Valeant's Thin Ice Strategies Finally Cracked

| About: Valeant Pharmaceuticals (VRX)

Summary

Valeant took advantage of the ACA's compromises to get huge prices for ordinary drugs.

The company was a roll-up that had to skirt the law to keep prices high.

Can putting Bill Ackman on the board help?

As I wrote three weeks ago, the ultimate lesson of Valeant (NYSE:VRX) is not hard to discern. That is, if something looks too good to be true, it is.

Valeant had a simple business model. Buy drug companies, cut the research budgets, monetize them with advertising and price hikes, and then ship the profits out of the country. Their hedge fund backers, I believe, had another motivation. Use the ACA's lack of government bargaining power against American consumers, then lobby to have the ACA rescinded so the scam can go on.

Valeant combined the business sins of three decades - the leveraged buyouts of the 80s, the advertising of pharmaceuticals that drove up health costs in the last decade, and the inversions of this decade, in which companies move their offices to other countries and pretend that money made here is actually made there.

That is not a long-term business model. What's amazing is anyone ever thought differently.

On Monday, Peter Kaye tried a sum of the parts analysis but made a basic mistake, valuing those parts at what was paid for them.

If you don't put new money into a medical brand, it deteriorates. Maybe not as fast as a PC on a foreign wharf, but pretty fast. Bausch + Lomb, for instance, now faces renewed competition from AccuVue, and the same is true for Salix' intestinal drugs. That 28% of value taken out by R&D cuts is money that now has to be put back in, if only to keep formulations current. You take that out of what you'd pay. Valeant's businesses do have fundamental value, but that value has also been larded up with the debt used to buy them.

Does anyone really think that doctors and pharmacists aren't going to read labels to see whether what they're prescribing comes from Valeant and work to see if there is something cheaper available? Do they think outfits like UnitedHealth's (NYSE:UNH) Harken Health unit, whose profits depend on giving the best possible care at the lowest possible cost, are going to keep being victims of mass market advertising, as their patients were?

It's really funny that the "victims" in Valeant's fall are primarily hedge fund managers like Bill Ackman, whom the company has put on its board in an attempt to get past the scandal. But can Ackman, who heartily endorsed former CEO Michael Pearson's old strategy, possibly fix what he helped make break?

You can't outsmart the market indefinitely. That takes the creation of real value. But Valeant has no pipeline, its equity is worthless in an acquisition (the market cap is down to $11 billion, down nearly 87% from its peak just last August) and its previous acquisitions leave more than half the assets burdened by debt.

Detroit Bear is right in that Valeant's problem was not its non-GAAP accounting. But he's wrong in thinking that, with more centralized control, the specialty pharmacies could have been kept secret. It's what I call "Al Capone" thinking, and the only way to keep things like that quiet is by going down a long, dark road that leads to violent crime. It's not something for accountants.

No. Michael Pearson's Valeant was not a drug company based on finding undervalued drugs and getting full value from them. It was a roll-up that required monopoly profits, financial manipulation and (in the end) specialty pharmacy distribution in order to work for as long as it did. It's not Enron, true. It's Worldcom.

The only hope that current or prospective shareholders have is that Peter Kaye is close to being right, that selling the parts and repaying the debt leaves more value than the stock has now. That is, at best, speculative. But those who bought the stock were speculating in the first place, betting that the merry-go-round of buying, cutting, raising profits and marketing, and moving the profits would continue indefinitely.

The music has stopped.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.