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The Market and Valeant CEO Mike Pearson: It's Nothing Personal

By Alex Dumortier, CFA - Feb 29, 2016 at 2:15PM

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The pharma announced that its CEO J. Michael Pearson has returned from medical leave, but it isn't all good news.

U.S. stocks are mixed in mid-afternoon trading on Monday. The S&P 500 (SNPINDEX: ^GSPC) and the Dow Jones Industrial Average (DJINDICES: ^DJI) (DJINDICES: $INDU) are are up 0.02% and down 0.03%, respectively, at 2:11 p.m. ET. In fact, stocks, oil, and gold are largely all up simultaneously today -- a positive correlation between stocks and oil is par for the course these days, but not between stocks and gold. But let's get back to a fascinating stock-specific story which continues to unfold before us: the ongoing saga of Valeant Pharmaceuticals.

Valeant CEO J. Michael Pearson is back on the job. Image source: Valeant Pharmaceuticals.

Assiduous readers of this column will know that I have been following the plight of Valeant Pharmaceuticals with much interest. On Sunday evening, the company announced that J. Michael Pearson had returned from medical leave to his position as chief executive, effective immediately.

Investors did not greet his return with the sort of warm welcome he might have liked, sending the stock down as much as 10% on Monday morning, to levels it has not seen since mid-November.

Goodbye, guidance...
Mr. Pearson needn't take it personally, however, as the press release announcing his return contained several other nuggets, including postponement of today's fourth-quarter earnings release and -- crucially -- the withdrawal of its prior financial guidance for 2016.

As I wrote last week, "Wall Street doesn't appear to have a lot of confidence in [Valeant's forward guidance]" and today's news is enough to (justifiably) stoke the market's worst fears.

It does not take to a crack analyst to observe that the company's now-obsolete guidance, which called for a 20% year-over-year revenue increase in 2016, including "double-digit same-store sales organic growth -- primarily driven through volume" looked fanciful. It's a safe bet that Valeant is not preparing to raise its guidance.

It is worth following Valeant's situation not as a potential investment opportunity -- I think individual investors ought to steer well clear of it, except inasmuch as they are speculating with "casino money," as opposed to investing retirement funds.

Indeed, the value of the Valeant case study (which is still being written) is to learn how to spot the difference between a truly innovative business model (what Valeant was peddling to Wall Street) and a bog standard "roll-up" acquisition strategy (what Valeant was actually engaged in). A slick presentation can fool even the most sophisticated investors.

"[O]ur own credibility ... has been damaged by this saga."
Last week, the Sequoia Fund, published its 2015 Annual Report (link opens PDF) in which fund manager Ruane, Cunniff, and Goldfarb was forced to make the following admission:

As the largest shareholder of Valeant, our own credibility as investors has been damaged by this saga. We've seen higher-than-normal redemptions in the Fund, had two of our five independent directors resign in October and been sued by two Sequoia shareholders over our concentration in Valeant.

Incredibly, the manager allowed Valeant to become, at its peak price, more than 30% of the Fund's assets. This is the same firm that Warren Buffett recommended (link opens PDF) to his investors in 1969 when he was preparing to shutter his private investment partnership (the same firm in name, at least).

(Speaking of the Oracle of Omaha, Buffett put up to 40% of his partnership's assets into American Express in the wake of the Salad Oil Scandal. Alas, Valeant is no American Express...and Ruane, Cunniff are no Warren Buffett.)

Valeant's story is far from over and it is still possible that my skepticism will prove wrong (at least to some degree). Either way, it will provide an education for stock pickers. Stay tuned!

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