Valeant: Another Philidor?

| About: Valeant Pharmaceuticals (VRX)

Summary

Wellbutrin, a decades old drug with generic competition, is Valeant's 2nd biggest revenue generator, but for how long?

The firm has severed ties with Direct Success, a Philidor-esque specialty pharma that helped sell Wellbutrin by keoping patient co-pays low despite massive price hikes.

Analysts call Wellbutrin's revenue model 'unsustainable,' and there may be some impacts from this development on the 3rd quarter earnings report.

At this point, even the detractors of International Perspective will have to admit that my coverage of Valeant Pharmaceuticals (NYSE:VRX) has been spot-on.

In my September 28th article, I brought up the issue of Wellbutrin and Valeant's 'Philidor-esque' behavior with the drug. Now, according to Bloomberg, Valeant is severing ties with the specialty pharmacy.

Source: pbs.twimg.com

This raises a question: Is Direct Success the last Philidor, or does Valeant have more skeletons in its closet waiting to be discovered?

History of Wellbutrin

There has been speculation on why brand name Wellbutrin does so well after decades of generic competition; some say that the drug is superior to the generic, and looking at the vast amount of patient reviews this certainly seems to be the case.

Generics (Bupropion) marketed by Teva Pharmaceuticals (NASDAQ:TEVA) and made by Impax Laboratories (NASDAQ:IPXL) have come under legal scrutiny, with patients complaining about reduced efficacy and increased side effects.

In 2012 the FDA declared Teva's 300 MG generic not therapeutically equivalent to Valeant's Wellbutrin. While these drugs have been taken off the market, consumer complaints about generic Wellbutrin persist.

With all this controversy surrounding generic Wellbutrin, it seems little surprise that the brand name drug's revenue contribution would hold up over the years - fair enough, but perhaps not to the tune of 90+ million per quarter as we saw in March.

The high sales number suggest something fishy.

The fact of the matter is simple: Valeant has a small (shrinking), but dedicated consumer market for Wellbutrin that it has exploited with price hikes over the years.

A Broken Business Model.

I remember watching Martin Shkreli's analysis of Valeant earlier this year; the stream was broadcast on Youtube and can be found here.

Click to enlarge

Source: Youtube.com

In his stream, Shkreli breaks down Valeant's revenue generating assets in a spreadsheet and comes up with several price targets for the stock using the DCF method.

The most interesting part of this stream was the breakdown of Valeant's intangible assets; the young pharma executive expressed surprise at the ongoing strength of Wellbutrin - a 30 plus-year-old anti-depressant that was still one of Valeant's top revenue generators in the 1st quarter of 2016 at $93 million in a single quarter.

Shkreli states, quote:

"Wellbutrin is one of the great puzzles in life; how this old multi-source generic drug continues to do well is uh, shocking, shocking and amazing, and I still can quite figure it out."

What Shkreli, the poster child of price hikes, did not understand was that Wellbutrin's 'strength' was illusory; the drug offset its flat organic growth with price hikes.

Source: Bloomberg.com

Valeant increased the sale price of Wellbutrin 11 times to a total of $17,000 per year by 2016. Valeant facilitated these hikes through Direct Success. The specialty pharmacy helped keep patient co-pays low and shielded lower income patients from noticing the massive price increases.

The reason why Valeant decided to sever ties recently with Direct Success is unclear, as the relationship isn't often mentioned in the media. The development was brought to light by Bloomberg; apparently, a Valeant analyst, Maris, asked the CEO, Jo Papa, about the distributor during an investor conference call last month.

On Monday the company stated,

"Valeant ceased the marketing relationship with this distributor and stopped seeking to enroll new patients in the program in mid-2016 as we began directing new and existing patients into our larger, consolidated partnerships"

Regardless of the reason why Direct Success is gone, this is an important issue to analyze for VRX investors.

Will This Affect Earnings?

Valeant's separation from Direct Success will probably have minimal effect on the November 8th earnings report. This is a far cry from the massive collapse we saw after the end of the firm's relationship with Philidor.

Even though Wellbutrin's revenue appears unsustainable, Direct success only represented 5% of Wellbutrin sales, and the end of the relationship between Valeant and the specialty pharma will not be too impactful.

However, in the short term, I expect to see a YoY sales decline of at least 5% for Wellbutrin on the earnings report - this is a significant drop for a flagship asset (Wellbutrin is second only to Xifaxin).

Over the long term, as unit sales continue to fall on this drug, revenue contribution will eventually follow unless Valeant decides to increase prices again.

The price elasticity of further price hikes on Wellbutrin may not be as favorable without Direct Success help to keep patient co-pays low.

Source Bloomberg.com

Conclusion.

When a firm's 2nd most valuable asset is a 30 plus-year-old anti-depressant with declining unit sales, along with illusory growth due to price hikes and a sketchy relationship with a specialty pharmacy, it calls into question the strength of the business model. It doesn't matter if you are a VRX bull or bear; I think we can all agree on this.

Investors on either side of the issue must consider two questions: How long before Valeant' business model collapses, and what other skeletons does this company have it its closet?

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.