) and Harold Geneen come back to life, only the guy is worse this time." These are very strong words, which I didn’t expect.
A few weeks after the Daily Journal meeting, I met one of Valeant’s largest shareholders who has a fabulous track record and who knows CEO Micheal Pearson quite well. I asked him his opinion on Valeant, and his answer was very interesting. He said although Valeant has been a great stock for him, he has never been 100% comfortable with the management style. He mentioned that the management team set very high expectations and would fire the managers who don’t make the numbers. These comments immediately raised a red flag in my mind because if this were true, there are enormous incentives for the managers to fake the numbers in order to meet the goals.
The recent letter from the Sequoia Fund made me feel worse about the management team. In the letter, Sequoia Fund wrote, “Our belief has always been that Pearson is honest and extremely driven. He does everything legally permissible to maximize Valeant’s earnings.” This sentence made me shudder. I’ve always agreed to Buffett’s Newspaper Test. There are a lot of things that are legally permissible but immoral.
Due to the aforementioned incidents, I’ve always had an uncomfortable gut feeling about Valeant’s business model. I was not even a little bit tempted when the stock dropped more than 50% due to a barrage of attacks. It’s much better to watch on the sideline and see what happens.
I’d like to end this with two quotes because I think they sum up the lessons very well
“One lesson of recent events is that sometimes doing everything legally permissible to maximize earnings does not create shareholder value. All enduring businesses must strive to earn and maintain a good reputation.”
- Sequoia Fund’s letter regarding Valeant
“Ability may get you to the top, but it takes character to keep you there.”
- John Wooden
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