Hedge fund manager Bill Ackman, who runs Pershing Square Capital Management, has a long career of successful investments. However, what Ackman will likely be best remembered for is his gigantic investing flub with Valeant Pharmaceuticals (NYSE:BHC).
For roughly two years, Ackman and Pershing held shares of Valeant stock, experiencing a roughly 95% decline in value from its peak in August 2015. By the time Ackman waved the white flag, he'd cost Pershing Square approximately $4 billion. Valeant's dismal performance is the primary reason why Pershing Square's 2015 and 2016 returns were negative 20.5% and negative 13.5%, respectively, all while the stock market motored to new all-time highs.
Ackman's mea culpa places the blame on these three factors
On Wednesday, Ackman released his annual letter to investors where, for the first time, he apologized for the funds' dismal performance on the heels of his misplaced faith in Valeant. While this mea culpa was long-awaited from investors, it also gave us a deeper look into why Valeant ultimately failed Ackman's investment thesis. In particular, Ackman cited three factors as the reasons behind Valeant's downfall in the annual letter to shareholders.
1. Valeant substantially overpaid for Salix Pharmaceuticals
First, Ackman blamed Valeant for significantly overpaying for Salix Pharmaceuticals. For those who may not recall, Valeant acquired Salix for $11 billion in April 2015. The allure of Salix was its line of gastrointestinal drugs, highlighted by Xifaxan, which was expected to grow into a blockbuster drug with $1 billion or more in annual sales. However, as Ackman points out, Salix's drug portfolio has mostly been a disappointment, with sales growth coming in considerably lower than expected.
As an added kick in the pants, rumor had it in early November that Valeant was in talks with Japan's Takeda Pharmaceutical (NASDAQOTH: TKPYY) to sell Salix Pharmaceuticals for $10 billion. Current CEO Joe Papa has suggested that Valeant would consider parting ways with its core operating segments (Salix and Bausch & Lomb) for the right price. Ironically, the "right price" in this instance would have meant a $1 billion loss on Valeant's purchase in a year and a half, although it was expected to supply Valeant with some much-needed capital. The deal eventually broke down over price.
2. Seasoned management teams can still make mistakes
Secondly, Ackman's letter to shareholders notes that despite Valeant having a seasoned management team, it's still possible for smart leaders to make mistakes.
Valeant's two core strategies for many years had been to use its pricing power on mature drugs to drive up its sales and margins, as well as to acquire new pipelines and/or companies with the aid of debt. When the system worked, no one complained – not even when Valeant racked up in excess of $30 billion in net debt. However, when the foundation came crumbling down, management proved ineffective in rectifying their overzealousness.
During the fourth quarter, Valeant noted that its pricing power was actually a detriment to its sales as opposed to an aid. This stems from former CEO J. Michael Pearson's admission in front of a Senate committee last spring that Valeant had made a "mistake" when pricing two acquired cardiovascular drugs, Nitropress and Isuprel (Valeant increased the price of these therapies by 525% and 212%, respectively).
In terms of Valeant's debt and reassurances from Pearson that the company would be successful prior to his departure, the company has been mostly unsuccessful in disposing of non-core assets and reducing its debt. In fact, it's had to renegotiate its debt covenants with its secured lenders on numerous occasions over the past year. These negotiations have led to fees and higher interest rates for Valeant, effectively digging its hole a bit deeper.
3. Politics were a problem
Finally, Bill Ackman blamed Valeant's poor performance on political factors. Ackman noted that he previously dismissed the extent to which political factors could impact drug companies like Valeant.
Specifically, Ackman is referring to Congress's crackdown on drug-pricing practices for certain drug developers, including Valeant. The two aforementioned drugs that Valeant was chastised for (Nitropress and Isuprel) had no formulary or manufacturing changes, which made the massive increase in their list prices all the more glaring.
If there's consolation here for Ackman, it's that Valeant's not alone in drawing the ire of lawmakers on Capitol Hill. Mylan, the manufacturer of the injectable anaphylaxis treatment EpiPen, and Mallinckrodt's Achtar Gel, which treats more than a dozen indications, have both come under fire by regulators for their pricing practices.
The big lesson learned
If there's one succinct takeaway from Ackman's unfortunate investment in Valeant Pharmaceuticals, it's that even the smartest investors are going to be wrong from time to time. There are always going to be unforeseen factors that we can't control as investors, which makes it essentially impossible to have a perfect investing track record.
At the same token, Ackman's smartest decision was to sell his funds' remaining stake recently and absorb the roughly $4 billion loss. With Valeant's business still in pretty deep trouble, and the company riddled with debt, Ackman's decision to salvage the remaining $221 million is probably a wise move.
Selling a stock because a company's valuation has dropped and you're losing money is often not a smart move if your investment thesis (i.e., the reason(s) you bought the company in the first place) is still intact. But, as we saw in Ackman's case, if your investment thesis is broken, taking your lumps and salvaging your remaining capital can be the smartest move to make.