The Valeant wreckage continues to smolder, and it will remain a tourist attraction for students of forensic accounting techniques for some time to come. For an informative look at the accounts of the people who have been holding its stock, check in with Matt Levine at Bloomberg. He’s gone through the public filings of Bill Ackman’s Pershing Square fund and has reasonable estimates of their stock and option positions in Valeant, and hoo boy. He believes that their break-even point is at about $161/share, and if that’s accurate then the traditional “underwater” adjective does not begin to describe where they are on this company. You need a robot submersible to explore these depths. Levine further estimates another inflection point, at just under $18/share, which is where Pershing Square will likely have lost their entire four billion dollar investment. I have no idea if they hedged this position somehow, as a. . .hedge fund might do, but Ackman himself delivered a four-hour exhortation back in October, complete with a massive slide deck that covered in detail just how incredibly right he was about investing in the company, so maybe not. He was only down a billion dollars at that point, though – good times, good times.
Last summer no one would have believed just how bad it could get, or (in the case of Ackman himself) that it was capable of getting bad at all. No, Valeant was great, and it was just getting better and better, the same way it had for years. The problem is that some people may still not take the right lessons away from this one. Valeant became such a popular investment because of their low-cost high-prices business model, which you’d think would have been discredited by this little stretch of difficulty, but there will surely be some who will say “Well, but this was fraud. No way to know that a company’s cooking its books when it just flat-out lies to everyone”. But that misses a key point: you can’t deliver the kinds of numbers that Valeant was delivering without trickery. The company kept selling itself as a growth play, when it was nothing of the kind. Despite their statements, most of the revenue growth came from raising prices on its stable of old drugs, which it obtained by taking on mounds of debt, which only had a prayer of being serviced if those prices were jacked beyond belief and sales stayed strong. But a lot of the sales at those raised prices came through a shady hidden network of specialty pharmacies that they didn’t tell anyone about. No, Valeant wasn’t a good idea executed fraudulently – it was a fraudulent idea to start with.
As pointed out by Ronald Barusch in the Wall Street Journal, this debacle also vindicates Allergan’s attempts to avoid being absorbed by Valeant a couple of years ago. That was a smarmy affair, with plenty of misrepresentations, and if you didn’t dislike Valeant’s management before that, you certainly had reason to afterwards. Well, unless you were running a multibillion dollar hedge fund, that is – several of those folks (and not just Ackman) didn’t let that slow them down at all. (What’s even more painful for them is that many of these managers have shown themselves willing to invest in a good short thesis, but they sure didn’t recognize that this was another one).
Matthew Herper has some other lessons in his column here, and he has some good points. I would add this one, which bears on some of his points about doing research: don’t confuse generic drug companies with research drug companies. Recent events have shown that many members of the public, and many legislators and journalists as well, are rather hazy on this concept. But the key is whether a company does research on new drugs to patent or not. That’s a very expensive proposition – too expensive, said Valeant and their CEO Michael Pearson. Better to buy up the things other people have found and raise their prices. So just calling Valeant a “drug company” isn’t that useful, because that term doesn’t distinguish a marketer of other people’s known drugs from a company that tries to invent new ones.
Now, you can buy up things that are still under patent and make a portfolio of those, but that’s also not a cheap model. Patents are worth quite a bit because of the market exclusivity they provide, and if a company already has a drug under patent that’s selling, than what is it that you’re bringing to the deal? (Usually, it’s marketing – “go with us and we’ll sell a lot more than you would on your own”) Or you can buy older drugs that are off-patent, which would normally be a lot cheaper, but also would normally bring in a lot less revenue. Those are the generic drugs, off-patent, now competing on price because the market exclusivity is gone. Or is it? That, of course, is the set of regulatory loopholes that the Valeants and T*rings of the world are exploiting, finding ways to get people to pay huge prices for decades-old drugs.
With any luck, that business model has been discredited. As Herper puts it:
Part of the appeal of Valeant and other specialty pharma companies has been the idea that you could avoid having to deal with all the kooky science and 90%+ failure rates of real drug discovery. This sales pitch has always been irresistible to investors. . .(But do you) want the financial benefits of curing disease? You have to take the risk.
Me, I cast my lot with the kooky science. I wouldn’t mind getting that 90% failure rate down a bit, but that’s going to take even more science than we have at present. Onward!