Not since the financial crisis has a multi-billion company seen its fortunes change as quickly as Valeant Pharmaceuticals.
In the past week, questions have emerged about its business practices that surprised investors and analysts who follow the Canadian drugmaker, and the market’s response has been brutal — about $US20 billion was erased from the company’s market value in just five days. At the center of it all is Valeant’s dependence on a previously unknown invisible web of specialty pharmacies that distribute its drugs directly to customers at a discounted co-pay rate, bypassing insurers.
On Monday at 8:00 a.m. EST, the company will hold a conference call to respond. How the company handles that call will determine the narrative for the foreseeable future.
To calm investors, Valeant will have to explain the details of its relationship with the specialty pharmacies: How many of them exist under Valeant’s umbrella and which of them does it own directly; how are they operated; and, how is their revenue accounted for.
Analysts aren’t sure about any of these, even though the specialty pharmacies — which seem to lean on a massive telemarketing operation to push Valeant’s products — could account for more than 10% of the drugmaker’s sales.
After all, many investors never even knew that Valeant owned any specialty pharmacies until last week. Until then, they were a secret.
Out with it
Doubts surrounding Valeant’s business model have been floating in the ether for about a month, with politicians from Senator Claire McCaskill (D-MO) to House Democrats asking questions about its pricing practices.
Those questions mounted on Monday, when Valeant revealed that it is the partial owner of a firm called Philidor.
Philidor distributes Valeant products exclusively and Valeant integrates Philidor’s revenue into its own balance sheet. Valeant also has the option to buy the specialty pharmacy, which in the last few years has grown to 700 employees in Pennsylvania and Arizona.
Valeant also revealed that Philidor is engaged in a lawsuit with another member of its network, R&O — a California-based specialty pharmacy. Valeant says R&O owes it $US69 million in sales. R&O says Valeant has never billed it.
It turned into a full-blown crisis on Wednesday whe short-selling firm Citron Research accused Valeant of accounting fraud. It offered the R&O case as proof, positing that Valeant was booking sales that never took place.
Valeant’s stock cratered 20% that day. Not even a 2 million share purchase from Valeant’s biggest champion and third largest shareholder, investor Bill Ackman, could stop the selling.
Things only got more confusing after the market closed. Around 7 pm, Philidor revealed that it has the option to purchase R&O and that R&O’s revenue is consolidated onto Philidor’s balance sheet.
All of this led analysts at BMO to say they could “not defend” Valeant’s business model any longer.
“Based on our understanding, 10% of Valeant’s revenues come from specialty pharmacies. While other companies also use specialty pharmacies, the structure of Valeant’s network seems different,” wrote BMO.
“In the case of Philidor, Valeant consolidates their financials and seems to have a controlling financial interest, while other companies say their affiliated specialty pharmacies are ‘fully independent.’ Valeant’s structure may not be illegal, but we find it aggressive and questionable.”
This screams uncertainty, so it’s not hard to see why investors are heading for the exits. To stop them, Valeant has to lay out some detailed answers.
How many specialty pharmacies exist in your network and where are they licensed?
Philidor operates in 46 states and Washington D.C., but it does not operate in California. It was denied a licence to operate there by regulators in May of 2014.
Government documents show that Philidor’s application was denied because Matthew Davenport, brother of Philidor CEO Andy Davenport, made false or misleading statements regarding the nature of Philidor’s ownership structure and who’s responsible for its accounting.
Still, two companies operated by Philidor employees and executives called Lucena and Isolani managed to take 10% stakes in a pair of California pharmacies — West Wilshire Pharmacy and R&O respectively. In its incorporation documents, Isolani discloses that it was formed for the sole purpose of purchasing R&O.
But to do this, Philidor employees were asked to disclose whether or not they were affiliated with a pharmacy that had its application to operate in the state denied. In both cases, employees said they were not.
The names of Sherri Leon and Gregory Blaszinsky appear on West Wilshire sale documents.
Considering the legal risk, investors will probably want to know if there are any more of these LLCs and pharmacies out there and what their ownership structure is like.
Are pharmacies in your network using each other’s credentials to sell product?
R&O alleges Philidor was pressuring R&O’s owner and pharmacist-in-charge, Russell Reitz, to sign off on fraudulent audits, according to filings related to a lawsuit between the companies. At issue in the suit is that R&O is withholding payments that it owes Philidor.
According to Reitz the story goes like this: Philidor approached him in the fall of 2014 about the sale of his pharmacy. The two parties made a deal in which Philidor gave Reitz 10% of the $US3.5 million sale price up front and would pay the rest when certain conditions were met.
One of those conditions was the approval of Isolani’s pending California pharmacy licensing. In the meantime, Philidor would take over most of R&O’s businesses operations while Reitz still signed off on sales.
Reitz alleges that Philidor never disclosed its relationship with Valeant, or that it had an application for a California pharmacy licence denied. A few days before the sale, Philidor created Isolani, and the R&O deal was done through that entity.
Court documents show that Reitz started asking questions this spring and summer — questions about the relationship between Philidor and Isolani. He also accused Philidor employees of using his pharmacy’s credentials with insurers to process sales from other pharmacies, some from even before R&O was sold to Isolani.
Philidor CEO Andy Davenport responded to that accusation by saying in an email that Philidor would stop using R&O’s credentials.
Reitz alleges that Philidor didn’t stop using his credentials after that email, and that is why he started witholding cash from Philidor.
So the question is: are credentials shared across Valeant/Philidor’s special pharmacy network? If so, why?
How much of Valeant’s sales are driven through specialty pharmacies?
On last Monday’s earnings call, Valeant CEO Michael Pearson said that specialty pharmacy sales accounted for about 10% of his company’s revenue.
But he seemed a little unsure about it (from the call transcript, emphasis ours):
David Risinger – Morgan Stanley – Analyst That’s great. And then just separately, you discussed alternate fulfillment, could you just put that in perspective, maybe what percentage of the US brand Rx business alternate fulfillment is and how much of that is Philidor?
J. Michael Pearson – Valeant Pharmaceuticals International, Inc. – Chairman and CEO Sure. It’s really primarily our dermatology brands and then some of our specialty products like Ruconest, Arestin, and some of the other orphan drugs. For certain products it’s quite large. For Jublia it’s probably 15%. For a lot of other dermatologies it’s much less. I’m sorry, I can’t — it’s significant but it’s — I don’t know the precise number but it’s certainly, of our US portfolio, 10%, 20%, maybe. Tanya’s nodding probably closer to 10%.
Now that it seems Philidor’s network may be more extensive than we thought, investors will likely want a breakdown of those sales and how they contribute to Valeant’s bottom line.
How does Valeant account for patient assistance programs (PAPs) and copay assistance programs (CAPs)?
Both on Monday’s call, and in a letter to Senator Claire McCaskill earlier this month Valeant said that it spent $US525 million on PAPs and CAPS in 2014 and that it expected to spend $US1 billion going forward.
These programs help subsidise the cost of drugs for patients whose insurance programs don’t include them. This is especially important in Valeant’s case, since many of its drugs — especially the ones Philidor distributes — are not life or death. They treat things like acne and toe fungus.
But another alarm here is that none of this CAP or PAP spending is broken out in Valeant’s earnings reports.
It’s also unclear how those funds are administered. Normally the funds are put in a pool with money from other drug companies and administered through a third party which disperses them accordingly.
When asked about it last Monday, Michael Pearson was unclear about how that worked. He was also interrupted by his staff.
From the transcript (emphasis ours):
Doug Miehm – RBC Capital Markets – Analyst Thank you. Couple questions, as well. Number one, with respect to patient access and foundations, maybe you could walk us through how many foundations you fund. And of those foundations what proportion of their annual operating budget would you provide to them? The second one just has to do with, if you were to split out the US neuro business, can you give us a sense of what EPS contribution or EBITDA contribution that business would have? And I’ll leave it there.
Laurie Little – Valeant Pharmaceuticals International, Inc. – Head of IR Why don’t you concentrate on just a couple right now. We’re trying to get through everybody. So, why don’t we answer the –. J. Michael Pearson – Valeant Pharmaceuticals International, Inc. – Chairman and CEO Pick your two favourite.
Doug Miehm – RBC Capital Markets – Analyst Just the foundations, just elaborate on that.
J. Michael Pearson – Valeant Pharmaceuticals International, Inc. – Chairman and CEO OK. I don’t have a precise number but it’s like four or five, so it’s a small number. We make sure, as we mentioned, that other companies are also contributing, or other organisations, at least, are also contributing. We do not want to be the only one to contribute. Again, we just give them the money and they do what they want to with that money. I don’t want to give you a precise figure in terms of what per cent of our funding because I don’t have that and I don’t want to guess. Next question.
If Pearson isn’t clear on it, investors certainly aren’t either.
And it’s only natural that after everything that’s happened, investors will want to know how Valeant’s specialty pharmacies are operated and their sales subsidized.
The last thing they — or Valeant — need now are more surprises.