The author of this article has a short position in ESRX
Who Loses Out If Valeant Is Successful With Their Own Specialty Pharmacy? by Issac Sprecher
I would like to discuss Valeant Pharmaceutical; a stock that is down almost 70% in the past three months and has been much maligned by the media and politicians.
Over the past three years, Pharmaceuticals in general have been the best performing stocks, led by breakthrough innovation, price increases, and more individuals on health insurance than ever before. Valeant Pharmaceutical (VRX) was arguably one of the fastest growing and top performing pharmaceutical corporations in the past three years. Valeant is led by CEO J Michael Pearson a former Mckinsey partner. I won’t bore with you going all the way back to the beginning of Valeant. Instead, I will start with what I think was a turning point for this particular corporation.
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In 2010, Valeant decided to buy Biovali; one of Canada’s largest drug makers. This would appear to be a lackluster merger. However, this deal launched Valeant toward becoming one of the largest pharmaceutical corporations. By merging with Biovali, Mr. Pearson was able to take advantage of a flaw in the US tax code which now allowed Valeant to create an inversion(merge and move their corporate office to a foreign domicile). A company may chose to invert because their tax rate on profits from foreign sources will be taxed at the rate where their corporation is domiciled. If a company does not choose to invert, they are required to pay a higher tax rate when they bring their foreign profits into the United States. For example, some large corporations including Apple, Google, Dell, and Pfizer, have billions of dollars trapped overseas and cannot bring it back to America without paying the high US tax rate. Following the Biovali and Valeant merger, Valeant was able to bring all of their foreign profits to the US, without paying the higher tax rate. Other pharmaceutical have followed in Valeant footsteps; Actavis bought Warner Chilott to invert to Ireland and more recently Mylan bought some assets from Abbot Labs to invert to Netherlands.
Now that we have established the success of Valeant, you may be wondering what the Valeant business model is. Valeant buys approved drugs and inflates prices. Although this is legal, many feel it is unethical. The Valeant business model was successful until Mr. Pearson made a critical error in judgment. In April 2014, Valeant chose to buy Botox maker Allegran. Instead of following the typical route for purchasing a company, Mr. Pearson decided to do this in an unconventional manner. He teamed up with legendary Hedge fund manager Bill Akman who bought shares in Allgeran in order to help Mr. Pearson get the necessary votes needed to complete this merger. I believe that this step was an enormous mistake as it caused much negative attention toward the Valeant bid on Allegran. Mr. Pearson should have gone the conventional route; put a mammoth bid on AGN which shareholders would not be able to justify refusing. In this way, Mr. Pearson would have gotten this prized asset. Instead his competitor, Actavis, led by Brent Saunders swooped in and bought AGN. This was a great buy for Actavis which recently changed their name to Allegeran. Mr. Pearson next bought Salix. This was not an intelligent move under any circumstance as this company had immense accounting issues. However, these issues did not deter Hedge Funds from investing in Valeant. By August 2015, Valeant had become a Hedge Fund Hotel.
On September 21, 2015 presidential candidate Hilary Clinton tweeted against drug pricing. Her tweet, which I am sure you all know by now, was a response to an obscure company in New York; Turing Pharmaceutical which raised an HIV drug overnight by 5,000%. This created a broad selloff in all healthcare related stocks. VRX, HZNP, ENDP, and MNK which all follow the same business models have been pummeling ever since. Valeant, however, has been hurt the hardest . They have gotten subpoenas from the US government on their business practices. I believe the main issue for VRX is twofold; a lack of transparency to their own investors and their accounting methods seem far too aggressive.
Valeant’s lack of transparency stems from their relationship with Phildor RX. Phildor RX was a specialty pharmacy which Valeant ended up purchasing for a 100 million dollars. Phildors Rx was a great way for Valeant to circumvent generic drugs from getting in the way of their own drugs. Phildor would send out drugs to patients and then bill insurance companies afterward, hoping to recoup the payment.
My outlandish theory is as follows. Who loses out if Valeant is successful with their own specialty pharmacy? The PBMS (Pharmacy Benefit Managers). I believe these companies (ESRX, CVS, WBA) are afraid of what might happen if drug companies start selling drugs directly to patients . Drug pricing has not gone down with PBMS, on the contrary prices have only risen faster than ever before. In my opinion, there is no need for a middle men to be involved in dispensing drugs. I believe insurance companies and generic pharmaceuticals should be the ones that motivate doctors which drugs to prescribe to patients, not PBMS. I feel that the reason VRX owned Phildor RX was because, down the road, they planned on getting rid of PBMS. Insurance companies fear this as well because drug companies are more likely to not charge patients co-pays and to bill insurance companies as opposed to PBMS. That would lead to patients not hesitating in filling their prescriptions.
In conclusion, I feel that Valeant is an unethical company and it has low accounting standards. However is their business model that different than large pharma companies who buy late stage de-risked assets and charge a lot of money for drugs that they put no R&D into? I do believe Valeant has some very high quality assets in their portfolio and they will not go to zero. We have seen plenty of companies get fines and have shady accounting and survive. I see Valeant as an excellent takeover candidate based on their 4% tax rate. Companies such as Pfizer, Merck, Gilead, and Bristol Myers who have ~ 25% tax rate should definitely be peaking under the hood based on their much lower tax rate.