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Bill Ackman, Pompey, and You

It’s been about a year since Valeant Pharmaceuticals fell apart into a pile of smoldering rubble. As that link details, its biggest investor and biggest fan, Bill Ackman, was at that point down several billion dollars on the investment, and things did not get any better. His fund sold out of its Valeant position last month, at a loss of at least $3 billion. If you cast your memory back to October of 2015, when things first started to go wrong, you can find Ackman quotes about the incredible skills of the company’s managment team, the tremendous upside to the investment, the worthlessness of the accusations about their business practices – enough schadenfreude to power a medium-sized city, actually.

And he’s recently sent out a letter to the remaining shareholders of his hedge fund, apologizing for losing so much of their money. Personally, I wouldn’t find that all that comforting, considering all the table-pounding that those expressing doubts got at the time, but better late than never and all that. This is a terrific example, and will be a terrific example for years to come, of overconfidence and the sunk-cost fallacy. This is not a new phenomenon – there’s a good example of it in how Montesquieu talks about Pompey’s dealings with Julius Caesar

I believe that Pompey was ruined more than anything else by his shame at thinking that he had lacked foresight in elevating Caesar as he did. He yielded as slowly as possible to this idea. He did not prepare his defense so that he would not have to admit he had placed himself in jeopardy. He maintained before the senate that Caesar did not dare make war, and because he said it so often, he always repeated it.

I think that investing in pharma and biotech companies makes a person peculiarly vulnerable to this sort of mistake. So many plays in this stock market sector turn on particular stories, clinical trial results or FDA approvals of specific drugs, and these fit right into the narratives that we humans (and we investors) like to tell ourselves. Investors in small drug stocks often get so, well, invested in these stories that they follow their beloved companies right over the cliff, denying at every step of the way that there could possibly be a problem. It’s very hard to be objective about such decisions, but drug stock stories are perfectly placed to capture the sorts of investors who have no interest from the start in being objective, anyway. It’s the brave little company and the poor patients they’re trying to help, fighting against the forces of evil. If the stock goes down, it’s not because there could be honest doubts about whether the new drug is going to work. No, it’s nasty short sellers. Or the evil “money managers”. Or the horrible FDA. Somebody. There has to be a villain.

Valeant’s case was driven by another narrative, to be sure: the one about how the industry is in its situation because of lack of business acumen, and never mind all that bleating about how hard drug research is. Someone like Bill Ackman is too sharp to be taken in by the more simple story of “Here’s why this drug is going to work”, and he’s not going to fall into the low-grade conspiracy thinking just mentioned. He was, though, perfectly positioned to be taken in by the more complex story of “Here’s how this business strategy is going to work”, and against the normal backdrop of the drug industry, a hard-nosed, cost-cutting, earnings-focused plan like the one Valeant was selling really stood out. None of this messy luck-in-the-clinic stuff; Valeant had it all down to a process that couldn’t lose. The rest of the drug industry was too slow and old-fashioned to realize it! That was the sort of exciting narrative a billionaire hedge fund manager could go for.

It’s one of the single biggest human cognitive biases that we turn things into stories, and we expect those stories to make sense. They should have beginnings, middles, and ends, and there should be winners and losers – but this isn’t the way the world has to work, it’s the way our minds apparently have to work to make sense of things. Investments are a good place to see this in action, but many of us can think back to research projects we’ve worked on and see the same effects. Drug discovery projects have their own narrative – at most companies, that’s how they start, with a summary proposal slide making the case for why Target X or Approach Y is a good idea. The hard part is being able to see these stories from the outside, and to realize that at times, that’s all they are (or all they might turn into, as new data come in). We all have Pompey’s fault – we don’t want to look like we didn’t see the trouble coming, so we deny that the trouble is coming at all.

Oh, and the CEO that took over at Valeant last year to turn things around? He’s just been paid $62 million for that. $980K is base salary, and $42 million is from stock awards, along with a $9 million bonus. You say that things haven’t actually turned around? Well, just imagine what the pay package will be if they do. If I were a Valeant shareholder (Heaven forfend) I would probably find all this somewhat annoying, but anyone who’s holding the stock now is a very different person than I am.

18 comments on “Bill Ackman, Pompey, and You”

  1. anon says:

    That’s the story we know. The stock hit ~$250’s at some point. Someone made good money out of this expected outcome.

  2. SirWired says:

    I have to feel some glee about Valeant’s failures since so much of their business plan appeared to be the “Find established drugs, buy the company that makes them, and jack up the prices as high as we possibly can” model. Not quite Shkreli-ian levels of greed, but the same general idea. (And they mixed it up a bit by adding control of a “specialty pharmacy” which appeared to “specialize” in something that looked a whole lot like insurance fraud.)

    1. skeptical says:

      Shkrelian (n): an alien race that makes the Ferengi look good.

  3. Xorl says:

    I wonder if he still has that jet-fighter’s pilot seat in his office as a nod to his ability to eject from deals at the crucial moment.

  4. Anon says:

    One man’s loss is another man’s gain. Or another sheep’s loss.

  5. Anon says:

    “lessons learned”???

    Ackman *still* hasn’t figured that Valeant never had a solid business model to create any real value in the first place! He still puts it down to “uncontrollable factors”.

    So I guess we can expect a repeat of his arrogant ignorance. Or should that be ignorant arrogance?

    1. loupgarous says:

      A slight text change to “uncontrolled factors” and it’d be perfectly descriptive.

    2. Pennpenn says:

      Moreoften I’d say it’s both ignorant arrogance and arrogant ignorance. They work so closely together sometimes it’s hard to tell one from the other.

      1. Anon says:

        Kind of like Ant and Dec.

  6. Adam says:

    There also seems to be a rhetorical disconnect between sales/business people and the process of science that contributes to this type of narrative: sales and business people (and many scientists who sell themselves well) learn to speak with conviction and certainty. But the process of discovery is often most successful when we admit our ignorance and uncertainty.

  7. Peter Shenkin says:

    @Adam Regarding sales people, one of the best I worked with for years had the mantra, “You’ve got to sell what you’ve got.” A completely reasonable, even admirable, attitude. And he was successful, for himself and the company. (He was also pretty clear, in internal discussions, on what he wished we had, which was also helpful….)

  8. Hap says:

    Has the new Valeant CEO improved the company enough to make that $62 M annual pay figure make any sense, or is this yet another example of boards paying its favorites or friends with other people’s money?

  9. Peter Shenkin says:

    @Hap My view isn’t quite so cynical. Certainly, a successful company replacing a CEO requires an outstanding person. An unsuccessful company trying to turn around perhaps requires an even more outstanding person. Outstanding executives don’t come cheap. And to take over an unsuccessful company, an outstanding person needs at least the compensation that he would have gotten at a successful company, to indemnify him should he fail; for then, who will want to hire him? Or her (can you say Marissa Mayer)? At the same, time, what Derek says extends to the current stage. I don’t see how they can have an upside, and in 2012, I didn’t see how Yahoo could have an upside. Perhaps Valeant now and Yahoo then were blinded to a certain reality. But if you really do believe there’s an upside, you’ve got to pay enough to get an outstanding CEO to materialize it. And that’s gonna cost you as much as if you had been on a successful trajectory.

    The best thing you can do about the waste of other people’s money is not be one of those other people.

    1. Hap says:

      I would have figured that CEOs generally came for less than $62M – otherwise, I can really see why the Chamber of Commerce would like the CEO/peon reporting ratio requirement removed.

      Less chippily, if the CEO of Valeant delivers, he would be worth more than that – but, in most other cases, employers generally demand of employees that they deliver before getting paid as if they had. That, I assumed, was the point of stock options – they only pay off if you do what you claim (and if they’re timed OK, the shareholders, CEO, and company can all win). If you pay as if he had already delivered, what are you going to have to pay if he actually does deliver? What do you do if he doesn’t? It’s this gap (management gets paid whether they succeed or not while employees only get paid occasionally when they succeed and not at all when they fail) that is irksome. this gap seems to be widespread enough that it’s hard to avoid, other than by not investing.

      1. NJBiologist says:

        @Hap: “I would have figured that CEOs generally came for less than $62M”

        Absolutely agree. It’s annual report season, with say-on-pay sections in each; looking at this year’s crop, CEOs for fairly large companies are getting $10-15M/year. Example: Exelon owns electric utilities in Chicago, Philadelphia and Baltimore. Their CEO’s total package was $13.5M.

    2. fajensen says:

      ….. outstanding person needs at least the compensation that he would have gotten at a successful company, to indemnify him should he fail; for then, who will want to hire him?
      Oh, Please! Everyone with a normal sense of entitlement would be able to retire on just one of the golden parachute(s) rewarded to the typical series-failing CEO’s. There is no “skin” left in the CEO game, if the business succeeds they make money, when the business fails they often make even more due to “the harsh business conditions they must endure” (and on the credit default swaps procured via a “tax free” Belgian numbered account).

      Executive compensation these days is simply organised looting. The same groups of people basically sit on “each others” executive boards and approve each others employment and pay packages; It is truly grotesque that this is allowed to happen, but it is.

      Here, in the least corrupt country of all, we have many people who’s entire career consist of running whatever it is they are given responsibility for straight into the ground to be picked up for nothing on the reconstruction, once creditors and investors are blown off. They doing this for huge amounts of money, almost as if this is precisely what they were hired to do.

  10. Magrinho says:

    @SirWired – I mostly agree with your analysis. Except that Valeant was every bit as greedy as Punchable Face (I won’t use his name).

    You are lucky if your adversaries are as dumb and punkish as PF. Valeant was much stealthier, smarter and darker. Fortunately for us, Valeant caught the attention of a preening, loudmouth who put a spotlight on its behavior for us.

  11. Emjeff says:

    Why would anybody listen to this guy ever again? He took a position on Valeant’s board, unbelievably. I predict investors in his hedge fund are gearing up for a big ol’ lawsuit…

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