Every Hedge Fund’s Best Friend – Valeant Pharmaceuticals

By Mahir Chadha ’18

In 2006, Valeant Pharmaceuticals was priced at $17.21 a share, a bargain for a high growth company with incredible potential. Over the next 10 years, Valeant became a favorite of “smart money” hedge fund managers including John Paulson of Paulson & Co and Bill Ackman of Pershing Square Capital Management. The rise of Valeant began with CEO, Michael Pearson’s business model.

Pearson believed that internal research and development was cost-inefficient and rarely resulted in exciting returns. Thus, Pearson sought to create a pharmaceutical giant that focused on acquisition and distribution. He stripped Valeant’s R&D funding and let smaller companies focus on the research. The plan, controversial at its core, required constant purchasing of these smaller companies. Consequently, Valeant piled on sizeable debt ($30.2 billion by the end of Q4 2015). But it seemed to work. Valeant’s stock rose to a high of $260 in 2015.

Valeant’s crisis began with Martin Shkreli, the CEO of Turing Pharmaceuticals, who infamously raised the cost of a life-saving HIV drug by 5000%. The ensuing federal investigation of Mr. Shkreli’s tactics caused the judicial system to question the prevalence of price gauging across the entire pharmaceutical industry. Thus, on October 14th, Valeant received a federal subpoena over its pricing strategy – buying drugs that it thinks are mispriced and hiking prices.

In the meantime, Valeant was also accused of accounting fraud for the miss-representation of information regarding its subsidiary Philidor. In an investigation conducted by Wall Street Journal, Valeant employees were discovered to regularly conduct business with Philidor and use phony aliases to hide their tracks – Valeant used Philidor to fake sales and increase revenue.

Magic – Once the trick is revealed, the audience is less mesmerized by the performance and so were investors. Valeant’s stock dropped 64% to $94 in less than a month. Under a severe liquidity crunch, Valeant faced the uphill task of repaying the existing amounts of debt. Valeant currently holds approximately $1.2 billion in cash on hand, but the major concern is Valeant’s inability to generate enough future cash flows to serve its debt obligation. With no multi-billion dollar drugs on shelf, dwindling relations with clients and limited R&D, it seemed like Valeant may file for bankruptcy.

Come March of 2016, and Valeant is at it again. Valeant failed to file its 10-K before March 16th, adding strength to the claim that Valeant may just default on its loans. Investor’s reacted swiftly as the stock plummeted another 72% to $26.98. Standard & Poor’s also announced that it will review (likely further downgrade) Valeant’s credit rating, which currently rests 4 levels into junk territory.

Will Valeant fail? The 10-K will answer all concerns. Come April, Valiant must disclose its 10-K and either demonstrate its ability to pay off its debt obligations or default and file for bankruptcy.

Bibliography

http://www.marketwatch.com/story/valeants-stock-plunges-but-jp-morgan-stays-bullish-2016-03-16

https://marketrealist.com/2016/03/will-valeant-able-manage-huge-debt/

http://fortune.com/2015/10/31/valeant-scandal/

http://www.cbsnews.com/news/martin-shkreli-charged-with-securities-fraud/

Image:

http://assets.bwbx.io/images/ij6SHq7dZCIs/v2/-1x-1.png

http://chart.finance.yahoo.com/t?s=VRX&lang=en-US&region=US&width=300&height=180

 

 

 

 

 

Filed in: Economy

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