Salix ruins its reputation with disastrous inventory admissions

Want to remember what company valuations looked like pre-biotech bubble, and before every mid-cap drug stock was a potential takeout target? Look no further than Salix Pharmaceuticals.

Shares in the company plunged 37% this morning, erasing $3bn from its market cap, after it admitted that months of channel stuffing had inflated its top line. Salix has been a strong beneficiary of growing investor confidence in the ability of smaller drug companies to successfully launch new products and attract larger suitors, optimism that has now rightfully evaporated.

The seriousness of what the company revealed cannot be understated. Inventory levels of all its drugs are much higher than previously thought – as long as nine months for its biggest growth driver Xifaxan, against the previous guidance of 10 to 12 weeks. The fallout of the inventory “discovery” cost Salix’s finance chief his job yesterday and, reportedly, derailed the Allergan bid approach earlier this year (Salix and Auxilium reveal an anti-chain in overdrive, September 23, 2014). 

On top of this the company lowered sales guidance, blaming slowing prescription growth caused by unexpectedly high turnover of sales reps after its takeout of Santarus earlier this year.

Salix intends to wind down inventories over the next two years, rather than taking a quick hit – a decision that  left equity analysts scratching their heads and puzzling over how exactly to forecast sales for the coming years.
All of which makes the loss in market value this morning look almost generous. Salix’s share price has only fallen to levels last touched at the beginning of the year, when it was closing the $2.6bn Santarus deal.

Taking shelter

On a conference call last night executives refused to answer questions on how exactly the inventory situation came about, saying they wish to "maintain the integrity" of an audit committee convened to investigate the situation.

Chief executive Carolyn Logan would only reiterate her belief that the company's accounting in relation to sales to wholesalers “has been appropriate”, and that executives remain “comfortable” with where inventories are now.

Few others are happy, however, particularly investors and analysts who now have the task of working out what is going to happen to sales in the next few years, and how to value the company. Given the contradictory nature of the company’s statements – when sales missed forecasts the last few quarters the company blamed de-stocking, but it now says that inventory was stable the last nine months – this task is made only harder.

What does seem sure is that prescription growth is struggling in a number of franchises. Quarter-on-quarter growth in Xifaxan prescriptions slowed to 4% in the third quarter, from 10% in the second quarter, while Uceris dipped to 15% from 19%.

So management really has two fires to fight – getting inventory levels under control and reinvigorating its sales force. It is not surprising that Allergan walked away from this mess.

The current bull market has partly been created by the willingness of investors to ignore the risks inherent in small drug makers – the biggest of which for companies like Salix is commercial implementation. Its current valuation is probably much closer to how it would have been judged a couple of years ago.

This is not to say Salix cannot fix these problems, and once again attract the attention of growth-hungry larger suitors. But the company has much work to do, and of course there is always the danger of things getting worse before they better.

To contact the writer of this story email Amy Brown in London at AmyB@epvantage.com or  follow @AmyEPVantage on Twitter

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