Valeant, Mr. Grant asserts, is a “financialized pharmaceutical company.” That isn’t a hard claim to back up – the company has made over 30 acquisitions since the beginning of 2011.
The pharma giant certainly isn’t like many of its major peers, like Johnson & Johnson, Pfizer, or Merck – it invests just 2.7 percent of sales into R&D, compared to the 13.8 percent average amongst those competitors.
“Valeant does most of its compound-hunting in the stock market, not the laboratory,” writes Mr. Grant.
According to Mr. Grant, the stock is also easy to borrow, which is partly a function of the incredible track record of CEO J. Michael Pearson. Since Mr. Pearson took the reins on February 1, 2008, the stock is up about 1,300 percent on the TSX:
Despite this incredible rally, Mr. Grant writes that he is “confidently bearish” on the name. Even more interesting is where he got the idea: from famous short-seller Jim Chanos, who employs Mr. Grant’s daughter.
Mr. Grant takes exception with a key part of the Valeant bull thesis – that its acquisitions will bear fruit. “We don’t see the data to support the contention,” he writes. Evan Lorenz, analyst at Grant’s Interest Rate Observer, elaborates on the matter, claiming that sales results suggest that “the longer a business is under a Valeant umbrella, the worse it performs.”
Mr. Lorenz notes that it is a challenge to gauge just how well the company is doing. “In any given period the company may present five different growth rates: ‘headline,’ generics, organic same-store sales including generics, organic same-store sales excluding generics, pro forma organic growth including generics, and pro forma organic growth excluding generics,” he explains.
According to the analyst, free cash flow (cash flow from operations less capital spending) is a good way to judge the pharmaceutical giant’s growth, as money spent on acquisitions doesn’t affect this metric. ”In 2013, free cash flow amounted to $927 million, or $2.89 per common share, up from $549 million, or $1.80 a share, in 2012,” he writes. “The 2013 reading would give Valeant a less-than-lordly free-cash flow yield of 2 percent.”
Mr. Lorenz also calls into question Valeant’s accounting practices, citing how the company changed the way Medicis Pharmaceutical Corp. recognized revenue after it bought the firm in 2012. “One is left to wonder what changes Valeant has chosen to effect in the numerous smaller acquisitions that never produced a similar regulatory paper trail,” he writes.
After investors digested Mr. Grant’s note on Thursday, they sent the stock 5.3 percent lower on the TSX. Given that Jim Chanos served as the inspiration for this declaration – and that his recent bet against CGI Group has paid off big-time so far – there may well be more downside from here.