Vice President :
Oh, the Canadian drug company that was set to reinvent the drug business, and it seemed the new way of doing the business would work!

Senior Management :
Yes, it seemed to work! Revenue started shooting up; operating incomes went up, the company’s market cap increased.

Student :
I've no clue on this. How did it pull this off? How did it take a business where most companies were stuck?

Senior Management :
The growth was of course through a lot of acquisitions. Unlike most drug companies that grow through RandD, Valeant’s mode of growth was to buy companies. It made an acquisition almost every month. Most of these acquisitions were small and paid for with cash, but there were a couple of very big ones.

Vice President :
Yea, who hasn't heard of them. One was Bosch and Lomb, and the other was Sellicks pharmaceuticals.

Student :
Those are big businesses man. If I'm not mistaken, the former was a public company! I'm surprised as to where a Pharma company could get so much of cash from!

Vice President :
Some through stock issuance, some through retained earnings, but the majority of cash came from borrowing.

Student :
Dude, are you kidding me?

Senior Management :
He's not kidding, they were breaking away from being a conventional drug company (drug companies are primarily equity funded and borrow very little) but who cares, results matter - this was their way of building themselves up and markets loved it.

Vice President :
I know, the market cap touched almost 100 Billion!! The share price was $250, and people like the Blackman and the Sequora fund still claimed it to be undervalued.

Senior Management :
That's what makes the fall interesting! A company passing the test through such diligent investors, yet losing almost 60% of its value in less than a month.

Student :
OMG, what happened?

Senior Management :
The trigger was a new story that came out about a court case in California over a pharmaceutical guy or a pharmacy called RandO pharmacy had sued to get money back.

Student :
what does this have to do with Valeant?

Senior Management :
That lawsuit unfolded and as it unfolded, it turned out that Valeant’s fingerprints were all over it. People said this was just the surface. But there was more stuff coming out, more scandals that would put Valeant’s value at risk. In fact, they used the words that 'this was the next Enron. The company was a gigantic accounting concoction ready to come apart.'

Analyst :
Great discussion happening here. As analysts, we should know about such red flags on the next exploding story we see! I think it would make sense to take a step back and look at the Valeant business model and what is it that made it successful in the first place.

Vice President :
The golden rule - Buy low and sell high. Valeant brought that strategy, at least from my perspective, into its acquisitions. It bought companies which had under-priced drugs. Drugs which could be priced high but were priced too low. It bought these companies, and one of its strategies was pushing up the price.

Student :
Isn't pushing the prices up of necessary drugs immoral and unethical?

Vice President :
I'm not going into the ethical issues here but that was a core component of their strategy, and it was legal. That’s why Valeant was ranked the highest amongst the pharmaceutical companies based on price increases in terms of drugs that it essentially re-priced.

Analyst :
I don't know much but scrolling up I could see that Valeant was unafraid to borrow money.

Senior Management :
and someone also wrote markets loved this - probably because markets thought it was doing the right thing. These companies are cash-machines, and they should be borrowing more money.

Vice President :
I observed one more thing, we spoke about reinventing in acquisition, I was wondering why isn't anyone mentioning about RandD. Valeant seemed to take the view that RandD is not sacred. It treated RandD like any other investment; it’s like we’ll invest in RandD if it pays off, if it doesn't pay off, we won't invest.

Analyst :
Now that's a more skeptical look at RandD than most pharmaceutical companies.

Senior Management :
Unlike most of the companies that keep on acquiring other companies, Valeant was very quick in converting acquisitions into earnings. Maybe because of the price increase that was driving up the earnings which it did not find that difficult.

Student :
Hold on, so where did things go wrong? Now people are questioning each component of their business model.

Lawyer :
Legal guy: you know I said repricing was legal. The truth is, on the surface, the drug market looks to be a free market, but in reality, it's a regulated market. Companies need to negotiate with the insurance companies and indirectly with the government when they set these prices.

Analyst :
So you're saying if it is going to increase prices, therefore, it has to do it under the radar. How was this a feasible strategy before, and why not now?

Lawyer :
That's the disadvantage of being in the limelight! Since now the company is front and centered, everybody knows about it. Not only is it going to be more difficult to increase prices in the future, I think it might be forced to roll back prices on many drugs that it re-priced.

Vice President :
As an account, I'd say Valeant has accumulated a lot of accounting debris, and that's the disadvantage of acquisition.

Student :
Debris in what sense?

Vice President :
Well, you have seen the goodwill climb up from $3 billion to $17.4 billion. It’s now about 36% of all the assets on Valeant’s balance sheet. It’s these useless accounting assets that nobody can quite tell what they stand for.

Student :
Isn't goodwill good?

Senior Management :
Not on the balance sheet. A company that has built the goodwill by its self will never have it on the balance sheet. Only such companies that overpay at acquisition will put goodwill on the balance sheet. To match the accounting double entry system, if you pay $12 for something that's worth $10, $2 goes to goodwill!

Student :
and what happens to 2 then?

Senior Management :
With goodwill, comes the amortization, the impairment of goodwill and intangibles. You also have these restructuring charges that come with acquisitions and again a bigger and bigger charge each year.

Lawyer :
I'm not completely getting the terms.

Senior Management :
My point is that many of these accounting charges have made Valeant’s financial statements difficult to read. Valeant has built a really complicated company. And this complexity is a double edge sword.

Lawyer :
Double-edged in what sense?

Senior Management :
Double-edged because it makes the good times better and bad times worse. People don't know about the complexity, so in good times people think something positive is behind it. But in bad times, this complexity becomes scary, and they attribute the worst of all possible motives.

Analyst :
Complexity is scary in all sense man. I was given to analyze this company, and I'd to take a week off to study it's six hundred page annual report!

Lawyer :
Messy! But I'm sure it won't be the case now. As per what I read above, it would no longer continue the acquisition-driven model. There would be no 20% growth, barely 2% growth!

Vice President :
Breaking more bad news, now since it is in the limelight, people are aware of it, people are aware of its unethical strategies, if regulators and government continue to let them hike prices, sick people will criticize such regulators. This would bring down Valeant's profits!

Student :
Is it even viable for the company to do business?

Senior Management :
Well, just as it built itself up, piece by piece by acquiring other companies, I find the best value strategy is to break itself up and sell off those pieces to somebody else who is not tainted, whose willing to pay you more for Bosch and Lomb or the Sellicks pharmaceuticals.

Analyst :
It's easier said than done!

Senior Management :
Yes, particularly because the managers who built up value by acquiring will find it very difficult to let go of what made them successful. But, as an investor we should attach no emotions to business, and if this is a valuable option, why let it go?