U.S. stocks are roughly unchanged in early afternoon trading on Monday, with The Dow Jones Industrial Average (DJINDICES:^DJI) and the S&P 500 (SNPINDEX:^GSPC) down 0.11% and 0.16%, respectively, at 1:15 p.m. EDT. Following a horrendous week during which they lost over a third of their value, shares of embattled pharmaceutical company Valeant Pharmaceuticals International Inc have been volatile today on the back of a conference call in which the company attempted to allay concerns about its relationship with specialty pharmacies in general, and Philidor in particular.

Valeant Pharmaceuticals CEO J. Michael Pearson was a Wall Street darling. Image source: Valeant Pharmaceuticals International.

Valeant released a 90-page presentation to go with the conference call. It goes without saying that anyone who owns the shares, or who is considering bottom-fishing, ought to review this document.

So far today, it appears the conference did little to bolster the market's confidence, although it did not further undermine it, either -- perhaps that is already a victory? The shares are up 0.50% at 1:15 p.m. EDT.

I've read the reactions of multiple analysts to last week's exploding controversy over the role of specialty pharmacies in Valeant's business model. So far, the only one who appears to have properly understood the true implications of last week's disclosures is not from a bulge bracket bank (I don't think this is coincidental -- Valeant has been a golden M&A fee-laying goose for Wall Street).

Bank of Montreal's (BMO) Alex Arfaei, who has downgraded Valeant's shares to market perform from outperform (and slashed his price target to $141 from $265), wrote:

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. 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.

That's not entirely accurate: As Valeant points out, Abbvie owns specialty pharmacy service provider Pharmacy Solutions. Valeant's relationship with Philidor is "different," or at least unusual. Philidor certainly isn't independent. For example, Valeant has rights to approve key appointments at Philidor and to appoint certain employees. In addition, last year, Valeant paid $100 million upfront for a 10-year option to acquire Philidor for...$0.

The risk related to specialty pharmacies is all in the price
In any case, Valeant's credibility problem now goes beyond Philidor or specialty pharmacies. As BMO's Arafei points out, "the downside from here is not limited to the specialty pharmacy business in question (we estimate that is priced in); it is dependent on the impact of the residual uncertainty on the rest of the business."

That the risks linked purely to the specialty pharmacy business in question are priced in ought to be clear: According to today's presentation, Philidor represented just 6.8% of total Valeant revenue in the third quarter, and roughly 7% of Valeant Ebita (earnings before interest, taxes, and amortization).

The entire specialty pharmacy channel accounted for 7.2% of Valeant's net revenue year to date (oddly, Pearson said the week before last that roughly 10% of Valeant's drug sales flow through specialty pharmacies).

Even if those revenues and profits were to disappear entirely, at 7.2 times next year's earnings-per-share estimate, the stock's current valuation would more than account for this. The trouble is, this episode has given rise to serious doubts concerning the credibility and transparency of Valeant's management. Here's Arfaei:

We believe most VRX investors didn't know about Philidor; what else is out there that we don't know? While this question applies to every company in our coverage, the existence of a questionable, not fully disclosed business practice increases the risk of others. The stock is unquestionably cheap in our view, but for the upside to materialize, we believe investors need to become comfortable with this uncertainty.

Morfit's return
Is there any good news today for Valeant shareholders? The return of ValueAct Capital's G. Mason Morfit to the board of directors is a useful development. According to data from Bloomberg, ValueAct is Valeant's sixth-largest shareholder, with a 4.37% stake (while it has lost a lot of money recently, as a long-term shareholder, ValueAct is still up hugely on the investment).

Speaking of which, the fact that ValueAct has been represented on Valeant's board on a near-uninterrupted basis since May 2007 should also provide some comfort to investors. Indeed, if Valeant were to have engaged in massive fraud, it would have done so under the nose of a very diligent, very interested party.

Nevertheless, I believe the revelations concerning Philidor aren't innocuous, and they raise some very troubling questions regarding Valeant CEO J. Michael Pearson's business judgement and ethics that may well be incompatible with a long-term investment. Caveat emptor.