Thursday morning I was catching up with an old friend of mine who’s presently an executive at a publicly-traded biotech firm who used to run his biotech hedge fund next door to my old tech hedge fund on the 40th floor of the Texaco Building in midtown. When I mentioned my thesis about how there’s about to be a bunch more pressure on pricing from the government, especially after the positive press and poll reactions to the recent headlines like: Sens. Bernie Sanders and Elijah Cummings are investigating sudden hikes in the costs of older medicines and this morning’s headlines that Valeant Pharma (VRX) Receives Federal Subpoenas Related to Drug Pricing, the conversation got interesting.
Biotech Andy talked to me about the way the biotech world thinks that the government crack down on pricing will be limited to companies and cases like Turing Pharmaceuticals (Company that hiked drug price 5000% now under antitrust probe) and others that don’t innovate many of their own drugs but roll up other drug and treatment companies, including Valeant Pharmaceuticals. I tend to think pricing for lots of drugs and treatments are about to be scrutinized but in the meantime, I started digging into into Valeant Pharmaceuticals because right now it sure is starting to look to me like it could be another great Revolution Investing short position.
“Valeant Pharmaceuticals International, Inc. develops, manufactures, and markets pharmaceuticals, over-the-counter products, and medical devices worldwide…”
The company’s been acquiring drug and treatment products/companies and raising the prices and is now under fire for it. It seems like most of Wall Street thinks the crack down from the government on this trend will come to naught. I think we are just seeing this crack down get started.
The company is a roll-up and I’ve seen a lot of roll-ups in the health care field go up 1000% or more only to end up at zero, such as Health South Rehabilitation and Med Partners Mulligan back ten, fifteen years ago. I’m not saying VRX will go to zero, but I do think that the concerns about the company’s aggressive accounting and the fact that roll-ups can use GAAP and non-GAAP are big red flags.
Speaking of aggressive accounting, Valeant has long been accused of being very aggressive in their accounting from the shorts in the name, which have been massacred over the last five years as the stock has gone up more than 10-fold. Here’s an article from March 2014 as an example:
“In this week’s edition of Grant’s Interest Rate Observer, the newsletter proclaims Valeant Pharmaceuticals a “financialized pharma company” that Grant’s is “confidently bearish” on.
Before going into the details of why, the writer offers a hat tip to noted short-seller Jim Chanos for the idea. Chanos is famous for shorting Enron before it collapsed because of fraudulent accounting.
Grant is critical of Valeant because he sees it as a serial acquirer that hunts for growth “in the stock market, not the laboratory.” He cites the 2.7% of sales Valeant spends on researching and developing new drugs. By contrast, Johnson & Johnson, Pfizer and Merck spend approximately 13.8% of sales on R&D.
This criticism is by no means new. Those who have dared to short Valeant on this acquisition thesis have been badly burned – the stock is up 113% over the past year and 982% over the past 5.
But the newsletter raises some interesting points. For example, before Valeant acquired Medicis in 2012 for $2.4B, the company used to recognize revenue when it was actually sold to the doctors – not when it was shipped to distributor (McKesson). Following Valeant’s acquisition, however, Medicis started recognizing revenue as soon as the products went out to McKesson.”
I’ve no idea if Grant rode his short in Valeant as the stock doubled from its levels when that article came out and I don’t care really. I do think that estimates for this company could start to come down and that would make the stock look rather expensive with its current $60 billion market cap. $60 billion!
Valeant has about a 15 billion dollars in debt vs just a few hundred million dollars in cash on the balance sheet. The stock is trading at 10x this year’s revenue estimates and 11x next year’s earnings estimates of $15, which would be up 40% from this year’s numbers. There’s a lot of expectation for continued price increases and very few analysts if any are modeling in lower prices and margins ahead.
Remember when we were shorting Apollo back in the $50s and rode it down into the $20s when I covered?
It’s now at $12 and probably headed to much lower as I’d always surmised in articles like “For-profit education flunks the test,” “The dark side of educational publishing” and “How to make 90% on a short position.” I clearly covered my Apollo short way too early.
Remember when I was bashing the alternative energy sector and shorting stocks like A123 long before they went bankrupt as solar started losing government support and subsidies (before I eventually turned bullish and got long First Solar after we saw dozens of alternative energy companies go bust) with articles like “How to trade the popping alternative energy bubble,” “Six stocks to get short for 2011” and “Solar firms are doomed and other news“? See also “How to make 90% on a short position.”
I make a lot of mistakes and I’m not going to bet my ranch that biotech and Valeant in particular have topped. But I do think we’ve got a good opportunity to help hedge our broader long growth portfolio with some shorts and puts as the sector could very well be headed for trouble in coming months and years.
I’ll continue to dig more on Valeant and its financials and prospects, but I want to go ahead and get started on a new short position in this name here around $167 per share and plan on adding to this short in coming days and weeks.
I am going to short about 1/3 of a full position in common stock.