John Hempton’s battle against Valeant Pharmaceuticals (VRX) is not over yet. In his latest letter to investors the founder of Bronte Capital recaps the pharma company’s problems. Although Hempton has covered some of the short he still has a position and he states why he thinks the stock is going to zero.

John Hempton on Valeant follow by the full letter in PDF.

We think these stocks will still collapse. But alas risk management dictated a small reduction in the short book that was probably ill-timed. Some of the underperformance this month was thereby made permanent. We had one very big win in the short book. We had a well-publicised position in Valeant Pharmaceuticals, a major US drug company. This stock collapsed taking many of the best-and-brightest on Wall Street down with it. Valeant has been coined the stock that ate Wall Street.

In particular, the Ides of March again proved to be a day for (corporate) empire-builders to beware. On March 15, Valeant held its long-delayed conference call to announce the results of the 4th quarter and the full year of 2015, though as-yet-unaudited and even today not filed with the SEC. An investigation of Philidor’s accounting—which was not, in our view, the real crux of Philidor’s machinations—revealed double-counting of revenue and resulted in disavowal of prior financial statements.

The company also disclosed a rare and very serious red flag, admitting it had a “tone at the top” problem, which is accountant-speak for “pressure to make the numbers and damn the consequences.” For this and other omissions it sought the resignation of Howard Schiller, former CFO and recent interim CEO, from the Board of Directors. With Valeant’s ills laid squarely at his feet, he declined, and, in the preferred Valeant fashion, issued a press release through his lawyer.

[drizzle]On the call management also revealed that performance had not been up to expectations set at an Analyst Day held mere days before the end of 2015, and forecasts for the future were slashed. There being no greater crime on Wall Street than “missing expectations,” the stock was cut in half.

Though it has sought waivers from lenders for the technical default arising from its delinquent filing of audited annual results, no firm details of their gracious forbearance have been released. (Press reports indicate Valeant has also sought waivers for debt and interest coverage ratios in its covenants, implying that reassurances on future profits previously provided to equity investors are also likely to be “waived.”)

Since then, Mike Pearson, the auteur behind Valeant’s nouveau company-building approach of buying old drugs and raising prices—who eschewed such careless, hidebound pharmaceutical company pursuits as research and development of new drugs—has himself been shown the door. As with all things Valeant, his departure is “pro forma” until a new executive can be found. Bill Ackman of Pershing Square, a large Valeant shareholder, also joined the Board.

It is a great pity however this turn of events did not happen some time ago – because we once had a large put option position on the stock. Only a small amount of that position was left at the end. With different timing we would have produced a high single-digit positive month in USD and been positive in AUD despite the massive adverse currency movement.

This alas is a problem with shorts generally. You need to be right – but you also need to be careful of all the intermediate positions – a stock which goes from $130 to $250 and then to zero (the path we expect of Valeant) doesn’t do a short-seller many favours.

We remain short some Valeant – but the size of the position has been reduced. The stock going to zero remains our expectation. This is one of the two biggest junk debt issuers in the US. We think the default when it comes will have market-wide repercussions.

 

 

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Valeant Pharmaceuticals

Valeant Pharmaceuticals
Valeant Pharmaceuticals

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