Valeant bargains for its life

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It is said that the stages of grief run from denial through anger, bargaining and depression, ending finally at acceptance. And after Valeant’s investor call today, convened to rebut allegations over opaque arrangements with Philidor and other pharmacies, the group is well into the bargaining stage.

Yes, Valeant seems to be saying, something unusual might have gone on, but please believe that we are isolated from it. Yes, our setup might seem strange, but many other companies have identical arrangements. If only the market would enter into the bargain things might revert to normal and Valeant stock would cease to haemorrhage value.

Yet so far, since last week’s accusations by the Southern Investigative Reporting Foundation, an investigative journalism outfit, and the short-selling fund Citron Research, Valeant stock has slumped by 25% – equivalent to some $12bn of market cap. The worst seems far from over, notwithstanding that Valeant has batted away the most serious allegations.

The problems are manifold. Valeant already faces questions over its reliance on drug price hikes to sustain growth, as well as being issued with federal subpoenas. And it has previously shown opaque business practices, as seen by its failed attempt to buy Allergan, which involved an insider buying a minority stake in the target on the quiet.

The latest controversy does nothing to blow away the mists of secrecy, and it will not go unnoticed that one of the first rules of investing is not to put your money into a business you do not understand.

Not true

To its credit, Valeant has done well to assure the markets that the most egregious allegations against it are not true. It had been suggested, for instance, that because Valeant effectively controlled Philidor it could “channel stuff” through this pharmacy, recording phantom revenue for products that never actually reached a patient.

Today Valeant said sales through Philidor were only booked once product was actually dispensed to the patient, so it was impossible to “stuff the channel”. Moreover, it says use of speciality pharmacies is common in the US, and cites AbbVie as owning Pharmacy Solutions, which distributes drugs including Humira.

In any case, Philidor accounted for just 6.8% of Valeant’s third-quarter sales, and 7% of Ebitda, the company stated. It also said the Philidor relationship had come through its 2012 purchase of Medicis, and the arrangement was working so well that last year Valeant paid $100m for rights to acquire Philidor as an insurance against competitors.

As such, Citron looks to have failed to land a knockout punch with its suggestion that Valeant “could be the pharmaceutical Enron”. The damage for Valeant appears to be limited to its non-disclosure of that $100m option to acquire.

But many issues will continue to trouble investors – a situation that will not have been remedied by Valeant’s move today to have an ad hoc internal committee review Philidor, or request to have the SEC investigate Citron.

There are worrying similarities between the opaqueness of Valeant’s pharmacy network and Elan. Back in 2002 Elan was undone by its use of minority-owned entities, though unlike Elan Valeant has not had to contend with accusations of double-accounting.

Link with R&O

Perhaps nothing illustrates the opaqueness better than today’s disclosure of the link between Valeant and R&O, another pharmacy in this mess: Valeant has an option to acquire Philidor, which itself has an option to acquire Isolani, a management company that owns 10% of R&O and also has an option to acquire R&O.

R&O is highly relevant because it was the canary in the coalmine for Southern Investigative Reporting’s initial exposé: it emerged that Valeant had invoiced R&O for $69.8m of drug sales but R&O was denying ever having done business with Valeant.

Still unanswered are yesterday’s claims by the Wall Street Journal that certain employees had – under different names – worked at both Valeant and Philidor. Valeant says its ad hoc committee will review this.

Ultimately the farrago has struck at the heart of Valeant’s business model. The fact that the depressed group is now in no position to do serious M&A, for instance, is just the beginning, and its ability to service its $30.9bn gross debt pile should now receive close scrutiny.

If Valeant’s hastily convened investor call featuring a battery of obviously sleep-deprived executives fails to prevent the stock’s slide into depression, acceptance that Valeant’s business model is broken could be next.

To contact the writer of this story email Jacob Plieth in London at jacobp@epvantage.com or follow @JacobPlieth on Twitter

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