1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Grahamites
Grahamites
Articles (403) 

My Indirect Experiences With Valeant Pharmaceuticals

A few personal incidents shed some light on Valeant Pharmaceutical

November 04, 2015 | About:

Valeant Pharmaceuticals International Inc. (VRX) 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) 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 (NYSE:POST) 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 (NASDAQ:DJCO) 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

About the author:

Grahamites
A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 4.6/5 (19 votes)

Voters:

Comments

snowballbuilder
Snowballbuilder - 5 years ago    Report SPAM

@grahamites Why you havent write an article on valeant a month ago ?

One month ago an article like this would have be interesting ,against crowd and helpfull....

Now to me seem a bit more a way to look wise that to be wise.

Just some thoughs best snow

Thomas Macpherson
Thomas Macpherson premium member - 5 years ago

Hi Grahamites. I wrote about Valeant several years ago in our annual report when a shareholder asked us why we weren't invested in the company. As the other side of our shop was in healthcare consulting, we gave a long and detailed discussion as to why we wouldn't be investing. There are several broad issues you had to accept if you wanted to be a partner with Mr. Pearson. First, we live with a health care system that is half for-profit and half not-for-profit. Valeant has chosen to accentuate the possibilities of the for-profit segment through M&A, price increases, and aggressive management and accounting methods. Second, as a cancer patient and user of specialty pharmacies, I found the structure and use of these entitities far outside the pharmaceutical industry norms. Third, it was our belief that a company that was based on M&A, extraordinary debt levels, and little R&D really doesn't add much value to the healthcare delivery system. For these reasons alone - and we really didn't address the financials - Nintai did not and will not partner with Valeant's management. Others disagree and that's what makes the markets work. For every bid there is an ask. How it will all play out is beyond my pay grade, but it will be most interesting to watch. Thanks for your article. Best - Tom

Grahamites
Grahamites premium member - 5 years ago

Snow - Thanks for your comments. I don't know how you get the idea but I certainly didnt' write the article to look wise. I'm not even sure whether staying away or investing in Valeant is a wise decision or not, it's hard to tell for someone who has limited knowledge about the business. Sometimes you get good results for bad reasons and sometimes you get bad results for good reasons and I'd be careful judging whether a decision is wise of not by looking at the stock prices.

I decided to share my experiences because the recent events are very fascinating and I'd like to make a few points. 1) A business's reputation matters and it's better to work with companies and management team who don't push the boundaries. 2) By doing some scuttlebutt work you can get some insight that you otherwise can't get from reading annual reports only and .3) There's a lot you don't know about Valeant, especially for retail investors so this article also serves as a reminder of staying within your circle of competency. I hope this helps clarifying the intention.

Grahamites
Grahamites premium member - 5 years ago

Tom - Great insights and great comments. Remind me of Ted Weschler's comments on how he looks at a health care company and Valeant fails two out of the three filters right away. I think what you wrote is very nice addition to Mr.Weschler's comments and thanks again for sharing.

Praveen Chawla
Praveen Chawla premium member - 5 years ago

Valeant's model may be looked at as buying R&D with debt. It remains to be seen in the ROI from these purchases is greater than the price of the debt. It is a risky strategy (but not an unethical one) - perhaps the risk was underestimated by some of the guru's who bought it.

batbeer2
Batbeer2 premium member - 5 years ago

@Thomas

I couldn't agree more.

IMHO those were and are the best reasons not to invest in Valeant.

Jean-Francois Nobert
Jean-Francois Nobert premium member - 5 years ago

Grahamites, once again outstanding, right to the point.

Mr.Macpherson, great comments and wish you the best with your health, Sincerely. J-F

snowballbuilder
Snowballbuilder - 5 years ago    Report SPAM

Second, as a cancer patient and user of specialty pharmacies, I found the structure and use of these entitities far outside the pharmaceutical industry norms.

Tom really hope and wish the best for your health. With friendship and respect . Snow

batbeer2
Batbeer2 premium member - 5 years ago

>> Valeant's model may be looked at as buying R&D with debt.

Perhaps it's more accurate to say they've been buying FDA approval with debt. There is a difference.

In the US it takes years to get a fairly simple dermatological ointment approved by the FDA or a chemical like 5-(4-chlorophenyl)-6-ethyl-2,4-pyrimidinediamine (aka Daraprim).

Daraprim is a fairly simple organic compound. It probably costs less than $2500 per kilogram to produce that. You wouldn't be breaking any patents or using proprietary know-how. In the US, you pay hundreds of dollars per gram for this stuff.

Why?

Because the FDA granted Turing a monopoly for a generic but crucial medication.

Ten years ago, the FDA decided to focus on bringing older drugs into their most recent approval scheme. In exchange for doing the legwork of re-applying an old drug for FDA approval, a company receives exclusivity. Among other things, it means thousands of otherwise redundant FDA bureaucrats get paid to re-approve generic drugs.

Sadly, it also means the US is the only place on earth where you pay thousands of dollars for generic and relatively simple drugs.

In short, there are many regulatory barriers to entry for selling drugs in the US and Valeant has exploited some of these to maximise its profits without doing valuable R&D. The question is, is this sustainable?

I don't know but FWIW I hope not.

Just some thoughts.

http://www.managedcaremag.com/archives/1105/1105.olddrugs.html

Praveen Chawla
Praveen Chawla premium member - 5 years ago

Agree, A lot of Pharma "R&D" is "me too" molecules, marketing , gaming the antiquated patent system etc. "Real" Pharma companies like Merck, Pfizer spend far more on sales and marketing than R&D. Though sometimes breaktrhough drugs appear like Solvadi.

Valeant and its cohort (which includes Actavis now Allergan) are turning this model on its head -- buy regulatory approval (or crystallized R&D) instead of doing R&D and price gouge directly instead of expensive marketing.

Thomas Macpherson
Thomas Macpherson premium member - 5 years ago

I think it's important to understand there is a great distinction between what I might call "traditional BioPharma" and "Private Equity BioPharma". In the final analysis, someone has to conduct R&D to discover, test, and finally commercialize products. Many traditiuonal pharma such as Merck, Pfizer, et al. fall under this category. Even though they have outsourced a considerable amount of R&D efforts through strategic CRO relationships, the risk is still born on the pharmaceutical's financials. As we all know, this is a risky business with far more failure than success. But it is a NECCESARY function of the biopharma world. The costs (and rewards) of this system are both a gift and a bane to our for-profit/not-for-profit system. Traditional biopharma accepts FDA regulatory, CMS proce constraints, and MCO formularies simply because the margins are still great even with these oversights. As usual, Wall Street decided to push this model much further by utilizing a relatively unheard (and unused) regulatory tools such as the Orphan Drug Act along with others to purchase rights to mostly generic drugs, rebrand them after a 10 person study, get a new IP patent, and increase prices dramatically. A classic example of this was the drug colchicine used to treat gout as well as my disease FMF. Having long been generic, URL Pharmaceuticals purchased the rights to the drug (currently selling for roughly $.09/pill), conducted a 12 person study for roughly $12M, rebranded it as Colcrys, and began selling the drug for roughly $5/pill. Same drug, same compound, same lever of action. This type of "Privare Equity (PE) biopharma" is based on profit margins and profit margins alone. It provides no particular value to managed care, medical teams, or most importantly patients. It is free market medical care at is most pure and unrefined. Over time, I think we will find Valeant was more on the Private Equity part of the biopharma spectrum. How this ends up will be part of a greater discussion of what type of healthcare system we want to have in the United States. It is important to understand that Valeant is more a symptom of the problem rather than the problem itself. Sorry for the length of this reply but this is a relatively important issue for myself and many with orphan diseases. Best. - Tom

batbeer2
Batbeer2 premium member - 5 years ago

>> It is important to understand that Valeant is more a symptom of the problem rather than the problem itself.

Yes. Bear in mind that Valeant is based in Canada.

From Valeants' point of view, the company is selling medication in the US at prices much higher than what they could sell that same drug for in their Canadian home market. Meanwhile, US rules and regulations prevent patients from travelling to Canada to have their prescriptions filled.

Praveen Chawla
Praveen Chawla premium member - 5 years ago

Tom, Thanks for post and sharing your experience with colchicine. The generic tablet sells for about Cdn 0.26 in Canada. So if you ever cross the border you should pick up a few bottles.

I know at one hand there is a desire to conduct research for orphan disease and creating incentives for industry and the question of how private equity can take advantage of this privilige. I think the only answer in some kind of price control to prevent outrageous conduct, as we cannot rely on a capitalistic system to practice self-restraint when there are millions to be made and in most cases its insurance that pays ( a victimless crime?).

batbeer2
Batbeer2 premium member - 5 years ago

>> I think the only answer in some kind of price control to prevent outrageous conduct...

Or with the Transatlantic Trade & Investment Partnership (TTIP) it becomes possible for EU pharmacies to fill US prescriptions for generic (off patent) medication and vice versa.

Not saying this is likely. Just pointing out there are other changes to consider that might affect Valeants' business model.

OPM Insights
OPM Insights premium member - 5 years ago

Thanks for the discussion. I learned a lot from the article and the comment thread.

Thomas Macpherson
Thomas Macpherson premium member - 5 years ago

Hi Everyone. Thank you for your very kind comments. I am a cancer survivor (and current patient) because of the outstanding research conducted by the scientists at BMS. I wouldn't be alive without them. At the same tme, my insurance company has done everything in its power to not pay for my chemo which has led me to spend $1.8M of my own cash to stay alive. I am one of those individuals who sees both the benefits - and costs- of a for-profit system. But I am fortunate that my health remains good and I look forward to a long and productive life. Thanks again for everyone's comments. Now back to the discission on Valeant. Best - Tom

AlbertaSunwapta
AlbertaSunwapta - 5 years ago    Report SPAM

So if they kill off the R&D, are they just accumulating brands, products and market share via leveraged buyouts? That's pretty common in any industry. Very disheartening in terms of science and the future of healthcare.

So where are they going astray of the law?

batbeer2
Batbeer2 premium member - 5 years ago

>> So where are they going astray of the law?

Don't know that but specifically for Valeant there are some allegations that their captive pharmacies have been supplying medication in states where they are not licensed.

http://brontecapital.blogspot.nl/2015/10/simple-proof-that-philidor-has-shipped.html

If true, that could be a very expensive mistake.

What's more, the company could be killed off even if they are never taken to criminal court. The insurers (including Medicare/aid) can burry the company under red tape by auditing every single prescription and deferring payment untill everything is perfectly accounted for.

In effect, the insurers could force a management change (and wipe out shareholders in the proces). I learnt this expensive lesson in the for-profit education space. Corinthian Colleges was not shut down for breaking the law. The ED shut them down by delaying payment for various reasons.... till the company ran out of cash. Same thing could happen here.

In this space excess profits can be made because the guy who needs the medication is not the one paying the bills. That would be a third guy (the insurer). It works untill the guy paying the bills decides it is time for a management change.

Thomas Macpherson
Thomas Macpherson premium member - 5 years ago

Hi Alberta. It's a great question. I'm not sure I've seen anything illegal. I look at Valeant more as a "no.....it's different this time" LBO shop. I think it was Batbeer who said "this goes on until it stops" which is quite astute. I don't think the market will bear LBO tactics when it comes to the buying and raising of essential health care product prices. Eventually payers will put their foot down with formularies, hospitals with order sets, and patients with closed wallets. This company requires constant growth and constant increasing cash flow simply to manage its debt. But as you pointed out, there is nothing illegal about this. In my mind it's just grossly dangerous to have 1/3rd of your portfolio invested in it. Thanks again for a very astute comment. Best. - Tom

AlbertaSunwapta
AlbertaSunwapta - 5 years ago    Report SPAM

Well, I've picked up a few shares - very few shares - basically a pure ,uneducated gamble as I don't have the time to study the situation but in some quick, light light reading about it - I don't fully understand all the negative views expressed in the current pricing. So maybe there's some opportunity here.

From what I've read, from among the stock's defenders, is that their price increases weren't dramatic. Still, that could really work against them.

Eliminating the R&D could lead to big savings. However, if pharma is like mining, when a company has a hit, you'll usually find that they burn through a lot of the profits trying to find the next big hit. Investors are lucky if they end up with anything close to a profitable business. It seems that VRX is just putting everything into runoff.

On the immorality of it - I'll think about it and maybe dump it if I agree. When Buffett bought Sees Candy, didn't he immediately raise the prices? Doens't everyone, with their salaries, with government and taxes, with insurance and premiums, with health care and wages and services, basically charge "what the market will bear"?

AlbertaSunwapta
AlbertaSunwapta - 5 years ago    Report SPAM

Something I just came across....

Wednesday, November 11, 2015

Checkmate or Stalemate? Valeant's Fall from Investing Grace

"The value that I estimate for Valeant's equity, on a per share basis, is $72.10, which is about 14% lower than the price of $83.64 at the close of trading on November 10. Your views on Valeant may be very different from mine, and you are welcome to use my spreadsheet to reflect those views. "

http://aswathdamodaran.blogspot.ca/2015/11/checkmate-or-stalemate-valeants-fall.html

AlbertaSunwapta
AlbertaSunwapta - 5 years ago    Report SPAM

So, as for what's taking place now (share price increase, new or continuation in deals), is it a dead cat bounce or has something fundamentally changed with this company?

snowballbuilder
Snowballbuilder - 5 years ago    Report SPAM

"Well, I've picked up a few shares - very few shares - basically a pure ,uneducated gamble as I don't have the time to study the situation but in some quick, light light reading about it - I don't fully understand all the negative views expressed in the current pricing. So maybe there's some opportunity here."

@alberta , i ve Made the same... A trade on fear and overreaction.

Buyed at 84 and sold at 108 $\share

Best for your trade . Snow.

Please leave your comment:



Performances of the stocks mentioned by Grahamites


User Generated Screeners


pjmason14Momentum
pascal.van.garsseHigh FCF-M2
kosalmmuse6
kosalmmuseBest one1
DBrizanall 2019Feb26
kosalmmuseBest one
DBrizanall 2019Feb25
kosalmmuseNice
kosalmmusehan
MsDale*52-Week Low
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)