Whatever other problems Valeant Pharmaceuticals (NYSE:VRX) has, for the moment the focus remains on Philidor Rx Services, a Valeant affiliate that has potentially troubling relationships with its employees, its (possible) parent company Valeant, and state regulators.
Valeant CEO J Michael Pearson (Source: Valeant Investor Relations)
Facing criticism and market uncertainty late last week, CEO Michael Pearson took the weekend to gather materials along with more than a dozen members of Valeant's board and senior management, to provide some clarity. Philidor topped the agenda for the company's Monday morning conference call (slide deck available here). For now, it looks like it's going to take more than Monday's 75-minute presentation to clear everything up.
If the important point was to explain the Philidor relationship, there's probably more work to do. Valeant doesn't own Philidor, but that seems to be only on a technicality. Valeant has an option to buy Philidor for $0, and consolidates the company's revenues on its financial statements. As Matt Levine at Bloomberg argues via some comical org charting, "economically, Valeant owns Philidor."
Ownership of, and liability for, Philidor is important because the legality of Philidor's behavior is in question and as of eight days ago, Valeant had not disclosed any relationship to Philidor. (Michael Pearson says, per WSJ, that management has found "no evidence whatsoever" of illegal activity.)
- Controversy around Philidor takes place against a backdrop of a seemingly broader federal investigation into Valeant's drug pricing and distribution practices. Valeant disclosed receipt of subpoenas on 10/14.
- Roddy Boyd at the Southern Investigative Reporting Foundation on 10/19 published "The King's Gambit," first revealing a relationship between Valeant and Philidor and highlighting the opacity of the latter's ownership structure.
- Boyd's reporting centered around a lawsuit stemming from a demand letter from Valeant to R&O Pharmaceuticals, a relatively small company, for $69.8 million.
- A 10/19 piece in The New York Times mentioned Valeant and Philidor in connection with its assessment that "Use of specialty pharmacies seems to have become a new way of trying to keep the health system paying for high-priced drugs."
- Citron Research published a report 10/21 raising questions around possible channel stuffing and using the phrase "Pharmaceutical Enron" in a headline that, while possibly overstated, drew attention to and supported the SIRF report. Valeant has emphatically disputed Citron's work and called for an SEC investigation.
- Boyd's 10/25 follow up, "The Pawn Isolated," raised questions around whether Philidor and related companies were seeking to end-around state pharmaceutical regulation, particularly California's rules around where drug orders are billed and shipped.
- Bronte Capital puts a fine point on this in the 10/26 post, "Simple proof that Philidor has shipped drugs where it is not licensed."
None of this is helped by opacity surrounding the subsidiary-in-all-but-name. Philidor employees themselves appear to inhabit a world of quantum uncertainty. A WSJ article published online Sunday 10/25 highlighted unnamed former employees' claims that some employees at Philidor used aliases like Peter Parker and Brian Wilson for certain workplace communications. Meanwhile, a Valeant spokesperson acknowledges that Valeant employees were placed at Philidor and operated at the company under distinct names to keep "their internal Philidor communications separate from the Valeant communications, primarily to reduce the risk of incorrectly sharing either company's proprietary information."
It certainly looks, even taking the most generous view of all this, like Valeant management has outsmarted itself. Exotic ownership structures, workplace pseudonyms, and innovative drug marketing tactics are all sources of potential advantage over competitors. But they seem hard to get right, and when you miss, your management is spending its Monday morning with 90-slide decks and 75-minute conference calls.
The trouble for Valeant and its shareholders is that the Philidor story isn't the only risk factor. Valeant has emerged as a poster child for controversy over prescription drug pricing. Furor over price hikes on old drugs prompted a Tweet from presidential candidate Hillary Clinton promising action on "price gouging" in the drug market. Potentially, the pitchfork-and-torches sentiment is a longer-term issue for Valeant, whose business model has fairly explicitly been to buy pharma assets, raise prices, and slash R&D expenses.
Valeant's acquisition-fueled strategy also has its share of detractors. Before and after the recent precipitous declines in share price, valuation of the broad business has been a point of contention. Per some analysis on Seeking Alpha, the floor for shares is much lower.
Ranjit Thomas, CFA, compared Valeant's accounting practices to Tyco's soon after.
The Drug Carry Trade: Valeant's Massively Leveraged Long-Short Strategy Is About To Unwind reframed the discussion around the notion that Valeant is a health care hedge fund, capturing arbitrage profits between its cost of debt and the cost of capital for its pharma assets.
Recently, well-followed healthcare contributor DoctoRx pointed out how dramatically earnings are impacted by the application of P/E ratios to Valeant's GAAP earnings.
Though sentiment has broadly turned bearish, some compelling contrarian takes have emerged. Early Retiree has been providing smart and fast takes on the legality of specialty pharmacies and the level of evidence so far provided by bears. Agloe Capital likewise questions the validity of a Citron Research report that helped precipitate Valeant's recent decline.
Valeant's management is beginning to acknowledge a need for a higher level of transparency. The issue now is that the market seems to require a lot more transparency than it got, and the questions from regulators, analysts, and the media seem to be proliferating rather than abating.
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. I have no business relationship with any company whose stock is mentioned in this article.