On Oct. 4, I singled out Valeant Pharmaceuticals International Inc. (NYSE: VRX) as a deeply troubled company, one that was emblematic of just about everything that’s corrupt and toxic in today’s markets.
The hedge funds loved Valeant thanks to its practice of buying other drug companies using junk bond financing, firing most of their employees – and then sharply hiking the prices of the drugs to which they’d just acquired the rights.
That’s an ugly business model. It came into sharp focus in September when Turing Pharmaceuticals’ Martin Shkreli bragged about hiking the price of a vital drug essentially just because he could, bringing a ton of bricks in public and political wrath down on the industry’s collective head.
Now, I expected VRX shares to plunge, but that ton of bricks landed harder and faster than I thought. And wave after wave of bad news – now including allegations of outright criminal behavior – brought the shares down 40% in one morning, from $148 to below $89 yesterday. The shares eventually rebounded to $118, but not for any good reason.
As you’re about to see, for as far as its fallen already, this rotten company could fall a lot farther before it finally craters…
Valeant Can’t Catch a Break – and Doesn’t Deserve One
This past Thursday, Valeant announced the U.S. government subpoenaed the company over its drug-pricing practices for two specific drugs. The stock dropped sharply in that session and then recovered on Friday. But investors were clearly nervous as they waited for the company’s third-quarter earnings report on Monday.
It turns out they had good reason to worry. Earnings weren’t the problem; they came in on target. The company earned $3.54 per share on $3.6 billion in revenue, in line with Wall Street expectations. And it nudged up guidance for the year to between $11.67 and $11.87 in earnings per share and said revenue would be between $11 billion and $11.2 billion.
But management announced several changes to Valeant’s strategy that suggest that the company is changing course.
First, Valeant said it would reduce its dependence on raising drug prices to boost profits. Price increases have accounted for about 8% of revenue growth in the first nine months of 2015.
Chairman Michael Pearson told investors that “outside pressures” (he really meant politicians) are “changing the pricing environment.”
In other words, politicians and the public are appropriately disgusted that a company that spends virtually nothing on R&D is raising prices on old drugs in order to pad its bottom line. For once, the people in D.C. are doing the right thing. As a result, the company expects to keep price increases, which have averaged 66% over the last years, to no more than 10% next year.
He also said that the company would stop buying old drugs and raising their prices, one of its key strategies in recent years. Having been caught with his hand in the cookie jar, Pearson figures he better take it out before his whole arm gets ripped off.
Second, the company also plans to try to sell its controversial neuroscience unit, which has grown almost exclusively through price increases. The unit is home to two drugs on which the company raised prices by 525% and 212%, respectively, which attracted the attention of Congressional Democrats. Again, the company is trying to run as far as it can from its reputation for raising drug prices.
The problem is that the company was built on the strategy of buying other companies’ old drugs and marking up their prices. And it used tens of billions of dollars of debt to do so.
The question now is whether it will be able to handle the $30 billion of debt that it took on in the process. The answer is probably “no.”
Valeant’s predatory business model places it at a disadvantage with investors because it depends on inflicting harm on people to make money.
You see, Valeant thinks R&D is a nuisance and would rather buy up other companies, fire people, hike the prices of their drugs, and let the government, insurance companies, and consumers pick up the tab.
And so investors, no doubt convinced that a leopard just can’t change its spots, reacted to the proposed changes by sending the stock into a freefall. The price went from $177 at close Friday to below $160.
Then things got worse. A lot worse. But I couldn’t be happier…
Double-Digit Losses Are Piling on Daily
Yesterday, short-selling firm Citron Research piled on by claiming it had discovered a “smoking gun” related to the company.
Citron has published several negative reports on Valeant in the past. Citron reported that Valeant is using pharmacies related to a company called Philidor to store inventory and record the transactions as sales.
Citron said that “Valeant/Philidor have created an entire network of phantom captive pharmacies” to create fake sales of drugs or to avoid the scrutiny of auditors. This is known as “channel stuffing” and is done to fraudulently inflate sales. VRX stock collapsed sharply on the report, all the way down to below $89.
When a company like Valeant loses the confidence of investors, it is very difficult to get it back. No doubt Valeant will try to refute the Citron report, but serious damage has been done to the company’s already battered credibility.
Oh, the company’s apologists point to subsidy payments that the company makes to certain patients, but that’s just a cost of doing business that allows the company to prey on everybody else. But those apologists are largely Wall Street firms beholden to the company for investment banking and underwriting fees whose apologies are written in blood money.
The bottom line is that Valeant is getting what it deserves. This predatory business model has enriched management and a bunch of hedge funds but has left everyone else with whom the company has come into contact severely damaged.
It won’t upset too many people that its largest shareholder is the activist investor Bill Ackman, who bought his stake in the company early this year after skirting insider trading laws trying to help Valeant in its failed bid for Botox maker Allergan Plc. (NYSE: AGN).
You know what they say about karma…
Overvalued biotech stocks like Valeant will get hit the hardest in the upcoming “Super Crash” Michael’s predicted. His Sure Money readers are getting the updates they need to protect themselves and take profits as stocks dive lower. Click here to receive Sure Money yourself at no charge, and you’ll get his Super Crash report, too.
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