Price of Valeant shares swelled by 2,631 per cent before plunge wiped out $50 billion in value
The share-price meltdown at Montreal-based Valeant Pharmaceuticals International Inc. serves at least one useful purpose. It’s a primer on stocks to avoid.
Valeant, the largest Canadian drugmaker, has been a stock-market darling, its shares skyrocketing in price by 2,631 per cent between 2008 and August of this year.
But the stock has plummeted since reaching its peak value of $263.52 (U.S.) per share in August to its current $111.51. That’s a two-thirds plunge, wiping out close to $50 billion in shareholder value.
No fewer than six U.S. government probes are underway into alleged Valeant price-gouging; unusual accounting and acquisition practices; and alleged bilking of Medicaid, the U.S. program that provides assistance to the poor and elderly.
Valeant stock began to soar after Valeant appointed as its turnaround CEO one J. Michael Pearson, 54, a London, Ont., native and son of a phone installer. Pearson propelled himself from a lower-middle-class upbringing to a 23-year career at management consulting firm McKinsey & Co. Pearson eventually headed McKinsey’s global pharmaceutical practice.
A troubled Valeant, then based in California, was so impressed with Pearson, its McKinsey consultant, that it hired him as CEO in 2008. Pearson’s business plan at Valeant hasn’t changed since Day One.
He cut the company’s R&D budget to less than 5 per cent of revenues. (Pfizer Inc., by comparison, spends the industry norm of 14 per cent.) He began buying scores of small, run-down drugmakers that possessed one or two potentially lucrative drugs in their otherwise dustgathering product lines.
Quebec-based Valeant’s business model of buying drugmakers and hiking prices on their products created unsustainable growth, David Olive writes.
Pearson immediately hiked the prices of those selected drugs by as much as 500 per cent, while laying off many of the acquired companies’ employees.
In 2010, Pearson engineered a reverse takeover of Montreal-based Biovail Corp. Valeant inherited Biovail’s lingering legal woes, including the recent U.S. probe into possible Medicaid fraud. But in acquiring Biovail, Pearson was able to domicile Valeant outside the U.S., in a corporate-friendly Canada where Valeant’s tax rate dropped to 5 per cent.
Valeant isn’t alone in the drug industry’s relatively new practice of imposing outrageous price hikes. But, as the New York Times recently noted, “the company leading the pack in drug-price increases is Canada-based Valeant.” Fair enough. Between 2011 and 2015, Valeant raised prices on its drugs by 20 per cent at least 122 times.
Why haven’t prospective buyers balked at Valeant’s apparent pricegouging? Some have.
Express Scripts and CVS Health, the two biggest U.S. drug benefit managers, said this year that they would no longer pay for drugs whose sticker shock was not accompanied by any improvement. That describes most of the products peddled by Valeant, Horizon Pharma, Mallinckrodt PLC and other firms in this unattractive niche.
Pearson has snapped up obscure drugs that are used by small patient populations, are life-saving drugs and for which there are few if any alternatives. On Feb. 10, for instance, Valeant bought the rights to two life-saving heart drugs, Nitropress and Isuprel. That same day, Valeant hiked their prices by 525 per cent and 212 per cent, respectively, without doing a thing to improve their efficacy.
These two drugs have been around for decades. Isuprel is used in treating heart-rhythm abnormalities, and Nitropress is administered in emergencies when a patient’s blood pressure has increased to lifethreatening levels. Doctors insist there are few reliable alternatives to these drugs.
But baked into the Valeant business model are dangers. Acquisition targets with hidden gems might dry up. And eventually there could be pushback on spectacular pricehikes, from the U.S. medical community and consumer-rights regulators such as the U.S. Federal Trade Commission.
That backlash has indeed begun, with several drugmakers this summer rolling back triple-digit price hikes within days of trying to impose them.
Where does that leave Valeant, whose M.O. is to maintain its shareprice momentum purely through nosebleed pricing of highly specialized medications? With financial engineering, claims Citron Research, a short seller based in Beverly Hills, Calif.
Short sellers have a bias. They are trying to drive down the price of a stock.
That said, the “shorts” are often right in calling out bad corporate actors.
On Oct. 19, Citron accused Valeant of engaging in fraud, saying it has been propping up its reported sales figures by making “phantom sales” to a network of shell companies. That is a commonplace, if dubious, practice known as “channel stuffing.”
Valeant denies the Citron allegations, which Pearson says are “completely untrue.”
Just the same, an already declining Valeant share price fell off a cliff the day Citron’s allegations were released. And there’s plenty more downside risk to Valeant’s current $111.51 share price, given the U.S. government probes and the likelihood of class-action lawsuits against Valeant.
Do investors really need reminding to stay clear of stocks like Valeant? Yes, obviously.
Valeant has a debt load of about $30 billion resulting from its scores of junk-bond-financed acquisitions. The peak $90-billion valuation that credulous investors placed on a company with a debt-equity ratio so radically out of whack was a triumph of hope — or greed — over experience.
That same lofty stock valuation was placed on a Valeant that lost a staggering total of $1 billion in 2012 and 2013, on sales that, to that point, hadn’t surpassed $6 billion. Any enterprise losing $1 for every $6 it takes in is flirting with a one-way trip to the bone yard.
Growth exclusively by acquisition is a sign that a company can’t or doesn’t care to manage its existing operations. That kind of growth is unsustainable.
Valeant’s revenue growth has exceeded profit growth by a wide margin. Any dealmaker can add sales growth by simply buying another company. A dealmaker CEO always has dozens of deals in his head, and hasn’t the time to properly manage the companies he has bought.
Don’t buy a stock because the “smart money” is doing so. Among the many prominent investors in Valeant are funds controlled by U.S. activist investor Bill Ackman, which have taken a $9.3-billion paper loss on the company.
And don’t expect your broker to save you. On Oct. 22, BMO Capital Markets, an erstwhile cheerleader of Valeant’s “limited R&D and aggressive M&A-driven strategy,” downgraded Valeant stock, saying “we cannot defend” Valeant’s business model.
By that point, Valeant shares had already lost close to 60 per cent of their value.
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