Valeant is a House Built on Quicksand

 

Photo: Business Insider

 

Today Valeant Pharmaceuticals International announced a lower earnings forecast and, more importantly, warned that it might miss debt payments. Highly leveraged with a lower earnings potential, Valeant has a big problem, to say the least. I said it before, and I say it now: Valeant’s problem is its predatory business model. This is a model that is inherently unsustainable in the long-term and for Valeant, the day of reckoning has arrived.

Much has been written about Valeant’s strategy of buying up companies and increasing the prices of drugs, especially those with no alternatives. This strategy reportedly accounts for 80% of revenues, making it a hedge fund darling in the last few years. Valeant has neglected R&D, spending just 3% of its revenues on drug development. In contrast, Pharmaceutical Research & Manufacturers of America (PhRMA) members spend an average of 20%. Valeant’s position on R&D is available here, which in essence says that it prefers its M&A model to the traditional big pharma model.

But when all is said and done, big pharma have their own products to stand on, while Valeant is rapidly sinking into the quicksand.  The heated healthcare debates in the US should have given Valeant clues that its pricing strategy would eventually be looked into due to increased Medicare and Medicaid spending on prescription drugs. It took a short-seller to flag that something was wrong with the company but Valeant itself exacerbated the situation by mismanaging the way it handled the crisis.

For one, the company has not been fully transparent to investors and to government bodies. In February, the company belatedly disclosed investigations by the SEC, the DOJ and other regulators into its pricing strategy, an omission so material to investors that it drove down the stock price. These regulatory investigations pose material risks to the companies and failing to disclose can be grounds of investor lawsuits. On 10 March, US legislators accused Valeant of stonewalling an open legislative inquiry. The company delayed the release of its quarterly report and is scrambling to release its 10-K, or it faces higher default risks. The last few months have shown that the company currently scores very low in the trust meter.

All these point to structural problems in Valeant, which need also need long-term structural fixes. The company may start selling non-core assets to raise cash in the short-term but this is only a band-aid solution. The real problem lies in the business model and unless this model is revisited, this company’s days may be numbered.

 

 

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