Valeant - It's Not a Game of Chess Part II

A case study of the rise and fall of Valeant

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Mar 20, 2017
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The date was Sept. 28, 2010. A company named Biovail completed the acquisition of another company called Valeant Pharmaceuticals International with Valeant surviving as a wholly owned subsidiary of Biovail. Biovail was renamed “Valeant Pharmaceuticals International Inc.”

As the predecessor of Valeant, Biovail was itself a pharmaceutical company full of controversies. For readers not familiar with Biovail, a little google search will result in quite a bit of interesting information. For instance, according to Wikipedia:

“In March 2006, CBS program 60 Minutes featured Biovail in a story about its lawsuit against hedge fund SAC Capital Partners and Camelback (now known as Gradient Analytics), among others. According to Eugene Melnyk, "there’s a group of people that got together and essentially attacked the company by putting out false reports, and we’re just fighting back for our shareholders.

"The alleged conspiracy began with Camelback, an Arizona stock-analysis firm that advertises that it publishes impartial financial reports on companies to help investors evaluate stocks. In the spring of 2003, the hedge fund SAC asked them for a report on Biovail. Darryl Smith, Mark Rosenblum, Demetrios Anifantis, and Robert Ballash, former Camelback employees, alleged that Camelback had allowed their client SAC to determine the content and timing of their reports on Biovail.

"Camelback said those former employees were lying and disgruntled, that Anifantis and Ballash were fired because of unethical conduct; Smith for poor performance; Rosenblum was laid off. These four say they were let go after they complained to their superiors about Camelback’s practices. SAC denied all the charges in Biovail's lawsuit and said that the decline in the Biovail's stock was due to earnings shortfalls and regulatory investigations.”

Another interesting incident with Biovail was the SEC charge on March 28 (link):

“The Securities and Exchange Commission today charged Canadian pharmaceutical company Biovail Corporation and its former CEO, former CFO, and two current senior executives with engaging in a number of fraudulent accounting schemes and making a series of misstatements to analysts and investors.

"The SEC's complaint alleges that present and former senior Biovail executives, obsessed with meeting quarterly and annual earnings guidance, repeatedly overstated earnings and hid losses in order to deceive investors and create the appearance of achieving earnings goals. When it ultimately became impossible to continue concealing the company's inability to meet its own earnings guidance, Biovail actively misled investors and analysts about the reasons for the company's poor performance.

"Biovail settled the SEC's charges and will pay a $10 million penalty. Four current or former Biovail senior executives still face SEC charges: former chairman and CEO Eugene Melnyk; former CFO Brian Crombie; current controller John Miszuk; and current CFO Kenneth G. Howling.

"We allege that Biovail and senior executives engaged in a pattern of systemic, chronic fraud that impacted its public filings of quarterly and annual reports over the course of four years," added Mark K. Schonfeld, Director of the SEC's New York Regional Office. "In an effort to conceal the fraud, Biovail's senior officers intentionally misled the company's auditors and the investing public, showing their complete disregard for their responsibilities to shareholders.

"The SEC's complaint alleges that in October 2003, Biovail and some of its executives schemed to deceive investors and analysts by falsely attributing nearly half of Biovail's failure to meet its third quarter 2003 earnings guidance to a truck accident involving a shipment of one of Biovail's products. Led by Melnyk, Biovail intentionally misstated both the effect of the accident on Biovail's third quarter earnings as well as the value of the product involved in the truck accident. The accident, in fact, had no effect on third quarter earnings.

"Biovail, over several reporting periods in 2001 and 2002, improperly moved off its financial statements and onto the financial statements of a special purpose entity approximately $47 million in expenses incurred in the research and development of some of Biovail's products.

"Biovail concocted a fictitious bill and hold transaction to record approximately $8 million in revenue in the second quarter of 2003.

"Biovail intentionally misstated foreign exchange losses that caused its second quarter 2003 loss to be understated by about $3.9 million.

"The SEC's complaint alleges that each of Biovail's fraudulent accounting schemes had a material effect on Biovail's financial statements for the relevant quarters and years and was engineered by Biovail's senior management in order to inflate Biovail's reported earnings. Biovail management also intentionally deceived the company's outside auditors as to the true nature of the transactions. The truck accident misstatements were intended to mislead investors about the significance of Biovail's failure to meet its own earnings guidance.

Valeant (

VRX, Financial), founded as ICN in Orange County, was a pharmaceutical company underperforming for many years before Jeff Ubben (Trades, Portfolio)’s ValueAct took a major stake in the middle of the 2000s. Along with the activist came Mike Pearson, a McKinsey consultant of 23 years specializing in the pharmaceutical industry. As a consultant, Pearson had numerous engagements with large pharmaceutical companies and had come to his own conclusion that the traditional business model of pharmaceutical companies was botched – the cost structure was bloated, the R&D productivity had been declining. “Don’t bet on science – bet on management” became Pearson’s motto.

Pearson’s vision led to the change in business strategy after the Valeant-Biovail merger. Here is an excerpt from Valeant’s first 10-K filing detailing the business strategy:

Business Strategy

Since the Merger, our strategy has been to focus the business on core geographies and therapeutic classes, manage pipeline assets through strategic partnerships with other pharmaceutical companies and deploy cashwith an appropriate mix of selective acquisitions, share buybacks and debt repurchases. We believe this strategy will allow us to improve both the growth rates and profitability of the Company and to enhance shareholder value, while exploiting the benefits of the Merger.

Our leveraged research and development model is one key element to this business strategy. It will allow us to progress development programs to drive future commercial growth, while minimizing our research and development expense. This will be achieved in four ways:

• structuring partnerships and collaborations so that our partners share development costs;

• bringing products already developed for other markets to new territories;

• acquiring dossiers and registrations for branded generic products, which require limited manufacturing start-up and development activities; and

• selling internal development capabilities to third parties, thereby allowing higher utilization and infrastructure cost absorption.

The merger also enabled Valeant to lower its tax rate dramatically as Biovail was using a mix of tax strategies to pay as little tax as possible. In fact, Valeant and Biovail had been able to get tax refunds prior to the merger mainly due to the following three tax items:

  1. Change in valuation allowance related to U.S. operating losses.
  2. Change in valuation allowance on Canadian deferred tax assets and tax rate changes.
  3. Foreign tax rate differences.

With the lower tax rate advantage, cheap debt and a “disruptive business strategy.” Mike Pearson and Valeant were ready to take off.

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