I have been wanting to write this for a long time, now it is time.
Running companies is difficult. It resembles the world of nature. Many are competing against you and none cares about you. Therefore, I never want to completely take credits away from a management or a company. Tough times come and go for everyone. However, this is an exception. Valeant was and still is one of the worst companies in the history of public traded companies. If you don’t want to lose your money, stay far away from it. In fact, I have a large short position on the company because I firmly believe the company’s bad karma has finally caught up with it, and now, it is in way over its head with its cover-up attempts.
Run down of the situation
Reasons to be concerned:
- Dishonesty stinks and sticks
- Papa is not the Great Saviour people think
- Lack of cash flow will not be sufficient to pay off debt
- Sales of divisions would cause implosions
Brief rundown of the background:
Valeant is a pharmaceutical that does no R&D (How is that possible?). It relies on three moves: acquisition, cost-cutting (aka, cutting R&D mostly, so nothing impressive), and price-raising. For a long time, it was expanding like a cancer virus. It hit its all-time high in Oct. 2015, about 270 USD.
- Andrew Left called out the company publicly, raising the possibility of accounting issues, in particular, revenue recognition.
- Left also helped expose the company’s unlawful relationship with a specialty pharmacy, named Philidor. Valeant has since cut ties with Philidor and now it is operating with Walgreens.
- The shares dropped about 90% and now it is currently trading at 27 USD per share.
- Rockstar hedge fund manager Bill Ackman stepped in and took control of the company after the share price tumble. The former CEO Pearson was let go, and a new CEO was since hired.
- The company has received two separate default notices since then, due to untimely filings of its 10K and 10Q.
- The company recently distributed 3 million dollars as bonuses to its executive management team and more in the forms of equity awards.
I have long expressed publicly about my distain for Valeant. I dislike strongly a corporate “roll-up” and I believe eventually things always catch up with them. In fact, Ben Graham in his Security Analysis said that companies that solely reply on acquisitions will fall. Furthermore, I always thought that Pearson and the rest of management team were making an obscene and unsustainable amount of money. Shareholders are the ones to suffer.
After some of the recent developments, I cannot help but be extremely disgusted and call the company “utter crap”! In fact, Buffett’s second in command, Charlie Munger, called the company “sewer” during this year’s Berkshire Hathaway shareholder conference. I think Mr. Munger was being too generous with his term. I truly think the company is toying around with the investors in an extremely disrespectful manner.
For one, the company has a record of lying to investors and playing with the numbers. Logically, I find it exceedingly difficult to trust this type of company. Based on my own experience, organizations and companies, once have developed a sense of financial irresponsibility and and have tasted the sweetness of dishonesty, are past the point of a falling off cliff where they could be saved.
Second, the newly hired CEO, Joseph Papa isn’t a glamorous saviour either. First and foremost, let’s not get ahead of ourselves and think Papa will easily turn the company around. The drug maker has over 30 billion dollar in debt and its market cap is less than a third of the debt. Making a U-turn with a bunch of distrustful investors at this stage of the development would be difficult for anyone. However, my point is, Papa’s record is not perfectly clean either. After he left Perrigo, the new CEO John Hendrickson told the public that the guidance Papa left him to deal with, was “unacceptable.” Okay, so Valeant brought in an exaggerator at best, and a liar at worst, to fix a dishonesty issue. It isn’t a good start.
Third, debt is not the end of the world for a company. However, even in a college finance class, students are taught that in order to pay off the debt, you either have to sell out existing assets or have a solid cash flow. I do not see in any way that Valeant can continue its old operating system with historical levels of cash flow. I say that for two reasons. 1) is that Valeant historically relied on jacking up the drug prices. With the spot lights now fixed on it, and the mass population pressing for a change, both parties in the United States will be more than willing to make a political move to change the current pharmaceutical pricing problem. Valeant executives have already been summoned before Congress and they promised to lowed the drug prices. Valeant’s old cash flow is entirely unimportant in making comparisons to future projections, because it is guaranteed that it will be drastically different.2) Valeant relied on pressing Phillidor to prioritize selling Valeant products before others prior to this year. However, now with Phillidor out of the big picture, Valeant probably won’t find easy and gullible partners like Phillidor to continue its questionable operations. Walgreens, for the sake of its own good, will be more than mindful of its relationship with Valeant as well. The Canadian company will likely feel the impact of some much lowered cash flow in the future.
Fourthly, the company has flip-flopped on the question of sales of divisions. If the company chooses to sell some of its divisions, of course, it will ease the pressure of the debt, but by how much? Any sales at this point will be quite futile. 1) Even if the company made a loose definition of “non-core business” and cashed out on all of it, it would still only take in south of 3 B. Comparing to the gigantic size of the debt, I cannot see much of an effect. 2) If the company sells now, it sends out a message that it is desperate for cash. Its stock will plunge. Ackman essentially made a promise to the retail investors that the stock will hold up at the current level at least. He will do anything to avoid another crash. With J.C. Penny hovering around 8 dollars and Herbalife stock soaring to its yearly high, he is already struggling in a major way. I think he will be extra careful with any decisions Valeant makes from this point on to protect his existing investments, especially now that he is closely involved in the company’s decision-making process. 3) Any sales offer will send out a similar message to the market, hence automatically making it a fire sale. It will be even harsher on the company when it cannot get a fair compensation on its sales.
The company is also being investigated by the SEC. I believe that a company should not have a drastically different number on its GAAP and Non-GAAP accounting sheet for a long stretch of time. Typically, differences can emerge when there accrues a number of one-time payments. This way, the adjusted Non-GAAP number would seem more attractive because it does not account the one-time expenses. However, in the case of Valeant, the temporary phenomenon seems to be more permanent than it should be. I would not be surprised if the company has more negativity to be revealed in the future about its accounting methods and operations. I am highly disappointed that Valeant’s mistakes, be them intentional or un-so, have caused millions of people to lose their pensions and the market to suffer.