It's becoming easier to counter attack against Valeant (NYSE:VRX), as the shorts have apparently run out of ammunition and what remains are just stereotyped punches below the belt for campaign speeches. Such is certainly the case of Hillary Clinton's violent attack directed against Valeant. I will obviously talk about the merits of the attack, but let me first share the full event with you as represented by the Clinton campaign:
Ellen Mayberry has been taking a drug that helps her cope with crippling migraines for more than 30 years. Over the past decade, the retail price of that drug has increased - not just a little bit, but by thousands of dollars.
When Hillary Clinton came to Iowa, Ellen saw a chance to share her story with someone who might actually be able to help. She handed Hillary a letter before her speech and hoped that Hillary would have a chance to read it at some point.
To Ellen's surprise, Hillary began reading the letter right then and there.
What follows are subtitled GIFs (!) of the subsequent conversation.
Now, all this was staged. First of all, because there is no need to take the branded drug. There are generic alternatives that cost about $11/shot - cheaper than back in the 1980s. A person that has taken the drug for over 30 years would likely know this. Even more so a person that is able to write the concise, data-packed letter pictured above and precisely distinguishes manufactured "by" and "for". Second, because the target is just too convenient: a non-U.S. company, the poster child for tax avoidance, price gouging etc. - when so many U.S. companies would be available for the very same reasons. I have already shared the following chart in another article:
So these hefty price increases prior to and after the entry of generic competitors are just common industry practice - and probably a necessity, given the sharp volume decline caused by generic competition. In fact, in the case of D.H.E. 45, Valeant keeps the branded drug on the market, but sells only ~200 packages per year. Therefore, these 200 packages need to pay for the maintenance of the manufacturing line and other costs associated with commercialization. (For example, Valeant is required to buy 1,000 packages from its contract manufacturer despite selling only 20% of that.) If manufacturers in such situations just stopped production, the result would be the usual outcry because of the resulting danger of drug shortages and less competition.
This story could end here with the request to the mainstream media to investigate whether Mrs. Mayberry has really been prescribed the expensive branded drugs for all these years. But there is more to it.
In fact, D.H.E. 45 has a very interesting story that in itself explains many of the absurdities of the U.S. healthcare system.
D.H.E. 45 is an ergotamine derivative called dihydroergotamine mesylate and is available in ampules, vials and as a nasal spray to treat migraine headaches. D.H.E. was first patented in 1946. It was produced by Sandoz (now part of Novartis (NYSE:NVS) and later on by the German Merck (OTCPK:MKGAY). So why can there be the possibility to sell it as branded and patented drug over half a century later? - Well, ask the FDA.
In 1962, the FDA started to scrutinize old drugs that had been on the market for a long time without having been tested according to modern standards. As a result of several new regulations, for ergotamine derivatives, there was no change at first: they continued to be available as low-cost medications. However, in 1984, a congressional oversight committee expressed concern regarding the thousands of unapproved drug products in the marketplace, which forced the FDA to crack down on those old drugs. This resulted in heavy burdens for manufacturers that had to run costly trials or, if they were not able to afford them, totally lost their sales authorizations.
Finally, after many generics had been forbidden, in 1990 Sandoz received its FDA patent approval for Migranal nasal spray - nothing else than the good, old dihydroergotamine mesylate. Now it was a branded drug, coming in an equally patented spray delivery system - and was far more expensive. And we cannot say this was not justified, as the company had effectively shouldered substantial expenses.
After Novartis had taken over Sandoz in 1997, the new owner even received its own patent for a new nasal spray formulation. Novartis later sold the drug to Xcel, which then became part of Valeant.
This is how shortsighted legislation put blinkers on the FDA and indirectly contributed to the creation of legal monopolies on drugs that had been around for decades or centuries. Presumably, it would have been far smarter and cheaper for the American public to pay for a few trials and keep most of the then-existing unpatented drugs without putting undue burden on their manufacturers.
What should investors make of all this?
The "headline risk" is obvious. Yesterday's attack caused an immediate panic sell-off and the stock ended down 9%. Yet I don't see much fundamental risk - or at least not an increased fundamental risk after Mrs. Clinton's attack. After months of political scrutiny, increased pricing pressure is presumably baked into stock prices. Valeant has already recognized that mistakes have been made and started the Walgreens partnership that will create substantial savings for the healthcare system by bringing costs for selected branded drugs down to the level of generics. (The partnership is up for a great start, by the way, as was reported today.) I also expect new CEO's hearing scheduled for 2/4 to provide more clarity on the changes implemented by Valeant. In summary, ugly headlines and stereotyped attacks might still cause some price volatility, but as today's recovery demonstrates, the stock market doesn't see increased fundamental risks.
What finally also matters for Valeant investors is that D.H.E. 45 represents just a tiny part of Valeant's sales. The whole Neurology segment is projected to make up about 10% of the company's future sales and D.H.E. 45 is a small part of this. Valeant expects to sell ~200 units this year for revenues of ~$1 million (showing by the way that net revenues to Valeant are only a third of the sticker price mentioned by Mrs. Mayberry).
Valeant also points out that:
Whenever the sales volume of a drug declines, manufacturers must consider pricing adjustments to keep production of the drug viable. Patients are able to choose generic versions of the drug, however, at significantly lower prices. [...] The generic version of D.H.E. 45 (manufactured by Perrigo) is widely available and outsells the branded product by more than 250 to 1. [...] In addition, we must purchase minimum sized batches from our contract manufacturer that far exceed what we sell (1,000 units versus 200 units).
Furthermore, for those that still like to view this story with their stereotype lenses on, it might be useful to consider that D.H.E. 45 had already been part of Valeant's portfolio before Biovail (with Mike Pearson as CEO) took over the company. At that point in time, Valeant was a 100% American company, based in California, just as this whole story is 100% American. U.S. legislators don't need foreign intervention to ruin their healthcare system and drive up costs. They are perfectly capable of achieving their objectives alone.
Disclosure: I am/we are long VRX.
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.