Valeant, the bitter pill of corporate greed and arrogance
Valeant’s sudden collapse has left the credibility of its management and its famous investors in tatters. The only difference between Chinese and western companies is that western ones play out their management and governance disasters in public with enough transparency for everyone to see.
Beguiling business plans and tenuous financing schemes cross all cultures. There’s nothing necessarily wrong with an acquisition strategy – Valeant closed US$37 billion of deals in eight years. But even the brightest people are led astray by greed and arrogance.
The recent departure of its CEO, Michael Pearson, another former McKinsey consultant turned superstar manager, followed the collapse in Valeant’s already hammered shares last week. Investors dumped its stock after it raised the possibility of technical default on its more than US$30 billion of debt along with the disclosure of inaccurate earnings forecasts.
Whether or not any improprieties occurred, the company may not recover from its internecine disputes. It blames its former chief financial officer, Howard Schiller, for submitting incorrect information to the company’s auditors, PwC. This caused them to submit several erroneous filings to the SEC. Schiller has denied improper conduct and intends to stay on as a member of the company’s board despite being asked to resign.
Sell-side research analysts have failed again According to a count by the FT last Monday, 21 out of 23 analysts were still advising investors to buy or hold Valeant shares at the current level of US$70 and several had set astronomic price targets at US$200. Valeant then warned about its possible debt default and the price dropped to US$30. Last August, Valeant was almost worth US$100 billion. Today its market capitalisation is about US$9 billion.
Not only are companies who preach highly leveraged “platform” or “roll up” strategies risky, but unit holders of their big investors – hedge and mutual funds – are also in peril. In Valeant’s case, Pershing Square and Sequoia, invested heavily and failed to see the warning signals.
Continual expansion or rolling up through buying rivals in unpopular or overlooked industry segments hopes to create a dominant business platform. Efficiencies or that management consulting cliché of yielding synergies and efficiencies as they go along has assumed a new disguise today. But, it’s merely a remix of an ’80s conglomerate building strategy that works now because of low interest rates.
Valeant couldn’t make scale economies or other large-scale synergies appear. Value was destroyed by too much debt and wishful business assumptions. So the concept of the ”roll up” may be abused as a financial construct laced with impressive management-consulting Powerpoint charts. Real-world business gravity caught up with Valeant.
Inevitably, high debt loads and ambitious growth plans translate into unrealistic performance targets set by board members like activist hedge funds. The two largest shareholders are Bill Ackman’s Pershing Square and Jeffrey Ubben’s ValueAct, who have openly disagreed on business strategies.
Stock option pressure can make managers do crazy things to boost share price. Valeant acquired two drugs last year for critically ill heart patients and proceeded to increase their prices overnight by 212 per cent and 525 per cent, respectively. The share price slid as politicians and doctors viciously condemned the move as being unethical and unsustainable and threatened a regulatory crackdown.
The $6 billion Sequoia Fund, founded in 1970 by Warren Buffett’s friend Bill Ruane lost almost 8 per cent of its value after Valeant warned about technical default. Valeant was the fund’s largest holding at 20 per cent of its assets as at the beginning of the year.
How Sequoia got buried in Valeant is a brutal example of why investing in funds run by ‘celebrity’ managers is dangerous. Their kind of management culture demonstrates limited tolerance for dissent and alternative opinions. Outsized egos mean a magnificent reluctance to admit failure. Betting large- and losing big, can wipe out years of cultivated and disciplined returns.
Just peruse Sequoia’s Q&A and investor call transcripts. On some occasions a fund unit holder voices concern about the manager’s Valeant position. Senior Sequoia executives sweep aside worries by extolling Valeant’s investment potential in glowing terms. The wall of self-justification and self-interest become insurmountable.
Hedge fund activist investors are more interested in short-term financial performance. Sustainable practices just get in the way.
Here lies the cautionary tale of a company whose main focus was not creating value with better pharmaceutical products to help people and make profits, but whose goal was to increase “shareholder value” through acquisitions funded with unsustainable levels of debt.
Peter Guy is a financial writer and former international banker