Everyone is comparing Valeant to the wrong corporate blow up

Since last October, when short seller Andrew Left wrote a report calling Valeant Pharmaceuticals the “Pharmaceutical Enron,” Valeant has been compared to that corporate disaster over and over again.

But it’s really the wrong comparison. Valeant is more like a completely different epic blow up — WorldCom.

Enron created phantom revenue out of nowhere. Valeant’s not like that. Valeant has real products and real revenue — the market just doesn’t know how much anymore.

In that way, and in the way that Valeant grew under a charismatic CEO — in the way that the company has lowered guidance and subsequently dumped that CEO — it’s more like WorldCom.

It still comes with a stark warning for investors, and if the parallels continue Valeant will be making some drastic moves in order to make the itself attractive to investors who no longer believe in its business model. We got a glimpse of that on Monday, when the appointment of billionaire Bill Ackman, a financial wizard to say the least, to the Valeant board prompted a rally in the company’s shares.

If Ackman can just find a way out of the hole he’s in, shareholders who are buying in now stand to make a bundle.

Of course, it didn’t work out that way for WorldCom’s investors. But we’ll get to that in a minute.

Why Left thought it was Enron

It was an October report from Citron Research’s Andrew Left that first triggered a crisis at Valeant. He accused the company of being an Enron-like fraud after finding legal documents connecting the company to two pharmacies that — as we found out later — were actually a part of Valeant’s secret network of specialty mail-order pharmacies.

Since he didn’t know that the pharmacies, Philidor and R&O, were a part of Valeant’s network, he thought that Valeant suing R&O for unpaid bills was a way for the company to book phantom sales.

Andrwe Left, Citron ResearchBloomberg TVAndrew Left, Citron Research.

Those pharmacies have since been divorced from Valeant in all the controversy, but that doesn’t mean the products they were distributing have no value. Their sales were real sales, albeit not in a way anyone expected, and perhaps not in a way investors would like.

So that isn’t Enron.

It’s in how you grow

We’ll tell you what it is more like, though.

In how it grew as a company, in the way its CEO captured Wall Street’s imagination, and then ire, Valeant is more like WorldCom the massive long distance telecom company that filed for bankruptcy with $107 billion in assets back in 2002.

They even share similar debt loads. Valeant is sitting on about $34 billion in debt, WorldCom was sitting on about $41 billion.

Valeant CEO Michael Pearson, who is on the way out, grew Valeant by making big acquisitions.

Bernie ebbers worldcom TBIBernie Ebbers, former WorldCom CEO.

Bernie Ebbers, WorldCom CEO’s who resigned from his post three months before the company went bankrupt, also saw acquisitions as a great way to grow the company. In 15 years it purchased 75 companies, really ramping it up with the 1998 acquisition of MCI, the second largest long distance company in the United States at the time.
Valeant has caught a bunch of flack for its low research and development budget. WorldCom started cutting its spending on telecom equipment and services in 1999.

Both Pearson and Ebbers took out personal loans from the company (more than $400 million in Ebbers case). Pearson was forced to sell 1.3 million shares of Valeant after Goldman Sachs called them in as collateral for one of his personal loans last year.

And it’s in how you shrink

Everything really started crashing down when WorldCom was forced to lower its earnings guidance in late 2000.

It also announced that it would split the company into two stocks — one tracking stock for MCI’s dying voice business, and the other for its internet business. Under this new structure, MCI stock would pay a dividend, and Ebbers said that this would give shareholders “compelling investment opportunities.”

This, people, is some good old financial engineering.

The thing is, analysts didn’t see the point of buying a stock when they knew the company’s revenue would decline, which MCI’s revenue was expected to do.

That is why Ebbers also said, “Management is not satisfied where we are today…This is not the best day of our life.”

That’s basically what Michael Pearson said on a call last week, when Valeant lowered its guidance for the coming year and said that it would not be able to produce its annual report on time. This is partly because a the company created ad hoc committee to review its accounting practices. The company has until April 29th to produce the numbers before bondholders can call in their debts.

WorldCom also created a special committee (“special investigative panel”) to review its accounting practices, though it did so after its bankruptcy and after Ebbers was replaced by John Sidgmore, who served as the Vice Chairman of the company’s board before.

The old rabbit out of a hat trick

Ultimately, WorldCom copped to failing to account for $3.8 billion in operating expenses. We don’t know what will ultimately come out of investigations by Valeant’s ad hoc committee, but in the steps it’s taking to get through this, it looks like a lot like a company desperate to buck a disturbing trend — and that means it needs to create something investors want to invest in.

A little financial engineering might seem like the answer, and it now has a master of that sitting on its board — Ackman, of Pershing Square Management.

It was Ackman who helped Valeant create a structure in which it could buy rival Allergan with very little of its own cash, and it was Ackman who profited from Allergan’s sale, even when it was sold to another company, and not Valeant — a very smart trick indeed.

Earlier this month, Ackman said he wants to sell parts of Valeant’s consumer eye care business, Bausch & Lomb, which Valeant purchased for almost $9 billion. Pearson rejected that idea, but he’s not the CEO anymore. On Monday he did have to stand next to Ackman and watch the hedge fund manager give a Valeant town hall more colour on what a B&L sale would look like.

From Bloomberg:

Valeant has said publicly it would look at selling some non-core assets, but won’t sell core businesses. What Ackman suggested was potentially selling a minority portion — perhaps between 10 and 20 per cent — of Bausch & Lomb in an initial public offering, and using the cash to help pay down Valeant’s debt. If that option was pursued, Valeant would retain control of Bausch & Lomb and hold onto the remainder of the company.

You see people, this is Ackman’s show now, and if financial alchemy is what is to come, he’s a perfect star.

None of this is to say that Valeant is going to go bust, or that anyone at the company will end up facing a 25 year prison sentence like Ebbers.

But what it does say is that this isn’t even close to over yet.

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