A case study on Valeant Pharmaceuticals Intl Inc (VRX) by Whitney Tilson.
A Brilliant Case Study in So Many Areas
Circle of competence
- Arrogance vs. humility
- Will anyone tell you when your shit stinks (and setting up norms and processes to ensure this)
- Portfolio management
-Position sizing
-What do you do when a big position runs up a lot, fast?
-What do you do when a big position goes down a lot, fast? - How to process disconfirming information
- The challenges of companies in heavily regulated and/or politicized industries
- The accounting gamesmanship possible with highly acquisitive companies
- Who to trust – and what would cause you to stop trusting someone?
- When to listen to short sellers (or not)
Valeant Incinerated Three of the Smartest Investors in the World
- Bill Ackman, Pershing Square
- Jeff Ubben, ValueAct (they were on the board)
- Bob Goldfarb, Ruane Cuniff/Seqoia Fund
Despite Munger warning them! Here’s what he said at the Daily Journal meeting on 3/25/15:
After a rant about the conglomerate crazy in the 1960s, he continued (unprompted): “And it’s still happening. Valeant, the pharmaceutical company, is ITT come back to life under Harold Geneen, except the guy’s worse. Worse! So it’s like my story about the unnecessary heart surgery in Reading…However bad you think it is, somebody actually comes by and does it worse. It wasn’t moral the first time and the second time it’s not better. And people are enthusiastic about it! I’m holding my nose. That’s the only correct response.”
Valeant Over the Past Decade
Sequoia Fund Over the Past 10 Years
Sequoia Fund Over the Past 5 Years
Sequoia Fund Since Mid-2015
Sequoia Fund Sold Its Entire Valeant Stake in Mid-June 2016, But Has (Slightly) Trailed the Market Since Then
Excerpt from 2014 Sequoia Letter to Investors
A topic many shareholders and clients wanted to discuss with us in 2014 was Valeant. It is the largest holding in Sequoia by far. One could argue Valeant wasted much of the year on a quixotic effort to buy Allergan, maker of Botox. Allergan had no interest in being acquired and fought a vicious and savvy public relations campaign to portray Valeant as unworthy of marriage to such a prized catch. In the end, Allergan found a suitor more to its liking in Actavis, and Actavis agreed to pay a substantially higher price than Valeant had offered.
In our opinion, much of what Allergan said was wrong but Valeant seemed unprepared for what it should have known would be an aggressive counterattack. The defenses available to the targets of hostile takeovers are considerable and Valeant has now lost three hostile bids for public companies since 2011. Meanwhile, Allergan’s stock price nearly doubled over the past year without so much as a thank you note sent to Valeant CEO J. Michael Pearson.
Some good came out of this defeat. As it fought for Allergan, Valeant stopped making other acquisitions and so stopped taking one-time charges for restructuring and integrating its serial acquisitions. This made its financial reports easier to follow, and more investors came to see Valeant has a fine business. Most of its product categories show strong organic growth, despite claims to the contrary by Allergan. Valeant throws off sizable cash flows. It has very few products vulnerable to patent expirations in coming years. Management has done an excellent job of picking its spots, both geographically and by product category, while avoiding dependence upon a single drug. It integrated the large Bausch & Lomb acquisition flawlessly. And it proved itself capable of launching a new prescription drug, Jublia, with a highly-successful direct-to-consumer ad campaign.
In short, Valeant lost the battle for Allergan but we believe it is winning the war to establish itself among the first rank of global pharmaceutical companies. The stock suffered for much of the year from Allergan’s broadsides, but performed better once the takeover battled ended. We think Valeant is poised for more growth, both organic and acquired. We think it is brilliantly managed by Mike Pearson and his team. And yes, we are comfortable with the size of our holding.
Sequoia turned in its second straight year of poor results in 2015.Teasing out the source of our underperformance doesn’t take much work. We began the year with a 20% weighting in Valeant Pharmaceuticals (NYSE:VRX). Valeant rose by more than 80% through the summer, driving very strong gains for the Fund. But the price collapsed in the fall amid revelations and allegations about the company’s business practices. Ultimately, Valeant declined 29% for the year and by more than 70% from its 52-week high to its low. We bought more shares in October, and we calculate that Valeant contributed -6.3% to Sequoia’s return of -7.3% for the year.
At its peak price, Valeant constituted more than 30% of the Fund’s assets. We’ve been criticized for allowing the holding to grow so large, but our feeling before the crisis erupted was that Valeant was executing well on its business model. Earnings were growing rapidly and we believed the company was making intelligent acquisitions that were creating shareholder value. Valeant was taking outsized price increases on a portion of its drug portfolio, but the entire branded pharmaceutical industry routinely has taken substantial annual price increases on drugs for more than a decade.
As you are no doubt aware, Valeant was rocked in the fall by the closure of an affiliated specialty pharmacy, Philidor, after health care payers said they would not reimburse Philidor for claims it submitted. It has been further buffeted by subpoenas from Congress over its pricing strategies and by regulatory and law enforcement scrutiny over practices at Philidor. A committee of Valeant’s board of directors is investigating the relationship with Philidor. Valeant recently said it would restate prior earnings as it improperly accounted for sales to Philidor in late 2014.
See the full PDF below.
