Valeant Pharmaceuticals (NYSE:BHC) has been in a prolonged crash and burn for almost a year now, and with it have fallen many mutual funds that were too deeply invested in it.
In this segment from the Market Foolery podcast, Chris Hill talks to Bill Mann and Bill Barker about Sequoia Fund, and how a trusted fund with 40-odd years of fantastic investments lost everything by betting way too much on a company that ended up tanking.
A full transcript follows the video.
This podcast was recorded on April 13, 2016.
Chris Hill: Morgan Housel and I talked about Valeant Pharmaceuticals yesterday. Bill Mann, you've written recently about one of the stories related to Valeant, less about Valeant itself, but the fund it took down with it.
Bill Mann: One of many. But one in particular is called the Sequoia Fund. It's run by an asset management firm named Ruane, Cunniff, & Goldfarb. Bill Ruane was the patriarch of this firm, and he was one of Warren Buffett's best friends from business school. So when Warren Buffett shut down his partnership, 45 years ago now, that was his suggestion. "If you want someone who invests like me, go to the Sequoia Fund, go to Bill Ruane." So they have a very, very long and august history. But they also had 31% of the Sequoia Fund in Valeant Pharmaceuticals -- 31%! Which is not something that we can even do! We are regulated as a diversified mutual fund.
There are also non-diverse mutual funds, of which Sequoia was one. But 31% in any one name means that not only -- I mean, you are betting everything on nothing bad happening. You're betting on your analysis being right; you're also betting a lot on chance. It's kind of a dirty secret about investing, that a lot of it does have to do with chance. When I look at a company or a fund that has that much in one name, I get the sense that there was a breakdown in process. And that's exactly what happened -- the principals of the firm have resigned, board directors have resigned, they've come out and said, "Oh, we're going to change how we do things from here on out." It's too late. I mean, it's really, really too late. You have a 45-, 50-year history of really good investing, and it has been destroyed by, not even one bad decision, but a process that's probably gotten a little bit sclerotic over time.
Hill: I bet, on the way up, it was nothing but a party atmosphere as Valeant was on its way to becoming the largest Canadian public company. I'm always curious about what happens behind closed doors. Was there someone in the room saying, "Look ... "
Mann: They were!
Hill: "This is great, but we really need to take some of this money and put it somewhere else."
Mann: Yeah, they were, and not only did they not take some off the table, but they kept buying. It wasn't like they bought an 8% and then it became a 31% position in the awesome way, which is the way that anyone who ever invests hopes happens. Instead, they were buying all the way up. So not only did they undo by virtue of not taking some off the table; I seriously doubt they have a positive return on a dollar-by-dollar basis, even on a Canadian dollar-by-dollar basis, from when they started.
Bill Barker: Well, the next chapter for Valeant is going to be interesting, given the possibility that it's going to have to shed some assets in order to eventually pay down ... I think it has about $30 billion in debt.
Mann: $30 billion in debt.
Barker: And the most frequently named solution to that problem is to sell off Bausch & Lomb, which is, you can find a lot of different guesses as to what that might be worth. It's certainly above $10 billion. And that would go a long way toward --
Mann: I wouldn't say certainly. I mean, on a revenue basis. But Valeant's strategy has always been -- I mean, this was their business strategy, go and buy assets like this and then strip out a lot of the R&D. So, yeah, there's a cash flow stream, but I'm not sure you could call ...
Barker: Bausch & Lomb ... they don't need to have a lot of R&D. Although, if you don't have R&D in the contact lens industry, and you fall behind, it's a killer. But, they're the No. 4 player globally, and it's a stable business, cash business. That is something they can do; that's a trick up their sleeve. There are plenty of real assets in Valeant besides Bausch & Lomb, but that's the one that gets mentioned the most frequently. I think Bill Ackman, who's played a lot of behind-the-scenes work with this company is saying it's not something they're going to divest. I don't know if he has the power yet to make that call, but I don't know. Let's see what happens.