Shares of Valeant Pharmaceuticals Intl Inc (NYSE:VRX) slumped by nearly 2% today after Allergan, Inc. (NYSE:AGN) officially rejected its latest buyout offer. This is a bit of good news for Bronte Capital’s John Hempton, who is short on Valeant. In a blog post today on his firm’s website, he shared some of the same concerns Allergan’s board raised regarding Valeant’s acquisition proposal.
Hempton dislikes Valeant’s business model
We first reported that Hempton was short Valeant Pharmaceuticals Intl Inc (NYSE:VRX) last month. In his blog post today, the hedge fund manager said Valeant has “the strangest business model” in the pharmaceuticals and biotech sector. The drug maker buys already-existing companies like Allergan, Inc. (NYSE:AGN) and then “strips them of most of their research and development and a large proportion of their other staff and extracts huge margins,” according to Hempton.
He referred to a point made by John Gapper of the Financial Times. He said that if every pharmaceutical company followed Valeant Pharmaceuticals Intl Inc (NYSE:VRX)’s business strategy, then innovation in the industry would come to a grinding halt.
A look at Valeant’s business model
Hempton agreed with Gapper, who said that Valeant Pharmaceuticals Intl Inc (NYSE:VRX) CEO Mike Pearson seems to believe that the pharmaceutical industry spends too much money on drug discovery, which often fails. He apparently thinks this is a waste of money because of the failure rate.
Gapper reported that Pearson slashed Valeant Pharmaceuticals Intl Inc (NYSE:VRX)’s research and development costs down to just 3% of its revenues. Most large pharmaceutical companies spend closer to 19% of their revenues on research and development.
Instead of spending money on research and development, Valeant Pharmaceuticals Intl Inc (NYSE:VRX) gobbles up smaller companies that have debt and also successes in drug discovery. Since 2008, Valeant has acquired more than 35 other companies, including Bausch & Lomb, which it paid $8.7 billion for just last year.
Wall Street likes Valeant
Hempton said clearly investors have appreciated Pearson’s approach, thinking that he “has the goods.” The hedge fund manager said Valeant Pharmaceuticals Intl Inc (NYSE:VRX)’s stock chart looks so good that it must be viewed in “log-scale.” The company now has a market capitalization of more than $43 billion. When adding in the net debt, he said Valeant’s enterprise value nears $60 billion, making it one of the biggest companies in the sector. He states that Valeant’s enterprise value is more than ten times its historic sales, although a bit less than that compared to its current sales run rate. His comment on that though was: “Whatever: this is very highly valued.”
The Bronte Capital chief said that he doesn’t “look at charts much,” however, so he is “inclined to take the accounting (and hopefully tax) issues head on and thus assess Mr Pearson’s achievement.” He plans to address this full issue in a series of blog posts, although he says this is one of the most complicated projects he has ever posted on the blog. As a result, he is unsure how many posts it will take him to fully explain his short position on Valeant Pharmaceuticals Intl Inc (NYSE:VRX).