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What Does Turmoil at Valeant Pharmaceuticals Mean for Investors?

By Keith Speights - Mar 9, 2016 at 3:37PM

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Predatory overpricing allegations. An SEC probe. Executive departures. Of course Valeant's stock price has tumbled. But is the long-term view as dismal as the short-term reaction would indicate?

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If it wasn't for bad luck, it seems that Valeant Pharmaceuticals (BHC 6.10%) would have no luck at all. The drugmaker came under attack in 2015 for its pricing policies. Its CEO was out for an extended period on medical leave before returning recently. A key executive just left. And, oh, there's that little SEC investigation in progress. What does all of this turmoil mean for investors?

Question marks
Let's start by examining each of the big question marks surrounding Valeant. The first issue to emerge related to allegations that Valeant overpriced several of its drugs. Of particular concern to several members of the U.S. Congress, Valeant hiked the prices of Isuprel by more than 500% and Nitropress by more than 200% after acquiring the drugs from Marathon Pharmaceuticals.

Those weren't the only drug price increases that raised eyebrows, though. Valeant raised the price of Glumetza and Zegerid by over 500% each. Deutsche Bank stated that the company increased prices in 2015 for 54 drugs by an average of 65.6% -- the highest average increase in the industry.

Former Secretary of State Hillary Clinton has made such jaw-dropping drug pricing an issue in her presidential campaign, and has put Valeant in her cross-hairs, stating in a TV ad that she's "going after" the company for its "predatory pricing."

In the midst of the furor, Valeant CEO Michael Pearson stepped down temporarily for a medical leave of absence. Pearson was hospitalized in late December with a severe case of pneumonia. While that development likely added to investors' anxiety, Valeant announced on Feb. 28 that Pearson had recovered from his illness and was returning to the company.

It didn't take long for another concern to pop up, though. Just three days after Pearson's return, Valeant announced the departure of Deb Jorn, who ran the company's U.S. dermatology and gastrointestinal businesses. Jorn had served as vice president of global marketing with Bausch and Lomb from 2010 through 2013, when the company was acquired by Valeant. After receiving questions from shareholders, Valeant clarified that Jorn resigned for "personal reasons," and that her departure was not the result of any action taken by the board of directors. 

Then, on Feb. 29, Valeant confirmed that the company was the subject of a Securities and Exchange Commission investigation. The company provided few details except to reveal that the SEC issued a subpoena in the fourth quarter of 2015. 

Potential impacts
It's not surprising that all this bad news has clobbered Valeant's stock. That's a short-term reaction, though. More important is: What does it all mean for Valeant's long-term potential?

The case can be made that several of the recent negative developments won't have a significant impact on Valeant in the long run. Certainly, any worries about Pearson's absence should now be put to rest. As for Jorn's departure, though she was a valuable asset to the company, the loss of one person shouldn't dramatically change the trajectory of Valeant's business. This assumes, of course, that there are no other damaging revelations to come concerning her departure.

Any SEC investigation is worrisome. It's worth noting, though, that Reuters has reported that Pearson told several individuals that the SEC probe stemmed from an investigation initially requested by Valeant itself concerning the company's relationship with specialty pharmacy Philidor. Valeant announced in October that it was severing all ties with Philidor.Even a negative outcome from an SEC investigation can likely be overcome over time.

That leaves the pricing issues, which perhaps hold the most potential to affect Valeant's long-term prospects. The company has already taken some positive steps on this front, most notably announcing a new deal with Walgreens Boots Alliance (WBA -0.13%) to cut the prices of its branded dermatological and ophthalmological prescription drugs by an average of 10%. This deal with Walgreens also will lower prices of many of its other branded drugs by an average of 50%. 

Significant price cuts will mean lower profits for Valeant. The company stated that the new Walgreens pricing would save up to $600 million per year for the healthcare system. Those dollars will come right out of Valeant's top line and trickle down to its bottom line.

Keeping things in perspective
We probably won't see many, if any, outrageous price hikes by Valeant going forward. The company's pricing is under a microscope, and that's not likely to change anytime soon. If most of Valeant's growth stemmed from price increases, that would be reason for concern. However, in the third quarter only 4.4% of sales growth came from higher prices; increased volume accounted for 8.2% of the growth.

Valeant owns several drugs that could drive significant revenue and earnings growth on their own. Xifaxan, which treats irritable bowel syndrome with diarrhea, is on track to generate over $1 billion in annual sales. Jublia and Onexton should each bring in hundreds of millions of dollars per year.

Don't expect Valeant's stock to rebound significantly until some of the dark clouds hanging over the company are removed. However, shares are down more than 70% in the last six months. Valeant is trading at a forward earnings multiple below 5. When the turmoil eventually dies down, some investors with a long-term perspective who buy at current share price levels could think Valeant's period of bad luck brought them plenty of good fortune.


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