Entering text into the input field will update the search result below

CVS, Express Scripts And United Health Jumping On "The Hate The Valeant" Bandwagon

Oct. 30, 2015 8:15 AM ETBHC3 Comments
Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

CVS, Express Scripts and United Health Jumping On "The Hate The Valeant" Bandwagon

Always a hot topic US presidential drug reform. Sentiment sucks when every news publication and regulator in the US are battering Valeant. However, when Valeant buys a company they want to get their money back. Their drugs are off patent so they have to raise costs in order to get their money back. Furthermore, patients are not hostage to their drugs, there are other drugs they can use.

The reason CVS, Express Scripts, and United Health are all jumping on the bandwagon, is that Valeant's experiment with Philidor is a brilliant competitive advantage. Cutting out CVS, Express Scripts, and United Health is cutting out the middle man. All these health insurance companies i.e. United Health, have to compensate Philidor for the product, hence, they are trying to punish Valeant, which is why they are all jumping on the Valeant hate bandwagon. Valeant is merely trying to save costs and provide a better service to their clients. It is not illegal for Valeant to own a specialty pharma company. Why would they disclose their connection with them if number one, they legally don't have to and number two, it is a competitive advantage? CVS has approx. 68,000 pharmacies and other specialty pharmas like United Health and Express Scripts have a network of patients that they provide health insurance plans to. Therefore, these insurance companies want pharmaceutical companies, such as Valeant, to yield to specialty pharma companies such as themselves. Valeant has shown that it realizes that some of the drugs they have acquired are mature drugs. It makes sense for them to squeeze out as much cost as possible, hence the competitive advantage. Why not set up a specialty network, to take away from CVS, Express Scripts and United Health. These specialty pharmacies i.e. Express Scripts are not saying anything about numbers when they say "non-compliant" further adding to the bad sentiment on Valeant.

Valeant is being shoved into a corner by regulators, politicians and now industry partners. Now Valeant has some really cool brands, and a tone of excellent brands and products. So when is this really done? Hypothetically speaking, let's throw out all estimates for next year. Let's assume no growth, no acquisitions, on less than 11X 2014's last years fiscal earnings. 2015 is well north of 3 quarters done and on track to earn approximately $11.85 a share. That equates to approximately 8X current earnings. Even though consensus for 2016 is for 30% cash earnings growth which would imply less than 6X earnings this is extremely cheap even if we assume zero earnings growth from 2015 to 2016 and still trading at a huge discount from the industry. While I understand that the market in general doesn't like the lack of clarity and seemingly non-stop headline risk, a rational investor has to stop and think to themselves, when am I going to value something on the financial facts or fundamentals, vs. just the bandwagon sentiment. I am not trying to defend Valeant of any wrong doing or any responsibility, one thing I know is that management has been an incredible allocator of capital and will move forward from this and adapt to the environment. Everyone thinks that the model of acquisition is now dead because the capital markets are gonna shun Valeant and raise interest rates, but the other side of the equation is that asset prices have come down dramatically and meanwhile Valeant has still created a cash generating machine of itself and can significantly create value just by focussing their free cash flows towards share buy back and debt repayment.

Valeant is vertically integrating a specialty pharma which is not illegal. Strategically this makes sense!! This will help them retain profits. Here's the interesting thing, Valeant may have been trying to cut costs, to get the product to patients. So you can't fault them for that, but the industry is trying to punish them for it. So these headlines with ES and all of them, so they want to distance themselves from public scrutiny but also don't be trying to "squeeze us out of the equation". So I'm actually feeling better about Valeant. So Valeant could all of a sudden say guess what, we are going to keep going forward with this type of arrangement and we are going to aim to build our own network of specialty pharmacies. If ES and all of them are trying to say "no we see what you are trying to do and you are trying to squeeze us out of it", this clearly is a huge positive for Valeant. See forbes article link here:

www.forbes.com/sites/stephenbrozak/2015/...

I'm not pretending to know that I know for sure, but to me it sounds like the bandwagon. First, it was said that Veleant was the only supplier to Philidor but now CVS and Express Scripts (ES) and United Health is dropping Philidor because of "non-compliance with the terms of their provider agreement"? So what did they discover? So… if it is not significant, how much did the Philidor network contribute to Express Scripts, United Health and CVS… I am guessing it was very insignificant if they didn't disclose numbers, but obviously worth more to them in terms of sentiment to completely cut ties and distance themselves because of the public scrutiny. Why is CVS, Express Scripts and United Health not getting into any trouble for only discovering this now? Why didn't CVS and look into this before!? Clearly, if this didn't become a public outrage they would continue having this non-compliant connection. Wait,.. Valeant has been getting beaten up, so why are CVS, Express Scripts and United Health saying Philidor is now non-compliant? ES is now saying they are dropping Philidor and saying they are investigating other Valeant drugs. Ironically, Express Scripts is a pharmacy benefits manager which is technically a specialty pharma company. OK, I would understand if this Philidor made up 50% of Valeant pharma sales but it represents merely 7%… LIKE COME ON!?*&^? Bill Ackman is a billionaire and lives in a $100million dollar condo in NY and he's getting up tomorrow to deal with this. Believe me he doesn't have to! :-)

Valeant missed this, just like CVS clearly missed this. There's 352 million shares outstanding on Valeant, Ackman hasn't sold, Value Act hasn't sold and Sequoia hasn't sold. Valeant's previous strategy was that they were spending a lot on R&D so Pearson was brought on by Valeant at the good advice of Value Act because they liked him and because he was the head of a Pharmaceutical advisory consultancy, Mckinsey where Pearson worked. Pearson stepped back and said that spending all that R&D yields a low Return on Investment and advised Valeant to look at acquiring already established drugs and companies (another form of R&D), while slashing R&D budgets and squeezing synergies and using internally generated cash flow to pay down debt. So Value Act liked what they heard so much that they helped persuade Valeant's board to offer him a job.

Berkshire has never once created anything themselves, they bought Burlington Northern and Heinz's. Valeant has done the same so don't count Valeant out! History has shown, and will likely prove again that it's overdone. The only way I would count them out is if there's evidence of widespread fraud. But if it's because they got involved with the wrong specialty pharma company then no. How can you blame Valeant when they are acquiring the amount of companies that they are? It is not always easy to know what is happening at the front lines, there's always way more going on than anyone can know and impossible to know what certain groups are doing. For example, let's just take a reputable bank like Wells Fargo that, for argument sakes, has a small subsidiary in Argentina, and there are some corrupt people working in a small office down in Buenos Aires, does that mean ALL of Wells Fargo is corrupt and dishonest? I beg to differ, NO, there are mostly honest good people working at Wells Fargo. The exact same thing is what Citron and other irrationally thinking and emotional people are trying to say about Valeant. But I am willing to say that there are a lot of mostly honest good people working at Valeant a reputable company supplying important medicine to the world. If I was to listen to all these corrupt irrationally thinking people and sell these assets then I wouldn't be the successful investor that I am and I would sell my shares and lose… BUT obviously I am not going to. I'm not going to follow the heard.

The point is this, when you're running a platform company and something isn't right on one side of it, it doesn't apply that the whole thing is a sham. A couple of years ago at Berkshire Hathaway, there was an executive caught for personally having traded shares in a company called Lubrizol a chemical company that Berkshire Hathaway was considering to bid on and this executive was likely considered in the know. "Will the Sokol-Berkshire-Lubrizol Affair Hurt Buffett?". Moreover, even if there was really shady stuff going on at Philidor it doesn't necessarily make upper management necessarily in the know that there was anything going on there at all. Rightly so, Valeant is in the legal process right now to ascertain whether or not anything uncouth was going on. This legal process can take time as we all know.

Think about Berkshire Hathaway and Bill Ackman's comparison to Berkshire Hathaway. Think of Valeant as a platform company, which grows by acquisition, however, because the investment community is unable to see the next acquisition, they are constantly unable to fairly value it. So for example, Ackman in his presentation said that when Valeant acquired Baush and Lomb, Valeant was trading at around $85 but when they announced the deal it made the investment community finally appreciate it because of all the earnings accretion and what not.

Based on a very conservative discounted cash flow analysis assuming 2.5 billion in free cash flow and growing at 3% for the next 10 years, 1 % long term after that with a discount rate of 10% and a terminal rate of 4% I calculate an intrinsic value of $50.4 billion US dollars vs. a current market cap in after hours trading of $34.3 billion US dollars. I think it's overdone.

Valeant is now trading near the price where it was when it announced the acquisition of Bausch and Lomb. What if people start analyzing the break up value of all these assets? Surely they'll be looking at all of this and saying this is just stupid right now.

Allergen got charged for health fraud today because a unit of theirs was called into question. Something about a unit that had been acquired. An example of how these companies, in this case Allergan, have become so large that there are some units within that aren't always compliant with regulations. This Valeant ordeal is stupidly overblown because of a corrupt short seller Andrew Left with no credibility that when interviewed, sounds like thug from the wrong side of town. Let's just say that this is one of the biggest buying opportunities for Valeant stock trading at merely 6x earnings. That said, the market hates all the negative sentiment, even though Valeant is said to grow earnings by 30% earnings, with a projected return on equity of 45%. Today the price of the stock got to 127 US and after hours it is trading at 95US.

If I believe the long term earnings power of this company is strong and nothing has changed (which I do), I'm going to buy it! If you believe that there is no fraud (and I don't believe there is) you can't tell me that this company isn't going to deal with this and move forward, can you? Even if there is fraud at this small company Philidor, which Valeant has an agreement with, it does not mean that Valeant's upper management was fully aware of it.

Valeant's top 30 drugs represents approximately 20% of their sales. And I get the whole concern that they have 30billion in debt, but they have 4billion in free cash flow next year which they can use to pay down debt, buy back shares, or use it to acquire additional assets.

The question now becomes has this gone too far? Is this just panic and has the sentiment gone too far? I believe, the stock has good support here because of the valuation multiple of 6x projected consensus earnings which will likely not be adversely affected considering Philidor makes up approximately 7% of sales right now.

Sequoia has talked to lawyers and they have said that Valeant hasn't done anything illegal. Albeit, Valeant did not disclose their relationship with Philidor but neither did CVS, United Health nor Express Scripts. We know Valeant did not disclose their agreement with Philidor because technically they legally did not have to disclose it as it was not over 10% of their sales. Why didn't these other specialty pharma groups not disclose their relationship with Philidor previously? In reality if you run a business and you are not required to disclose a competitive advantage then why would you? And in this case it appears that this competitive advantage may have some other things that Valeant was not aware of. The perfect storm.

Valeant has always had critics because it is an easy industry to pick on because of drug prices and because it used to be a US company that inverted itself for tax purposes. So when Hilary Clinton talked about it, it reignited all these critics, which is why now I believe it is a good time to buy. To the CEO's defence, Valeant didn't disclose Philidor because they did not have to for accounting reasons and that it may have been a competitive advantage. Even Forbes says it's overblown. Furthermore, companies that are dropping Philidor now, are jumping on the bandwagon trying to distance themselves from any potential wrongdoing.

Once in awhile you get involved with the wrong people in your life. So who's to say Valeant didn't get into the same situation?

So what might happen is Valeant may also cut ties to Philidor and because they are now dealing with Philidor head on, the stock will probably rally because they are dealing with it and will, in addition, pay down debt with a possible share buy back. My take on it is this, just a guess because I have no insight but right now the stock is getting crushed. Express Scripts, United Health and CVS etc have some sort of agreement with Philidor so just to protect themselves, they are pre-emptively terminating agreements with Philidor even though they have no financial loss, simply to protect their reputation and also to send the message to the industry, as they are the middle men trying to protect their place in the supply chain, to not get any ideas that this is a feasible solution to cut costs. That's my take on it.

The market participants pretend that the acquisition growth model is done as though that's the only thing Valeant has done. On the contrary, they will adapt to the situations and if they feel there's an opportunity to buy back dept they will or other such opportunities. There is not a one size fits all scenario. I don't think Valeant meant to do any of this. If there was fraud then the first thing you would look at is cash flow statements. If accounts receivables explodes or gets out of wack in relation to let's say sales, then there could be some sort of suspicious activity there, but because they've all been moving in line together then it is highly unlikely. Nonetheless, Valeant I am sure will get to the bottom of it.

Here's the other thing, there might be a massive international company out there that says "Hey!, we really like Michael Pearson" (CEO of the year in Canadian Business Magazine) and Valeant because of the assets they own. This could get really interesting.

The storm will pass at some point. Instead of running, people should be sharpening their pencils. Valeant after the investigation may decide to get rid of Philidor, or acquire them, or who knows?

Analyst's Disclosure: I am/we are long VRX.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Recommended For You