The past month has been volatile for the health care sector in general, and for Valeant Pharmaceuticals specifically, with the stock down over 50% from the peak in August and approximately 20% year to date. While some of the issues impacting Valeant are relevant to the entire sector (pricing and U.S. government headline risk), many of the drivers of the stock’s decline are specific to Valeant and, we would argue, self-inflicted.
We do not own (and have not owned) Valeant equity or bonds in any of the Signature portfolios due to our concerns around both the business model and the culture of the company. Although massive declines in market value always necessitate a re-analysis, nothing we have heard from Valeant to date gives us sufficient comfort around the direction of the company going forward becoming more constructive. We maintain our long-held view that the risks outweigh the possible returns.
Our view on Valeant is relatively simple – we are not believers in the long-term strategy of the company, as we ultimately do not believe Valeant provides significant value to the health care system. Rather, Valeant appears to be a company designed largely to extract value from payers, patients and governments, contributing little to new product innovation, affordability or access (or even paying taxes). In our view, companies like this are likely to be relative long-term losers as health care systems evolve to focus on value for money. When coupled with the company’s aggressive business practises, we think there are multiple ways to lose by owning the stock.
In terms of the specific accusations levelled by Citron Research, while we are not convinced there is systemic fraud at Valeant, the business practices unveiled over the last week seem questionable at best. This boundary-pushing behavior seems to be all too common an occurrence at Valeant, with the company taking more aggressive positions on virtually all aspects of its business (price increases, distribution, acquisition strategy, tax structure, restructuring, leverage) than any of its peers. Without going into specific details, we have long been concerned that the company’s roll-up strategy and its extreme focus on sales growth could lead to questionable behavior. In recent weeks, investigations by the New York Attorney General, Massachusetts Attorney General, the FTC and the DOJ have all been announced – the outcomes of which are anything but certain.
In addition and somewhat underappreciated given recent events, the company recently indicated it would shift direction on a number of strategic fronts, curtailing the practice of taking price increases and de-emphasizing M&A. Instead, the company reported it intends to focus on organic growth and de-levering organically and has even talked about increasing spending on R&D. Although probably a wise course, this represents a major strategic shift for the company (ironically towards many of the principles of “Big Pharma” the company has eschewed for years). We are not convinced the company has the requisite skill sets remaining after aggressive cost reductions or the appropriate culture to enable this transition without a change in management. The stakes are high however, as the company is highly leveraged and potentially facing significant growth challenges, due to the increased scrutiny on its commercial practises.
A key tenet of our investing strategy at Signature is active management with a global view, which allows us to look outside the Canadian index for the best fundamental investment opportunities (see Geof Marshall’s accompanying blog post Trick or Treat 2 regarding our views on managing to an index). We are therefore not forced to look to Valeant as our only option if we want to increase exposure to the health care sector.
As sector specialists, we have spent a great deal of time deciphering what the broader health care sector trends are likely to be over the next 3-5 years. We maintain our view that the companies that are best-positioned to succeed in the evolving landscape are those that can either: 1) truly deliver improved patient outcomes such as companies involved in the immuno-oncology space (e.g. Bristol-Myers Squibb and Roche); or 2) deliver value to health care systems by effectively allocating care (e.g. managed care organizations like United Health).
These companies should be able to reap the benefits of the secular demand drivers in health care (demographics, newly insured and emerging market growth), while minimizing negative exposure to any potential changes in the reimbursement structure of the industry. We believe companies that do neither are at risk, even without the regulatory and commercial scrutiny Valeant currently faces.