From Bad To Worse: Valeant Investors Bail As Credibility Plunges

Investor allegiance to CEO Michael Pearson is fading; the company substantially reduced 2016 sales and earnings guidance just weeks after his return.

Just when it seemed like Valeant Pharmaceuticals International Inc.’s luster on Wall Street couldn’t fade further, it has. The company revealed March 15 that sales and earnings for 2016 will be substantially lower than previously forecast in December, even as it has yet to file finalized 2015 financials – at the risk of defaulting on its credit agreements.

CEO J. Michael Pearson was there to walk investors through the numbers during a conference call, his first public statements since returning from an extended medical leave of absence amid the company’s crisis. But the return of Valeant’s outspoken leader did little to soften the blow from the news, and investors hit back.

The company’s stock plunged 51% on the news, hitting a 52-week low of $33.01 before closing the day at $33.51. The company’s fall from a 52-week high of $263.81 in August has been staggering.

Ackman has increased his stake in Valeant to 9% of the company, representing a value of $2.03bn as of March 8. That means Pershing lost more than $1bn in one day. In a letter to investors March 15, Ackman insisted Pershing will take a more proactive role at Valeant to protect its investment.

Investors hoping Pearson would come to the preliminary fourth quarter sales and earnings report with a plan that would begin to restore the company’s credibility were left wanting. Instead, the unexpected change in the financial forecast only added to the uncertainty surrounding the firm and what has been a steady stream of disappointing news over the last six months, including a legal probe into Valeant’s pricing tactics, accounting fraud charges and management issues amidst the controversy.

Valeant has not yet released finalized 2015 financial results while it sorts out the accounting issues related to its controversial relationship with the specialty pharmacy Philidor Rx Services that came to light in October (Also see "Well-Rehearsed Valeant Call Unlikely To Stop Deeper Probes" - Pink Sheet, 26 Oct, 2015.).

The company previously announced it would delay filing its annual report to await the completion of a review into the issue by an Ad Hoc Committee of the board of directors. If the company does not file the10-K by March 30, the company risks defaulting on its credit agreements. Pearson said his best guess for when the document would be filed was “sometime in April.”

As for the lower sales and earnings expectations for 2016, Pearson said, “While our businesses continue to grow, we are now forecasting a lower growth rate in certain businesses, such as dermatology, given the continued external pressure from managed care, the pricing environment and our slower than expected start in 2016.”

In December, the company announced a plan to lower prices on branded dermatology and ophthalmology products by 10% for certain patients and announced a fulfillment agreement with Walgreens Boots Alliance Inc. to directly distribute Valeant’s products (Also see "Valeant Discounts Will Save Health Care System $600M Annually, Firm Says" - Pink Sheet, 15 Dec, 2015.).

Valeant continues to expect strong growth to come from gastrointestinal products, oral health, oncology, generics and certain emerging markets, he said.

“Many of our business units have lowered their revenue forecast for the year from when they first put them together in the fall,” he added. At the same time, the company plans to increase spending in areas like accounting, managed care, and government and public relations.

The company reported fourth quarter preliminary revenues of $2.79bn, just below analyst consensus expectations. The big disappointment was the 2016 forecast; Valeant said it expects revenues to be $11bn-$11.2bn, substantially lower than previous guidance of $12.5bn.-$12.7bn. Adjusted earnings before interest, taxes, depreciation and amortization are expected to be $5.6bn-$5.8bn, compared to previous guidance of $6.9bn to $7.1bn.

“A Starting-Over Point,” Pearson Says

The confidence of some analysts who have supported the fundamentals of the company during the tumultuous period has begun to crack. “This has clearly been a very humbling call for me,” Evercore ISI analyst Umer Raffat said in a same-day email to investors.

“My base case until today has continued to be that the fundamental problem at Valeant was a communication issue … and the noise may have created minor disruption in business,” Raffat said. “However, today’s results suggest that while communication issues remain, there may have been a disruption in business – at least in 1Q16.”

Another analyst, Nomura’s Shibani Malhotra, questioned Pearson on the conference call asking, “How can we be confident in what you are saying today about the business, given that you were positive in December and January, and how do we get comfortable that Valeant is able to execute and deliver for shareholders?”

Pearson acknowledged the company’s shortcomings in response. “We’ve had some underperforming businesses. That’s totally on us, so we have to earn back the credibility. We have to deliver on the results. We have to meet or exceed this guidance, and I think we all recognize that and so it’s a bit of a starting-over point at this point for me in the company.”

Investor Patience Waning

But investors may not have the patience to wait for organic change much longer – or they may push for more drastic changes like new management or big divestitures.

Pearson said the company will continue to consider divesting non-priority assets, but has no plans to divest any major platforms.

As for potentially breaking up the business, Pearson said management and the board are committed to considering alternatives to drive shareholder value – if the company’s valuation doesn’t recover.

“But we do think we have a plan that will generate strong cash flows, allow us to reduce debt, and we can demonstrate real growth, organic growth, in our businesses,” he said. “We believe if we’re successful doing that, the stock price will start trading more on fundamentals, which it is not right now.”

One of Valeant’s biggest investors is the activist shareholder Bill Ackman, who owns Pershing Square Holdings, the hedge fund that first bought into Valeant when the company made a hostile attempt to buy Allergan PLC in 2014.

Ackman has increased his stake in Valeant to 9% of the company, representing a value of $2.03bn as of March 8. That means Pershing lost more than $1bn in one day. In a letter to investors March 15, Ackman insisted Pershing will take a more proactive role at Valeant to protect its investment.

“We continue to believe that the value of the underlying business franchises that comprise Valeant Pharmaceuticals are worth multiples of the current market price,” he said.