When the latest sequel of the saga was published, the investing world took barely notice:
Last year, the Canadian drugmaker doubled the price for Seconal, also known under its generic name secobarbital, one month after California lawmakers proposed to legalize physician-assisted suicide.
How could anybody still be surprised or shocked by this - after months of bad news coming out of Valeant (NYSE:VRX) and all the attacks because of "price gouging"? And what does it mean for investors when bad news isn't noticed anymore? Is the bottom in?
One might quip that Valeant is clearly an expert in the field: Its own suicide was pretty expensive as well. The company lost ~90% of its market cap within less than one year. But was it really suicide - and not maybe murder?
(As a note aside, Valeant has explained that it raised the price for Seconal far before the law passed and that the use for assisted suicide is an off-label use. Yet, this statement hasn't made it into the news - something followers of the saga are used to as well.)
It appears that for some time important shareholders saw the crash as caused by others and not so much by the company's own actions. At least until a few weeks ago. Bill Ackman put the blame several times on "bad PR". Glenn Greenberg talked about a "witch hunt".
Back in October 2015, the company's largest shareholder, the legendary Sequoia fund, wrote a letter to investors which is interesting to consider again, especially since the Valeant stake has caused a lot of turmoil at the fund:
We have been asked by clients and friends why we own such a company. In our view, Valeant is an aggressively-managed business that may push boundaries, but operates within the law. When ethical concerns arise, management tends to address them forthrightly, but in the moment. We would stress the importance of taking a more systemic approach to managing business practices with an eye on the company's long-term corporate reputation. We believe the company will learn from the current crisis the importance of reputation and transparency to all stakeholders, especially the shareholders.
So far Sequoia seemed to support Mike Pearson's "unusual, but legal" line of defense and saw the most important issue in "bad PR" (or something similar) as well. The letter closed as follows:
The company has a robust pipeline of new products and has said that it will not need significant price increases over the next three years to achieve double-digit earnings growth. In 2016, we believe Valeant should grow earnings by at least 30%, generate free cash flow in excess of $4 billion and have the liquidity to pay down some of its bonds before their scheduled maturities. At a recent price of $110, Valeant trades for about seven times the consensus estimate of 2016 cash earnings, which does not strike us as a rational price for a company with a diverse collection of product lines and strong earnings growth.
- Well, this sounds really bad today. The stock now trades for less than 30% of $110, earnings and FCF estimates have come down drastically, Sequoia's legendary CEO Robert Goldfarb retired and the firm's Valeant analyst left. This tells us how much fundamentals have changed in the eyes of the firm. And this change materialized only recently. So Sequoia did not change its mind based on short attacks, Philidor revelations, bad press or "unusual, but legal" practices. Otherwise the fund would have changed analyst earlier and maybe sold its stake. (It still hasn't sold, however, besides some minor sales for tax loss harvesting.)
So what is it that has changed?
Well, when a company accuses its former CFO and ex-interim CEO of "improper conduct", this is nothing to sneeze at. Howard Schiller used to have the full trust of all major investors and was a close friend of Mike Pearson. The fact that Schiller denies any wrongdoing adds only to the drama. We can imagine the board of directors communicating through heavily lawyered letters - not exactly what a company needs in times of crisis. After all, this very same board has only four weeks to avoid a default by finally presenting its delayed 10-K.
Michelle Celarier reports on Fortune that this won't be easy:
According to a person close to members of the board, the problem was that the board was "freaked out" about its potential liability if it signed off on its internal investigation into the alleged improprieties surrounding Philidor. And the board had to sign off on the internal investigation before Valeant could get audited financial statements.
This confirms my early deductions in " The Valeant Endgame Has Begun":
Without the Philidor report the auditors can't sign off on the 10-K. But the Philidor report is not ready yet and won't be, according to the company, for a long time. (But then Nomura says the Philidor report is "almost complete". - If you accurately read all the sell-side accounts of the recent private conversations with management, they are only apparently telling the same story.) Why that? It can't be just the already announced earnings restatement. There must be other issues in this case.
In fact, we just need to read the standard certification CEOs and CFOs are required to sign:
"Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; …"
So, if CEO and CFO want to avoid civil and criminal penalties for intentional or grossly negligent misstatements or omissions, they will have to wait for the completion of the Philidor report. After all, it's in their best interest to dig as deep as possible, as only when the facts are known, accounting and financials don't risk to be materially misleading.
However, this means that the board's interests and the company's interests are not aligned at this point. Valeant risks a default if the 10-K is delayed, while the board might risk criminal charges if it accelerates the filing.
I had first thought that bringing in a new CEO would have improved the odds of a timely filing. But who in his right mind would sign off on a 10-K in such a situation and only a few weeks after taking the job? So the stalemate on the BOD will need to be solved. But mutual trust has gone.
The above mentioned Fortune story also confirms that Bill Ackman has been working for some time behind the scenes to oust Mike Pearson. (My readers understood this three weeks earlier.) ValueAct and Ackman, who both have two representatives on the board, apparently can't stand each other. Howard Schiller is still tied to his seat. Robert Rosiello, Schiller's successor and current CFO, came in only in June 2015 and might not want to sign off on the mess created by those who managed the business before his arrival.
Quite frankly, all this does not look like a murder. Hillary Clinton and short sellers have certainly damaged the company, but if things had really been as clean as Bill Ackman in his legendary 4-hour conference call back in October seemed to intend (and I believed myself), Valeant would not have fallen so deep. Mike Pearson would not have lost his job and Robert Goldfarb and his Valeant analyst would still be working for Sequoia.
So, to a certain extent, Valeant has done the job alone. Its fall was a suicide, certainly assisted and accelerated by politicians, disgruntled competitors, PBMs, short sellers that jumped on the occasion and a sensationalistic and often incorrect media treatment (which everybody should expect in such a situation). Yet there is no innocent victim and it was no murder.
- So, is the bottom in? Have we reached the bad-news-panic peak? Have all potential sellers finally sold?
From my conversations with fund managers I am not so sure this is the case. I still sense a stubborn rest of the almost blind trust in Mike Pearson and Valeant's supposed superiority. Some believe the company will rapidly present an excellent new CEO which will be cheered by the market. Others believe the 10-K will be filed surprisingly soon and the Philidor report will show how clean everything really was. Somebody told me that Pearson was brought back in with the intention to sacrifice him to the bloodthirsty enemies of the company, so that they, in exchange, would discontinue the hostilities. And obviously if the earnings guidance was heavily "sandbagged", there would be nice surprises.
For some time, I had fallen for this kind of narrative as well. Yet, after the delayed earnings call and encouraging messages delivered to the wider public by friendly analysts - then dramatically disappointed by the disastrous 3/15 conference call - I think Valeant investors should honestly ask themselves what would need to happen to trigger a sell order.
If every bad news is immediately spun into a positive one, investors need to find out if they are actually giving the company any chance at all to disappoint them.
Psychologists know the phenomenon of the so-called "Stockholm syndrome",
in which hostages express empathy and sympathy and have positive feelings toward their captors, sometimes to the point of defending and identifying with the captors. These feelings are generally considered irrational in light of the danger or risk endured by the victims, who essentially mistake a lack of abuse from their captors for an act of kindness.
Stockholm syndrome can be seen as a form of traumatic bonding, which does not necessarily require a hostage scenario, but which describes "strong emotional ties that develop between two persons where one person intermittently harasses, beats, threatens, abuses, or intimidates the other." One commonly used hypothesis to explain the effect of Stockholm syndrome is based on Freudian theory. It suggests that the bonding is the individual's response to trauma in becoming a victim. Identifying with the aggressor is one way that the ego defends itself. When a victim believes the same values as the aggressor, they cease to be perceived as a threat.( Source)
Analyzing the situation along these lines, there is an surprising amount of analogies, especially if we consider the enormous importance of Mike Pearson for the Valeant saga. For many investors, he was the omnipotent, trusted father figure. Everything that was going wrong with Valeant happened without his fault. When investors suffered, they suffered with him (his shares lost value as well). Yet Mike Pearson has already conceded (as was confirmed in the Sequoia letter) that concealing Philidor was "stupid". Investors affected by the Stockholm syndrome immediately applauded his blunt honesty - but ignored the damage this stupidity inflicted on them. They certainly did not expect Howard Schiller to be accused of improper conduct. And nobody had expected the company to misstate revenues.
Yet it is tough to escape the vicious cycle of the syndrome because, as the theory explains, you have to identify with the one who causes you harm to defend your ego. Having trusted the wrong people means to recognize your own limits and stupidity. It hurts.
But it's even more stupid to sheepishly follow them on their path towards suicide - which dozens of enemies hope to accelerate.
That said, Valeant can still get out of the mess it created. The stock will certainly recover in this case. For me, however, it remains uninvestable as long as the Philidor report has not been filed along with the 10-K and the chaos on its BOD hasn't found a solution. There is a not-so-small chance Valeant goes bankrupt and I really don't see why I should entrust my money to a company that has betrayed my trust so many times.
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.