Valeant Pharmaceuticals:
a Momentum not Value Company
by Ignatius Chithelen*. December 4, 2015.
Investors in Valeant Pharmaceuticals accepted
characteristics remote from value investing: rapid revenue and margin growth
driven by costly acquisitions which ballooned debt, massive price increases which
risked payer backlash and new competitors and a high technology business with
low R&D spend. And now, after its stock price collapse, its future is
largely dependent on legal and legislative battles.
(Since 12.4.2015 the
stock fell from $96 to a low of $13.)
(*Ignatius
is managing partner of Banyan Tree Capital Management, New York. He has no
position in any Valeant securities.)
Valeant Pharmaceuticals was indeed a very hot company and stock.
Its revenues grew over ten-fold to $8.3 billion, in the six years to 2014,
while operating income soared 17 fold to $2 billion. An investment of $100 in
the stock in December 2009 was worth $1083 in December 2014, over five times
greater than an investment in the S&P 500 Index. The stock gained an
additional 126% when it reached an all-time peak price of $264 in August 2015.
A company based in Quebec, Canada, Valeant develops, manufactures
and markets drugs in areas of dermatology, gastrointestinal disorder, eye
health, neurology and branded generics. Earlier, from 2006 to 2008, increased
competition and reduced payments from third party payers had halved its
operating income. It then shifted from oral drug delivery technologies to developing
drugs for central nervous system disorders such as epilepsy, Parkinson's
disease and multiple sclerosis.
Valeant’s strategy shifted again in 2010 when J. Michael Pearson
became CEO following an acquisition. Pearson
had been CEO of the acquired company since 2008. Earlier he was at McKinsey,
which he joined in 1984, heading its global pharmaceutical practice and serving
on the board of directors.
The strategy under Pearson, the company’s 2014
10K SEC filing states is rapid acquisitions of companies with drugs which ”.. are largely
cash pay, or are reimbursed through private insurance, and, as a result, are
less dependent on increasing government reimbursement pressures...” It bought over 50 companies, using cash and debt and paying
steep prices. They include dermatological drugs provider Medicis
Pharmaceuticals, bought in 2012 for $2.7 billion, nearly four times its 2011
revenues, eyecare company Bausch & Lomb in 2013 for $8.7 billion, roughly
three times 2012 revenues and in April 2015 gastroenterology drugs maker Salix
Pharmaceuticals for $15.8 billion, fourteen times Salix’ 2014 sales.
Typically companies list risks in their annual 10K filings more
for legal protection than to state likely risks. But in Valeant’s case its
mention of “Debt-related Risks”, in its 2014 filing, is a real one: “We have
incurred significant indebtedness, which may restrict the manner in which we
conduct business and limit our ability to implement elements of our growth
strategy.” At year end 2008 Valeant had a good balance sheet with no long term
debt, cash of $340 million and equity of $1.2 billion. But at September end
2015 it’s debt was $30.2 billion, nearly five times its equity.
A drug company with patents and other intellectual property
typically has a fair amount of intangible assets. But Valeant’s intangibles at
September 2015 were $22.5 billion, over three times its equity. It also had
$17.4 billion in goodwill, resulting from acquisitions. Overall it thus had a
negative tangible equity of $33.4 billion.
Salix, before its purchase by Valeant, spent 15 % of its $1,133
revenue in 2014 on research & development. Drug major Merck too spent 15%
of its $42.2 billion 2014 revenue on R&D, excluding restructuring and
merger related expenses. In contrast, Valeant slashes R&D costs at
companies it acquires enabling it to grow operating margins. In 2014, for
instance, it spent only 3% of its revenue on R&D. While this low spend
helped increase profits short term, strong R&D expense is key to future
revenue and profit growth for drug and other companies with patents,
intellectual property and competitors.
Under Ethics, in its 2014 10K filing, Valeant states that its “.. most important objective is to serve our stakeholders,
including the patients and consumers who use our products, the physicians who
prescribe/recommend them, and the customers who provide retail outlets for
these products.”
Yet Valeant’s drugs had the highest price increases amongst the 19
commonly prescribed dermatologic drugs tracked in a research study published in
the Journal of the American Medical Association in November 2015. The study was
conducted by Miranda Rosenberg and Steven Rosenberg, a daughter and father team
with the daughter a student at The Perelman Medical School at the University of
Pennsylvania. Valeant raised the price for 30 grams of its Carac cream, for
treating pre-cancerous skin lesions, from $159 in 2009 to $2865 in 2015. The
price for its Targretin gel 60 g tube to treat skin cancer was raised from
$1687 to $30,320 over the same period - both about a 1700% increase.
The mean price increase, by Valeant and other drug companies, for
the 19 drugs was 401% over the six year period, while the consumer price index
rose 11%, the study found. “We’re not talking about new
drugs,” Steven Rosenberg, a dermatologist in West Palm Beach, Fla., who led the
research told The New York Times, November 26, 2015 “We’re not talking
about exotic drugs. We’re not talking about drugs that are listed as being in
shortage.”
In October 2015, Valeant’s stock price was cut in half to $94,
after news reports that it instructed workers
of Philidor, a pharmacy with ties to Valeant, to use a variety of questionable
methods to try to get insurance companies to pay for its drugs. Also that month
a company news release said it received subpoenas from U.S. Attorneys in
Massachusetts and New York seeking documents “..relating to financial support
provided by the company for patients, distribution of the company's products,
information provided to the Centers for Medicare and Medicaid Services, and
pricing decisions.” A couple of weeks later Valeant appointed Mark Filip, a
former Deputy Attorney General of the United States of the law firm Kirkland
& Ellis, as an adviser.
Charles Munger, partner of Warren Buffett in
running Berkshire Hathaway and a very successful value investor, told Bloomberg
November 1, 2015 that in his role as chairman of the Good Samaritan Hospital in
Los Angeles, he "could see the price gouging.” Valeant’s practice of
acquiring rights to treatments and boosting prices, Munger added, was legal but
“deeply immoral”, deeply wrong and unsustainable.
In early December 2015 Valeant’s stock traded at $96, down from
$117 at year end 2014. Its strategy of buying companies to get more products
requires increasingly bigger purchases to boost profit margin growth, since the
denominator gets larger with each purchase. Also its huge debt load, higher
interest costs due to a cut in its debt ratings and a fallen stock price will make
large future acquisitions difficult. Valeant’s survival hence depends, not on
its business economics, but on whether Pearson and major investors can save it
from punitive actions from politicians and regulators and if it can manage its
huge debt load.
No comments:
Post a Comment
Your comments welcome.