It's a good day for U.S. stocks, with the Dow Jones Industrial Average (^DJI 0.44%) and the S&P 500 (^GSPC 0.27%) up 1.73% and 1.67%, respectively, at 1:30 p.m. EDT. Meanwhile, shares of Valeant Pharmaceuticals International are down another 17.54%, adding to a 19% fall yesterday prompted by the publication of a negative, somewhat sensationalistic report by short-seller Citron Research comparing the company to Enron.
The opacity of Valeant Pharmaceuticals' operating performance is a risk factor. Source: ABC. Licensed under Public Domain via Commons.
What an extraordinary fall from grace for a former stock market darling! Valeant's stock has now lost roughly 60% of its value relative to the all-time high of $263.81 achieved at the beginning of August.
Yes, Citron's report is framed in sensationalistic terms, claiming on its front page to contain "the Smoking Gun!!", referring to to Valeant's relationship with specialty pharmacy Philidor RX. While this relationship may be less than Citron makes it out to be, Valeant's response to what it labeled an "erroneous report" was terse and, frankly, insufficient to definitively dispel this columnist's concerns.
Unfortunately, this is another red flag on top of the questions concerning the quality of Valeant's operations and disclosure and its acquisition strategy. The comparison with Enron may be unfair, but I do see some signs that are adding up to a pattern certainly reminiscent of Enron and other spectacular cases of corporate fraud. Here are three.
Extreme complexity that seems unjustified
Large banks are notoriously complex. JPMorgan Chase, the largest U.S. bank by assets, conducts in retail, corporate, and investment banking, and asset management through numerous subsidiaries. In 2014, JPMorgan generated revenues of $94.2 billion and ended the year with a $2.6 trillion balance sheet. JPMorgan's 2014 10-K report is 307 pages long.
Valeant Pharmaceuticals' 2014 10-K report is 537 pages long.
This for a company that generated $8.3 billion in revenues last year, with end-of-year assets totaling all of $26.4 billion. The 2014 10-K of Johnson & Johnson, the world's largest pharmaceutical company by revenues, is 107 pages in length.
A CEO seemingly willing to make false, promotional statements
When Valeant was pursuing Botox maker Allergan last year, CEO J. Michael Pearson was asked during a luncheon for equity analysts how he would achieve the ambitious post-merger cost savings he was trumpeting.
According to a (corroborated) account from one analyst who was there, Pearson responded: "Have you been to their headquarters? Have you seen their golf course? Yeah, they have a golf course."
To no one's surprise, Allergan does not own a golf course.
Pearson has been lionized for Valeant's stock performance under this tenure. Just three days ago, Canadian Business named Pearson its CEO of the year.
Pearson is a McKinsey alumnus, a 23-year veteran of the prestigious consulting firm. McKinsey has been referred to as a secular priesthood, but not all of its alumni have kept to the path of righteousness.
In fact, it's unfortunate that this raises another comparison with Enron: Jeff Skilling, the CEO at the time of the energy company's collapse, was a former McKinsey partner who spent more than a decade there.
One shouldn't make more of this than it is: A reminder that a prestigious calling card isn't an immunity against incompetence (think former Goldman Sachs CEO Jon Corzine) or dishonesty.
Executive turnover
Speaking of Valeant's management and Allergan, the latter produced a presentation concerning risks associated with its would-be acquirer. From this document, we learn something that hasn't received much attention: the frenetic turnover in Valeant's executive officers.
Between 2011 and May 2014, only two people were fixtures on the list of corporate officers (one of them being Pearson). The frenetic level of Valeant's M&A activity may partially explain this phenomenon, but it is not generally associated with stable, healthy businesses.
None of these points, either individually or in unison, add up to proof that Valeant is a house of cards. However, they're enough to make this columnist very uncomfortable. Does this mean there can be no rationale for buying shares of Valeant at current levels?
Not at all. Situations that present significant uncertainty and/or complexity are often those that offer the enterprising investor the greatest upside. However, it requires you perform adequate due diligence to address the sources of that uncertainty and complexity, and to satisfy oneself that the price more than accounts for the risks involved.
Why you shouldn't touch Valeant
Still, one ought to keep in mind that this is a speculation -- a permanent impairment of the capital at risk cannot be ruled out. In practice, all but the most sophisticated, most committed individual investors should put this situation in the "too hard" pile and move on to something else.
Valeant is the sort of situation hedge fund managers get paid to assess. For non-professionals, there are easier ways to earn an honest return.
