SHORT SELLER: This is the 'smoking gun' that is making a pharmaceutical company look like Enron

Valeant Pharmaceuticals is being accused of an Enron-like fraud.

Short selling firm Citron Research released a report highlighting its mysterious relationship with Philador, a pharmacy that distributes drugs for specialty pharmacies, which it has the option to purchase.

After the report was released the stock fell 30%.

Citron says that Valeant has been using its relationship with Philador to file fake invoices and make its revenue appear greater than it is. Valeant is Philador’s only customer, Citron points out.

This is a jarring turn of events for a company that has been a Wall Street darling for years. Until last month, the stock had risen almost 120% in the last year. Then Valeant came under scrutiny when government officials started asking questions about price gouging at pharmaceutical companies.

House Democrats floated the idea that Valeant CEO Michael Pearson testify before Congress; federal prosecutors in Massachusetts and New York have subpoenaed the company; and Senator Claire McCaskill (D-MO), chair of Senate Investigation committee, has started looking into the company. Then the New York Times and other media outlets started looking into its relationship with Philador.

Its stock has fallen 50% since.

For over a year, though, short seller Jim Chanos — the hedge fund manager who alerted the public to Enron’s massive accounting fraud — has said that the company is a roll up. A company that uses shady accounting and serial acquisitions to hide that it lacks organic growth.

The smoking gun

It wasn’t until Monday, on Valeant’s earnings call, that it disclosed that it had the option to purchase Philador. It also tried to explain why there is a strange lawsuit filed in California court between it and another pharmaceutical company that acts as a distributor for Valeant, R&O.

In the lawsuit, R&O says that Valeant sent it an invoice for $US69 million — an invoice for products it never received.

Valeant, for its part, said during its earnings call that R&O sold a bunch of its product and was holding more.

And here’s a key part: The Valeant products that R&O sold are booked as revenue for Valeant. Those that R&O still holds are not.

“R&O has never received a single invoice from Valeant in any amount and until September 4 had never received a single demand for payment from Valeant. R&O has requested copies of the invoices, but to no avail. Indeed, it seems that Valeant has no evidence whatsoever to back up its claims,” said the lawsuit.

What Citron considers the smoking gun here is that Philador and R&O are actually the same company. Since Valeant basically owns Philador, this would imply that Valeant is invoicing itself to pump up its revenue.

“…it is obvious that Philidor and R&O are ARE THE SAME COMPANY AND SHARE MANAGEMENT. The two companies have the same patient privacy disclosure, in fact formatted identically, on both companies’ websites. Note the R&O website refers to themselves as Philidor,” Citron wrote.

More links to indications that Philador and R&O are on in the same are here and here.

The companies also share the same privacy officer, and the two companies registered all their websites on the same day. Digging deeper, Citron found more pharmaceutical companies with the same lineage.

“It is apparent to Citron that Valeant has created a network of ‘pharmacies’ as clones of Philidor. Why do these exist? Citron believes it is merely for the purpose of phantom sales or stuff the channel, and avoid scrutiny from the auditors,” Citron wrote.

Citron spends the rest of the report pointing to instances where Valeant looks a whole lot like Enron, from its management, to its insistence that it has been transparent in all its dealings.

A walk back

On Monday, Valeant tried to walk back from its business model, saying that it would spend more money on R&D, rely on less on raising prices for revenue, and potentially engage in stock buybacks.

This goes directly against the business model that made it a Wall Street darling — a model that hedge fund billionaire Bill Ackman, the company’s third largest shareholder — praised earlier this month.

“Valeant believes that they are not good at drug development, i.e., or really coming up with new molecules and taking them all the way to the approval process. That’s a — has been historically a very low-return business,” Ackman said discussing Valeant’s R&D spend, which sits at about 3%.

Valeant’s changes would turn it into the low return business Ackman mentioned, but it would likely get the government off its back.

Now, if regulators are seeing this report, it may not have that chance anymore.

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