Smoking Gun? Interesting article for sure. But in my view the Smoking Gun is not so smoking at all. If anything, in my view the regulators should question more the ethics of the Insurers rather than Valeant. At least the way I understand it, it is a tug of war between the insurer wanting to pay less and forcing the pharmacist to substitute that branded prescription with a generic one and Valeant using questionable means to bill insurers for their right to be compensated for their more costly brand.
If a Jublia sales rep convinces a doctor to prescribe their Brand Name, as opposed to a generic.... then how is it ethical or perhaps legal for the insurer to manipulate the pharmacist to alter the prescription and substitute a generic? Valeant already has programs in place that lowers the cost of their branded drug by offering a subsidy. These subsidies are usually in line with the generic price. In the end, it comes down to - whose drug gets filled and sold......Valeant's or someone else's? As much as patients believe that a generic is the same as a branded med, doctors will tell you it's is not, and there are added benefits in branded drugs. Valeant has a right to defend their product sales.
In any case read it and form your own opinion. It is not all cut and dry, but it seems to me that the smoking gun is more about ethics (and trying to profit from destroying the share value) rather then Valeant doing something illegal.
Valeant - Is That The 'Smoking Gun'?
by SHOCK EXCHANGE | NOV. 1, 2015
Valeant (NYSE:VRX) has been the talk of Wall Street over the past week. The drama was created after R&O Pharmacy filed a lawsuit denying that it owed Valeant a $69 million payment. Citron Research cited that Valeant may have partial ownership of R&O and [ii] surmised that Valeant could have been creating phony invoices to book fictitious revenue.
Members of the investment community immediately dismissed Citron, claiming that he didn't have a smoking gun, and putting the onus on Citron to prove its claims. Well this week the "smoking gun" appeared. According to the Wall Street Journal Philidor used some aggressive and unusual sales tactics to boost payments:
A mail-order pharmacy used by Valeant Pharmaceuticals International Inc. had a simple message for staffers charged with getting health insurers to pay up: Don't take no for an answer. If a health insurer wouldn't work with Philidor Rx Services LLC, the pharmacy instructed staff to try again using the identification number of a partner pharmacy to secure payment. "We have a couple of different 'back door' approaches to receive payment from the insurance company," a Philidor training manual said.
Insurers attempt to control spending on expensive medicines by directing pharmacists to fill prescriptions will lower-priced generic drugs, or asking patients for higher copays. Philidor attempted to circumvent these constraints. According to the Journal, Philidor's training manual included about six different methods its staff could use to reduce copays to as little as $35.
To entice insurers to reimburse payments for certain drugs, it would submit a lower quantity; my interpretation of this is that the insurer could potentially focus on the all-in costs of the prescription rather than the cost-per pill. Lastly, in instances where an insurer denied a claim because Philidor did not have a contract with the insurer, Philidor would use the identification of another pharmacy, such "as our partner in California, West Wilshire Pharmacy."
Valeant Distances Itself From Philidor, But Die Has Been Cast
On Thursday October 29th -- within a day of the Journal's article on Philidor's sales tactics -- CVS (NYSE:CVS) and Express Scripts (NASDAQ:ESRX) dropped Philidor from their networks; CVS cited Philidor's "noncompliance" with its provider agreement. Valeant latercut ties with embattled Philidor:
We have lost confidence in Philidor's ability to continue to operate in a manner that is acceptable to Valeant and the patients and doctors we serve. We understand that patients, doctors and business partners have been disturbed by the reports of improper behavior at Philidor, just as we have been. We know the allegations have also led them to question Valeant and our integrity, and for that I take complete responsibility. Operating honestly and ethically is our first priority, and you have my absolute commitment that we will make it right.
Based on Valeant's prior actions, it will be interesting to what the company does to "make it right." After Citron's initial claims, Valeant urged the SEC to investigate Citron -- a form of punishment for questioning Valeant's business practices. Instead of seeking an objective outcome, Valeant hired a committee of insiders to investigate the fraud claims. Moreover, simply cutting ties with Philidor may not be enough. The market and pharmacy networks could potentially guarantee that things are made right by hitting Valeant in its pockets.
Potential Impact On Valeant
Seven Percent Of Revenue Could Be Lost
Philidor accounted for 7% of Valeant's Q3 revenue of $2.8 billion (about $780 million), so there is the potential that 7% of Valeant's revenue could be lost. The company had Q3 EBITDA of $1.4 or an EBITDA margin of 49%. If revenue declines sharply due to the ending of relationships with Philidor, CVS, Express Scripps, et. al., I would expect the company's EBITDA to fall by more than 7% initially. It may be difficult to cut costs in lockstep with such revenue declines.
Pharmacies Could Ban Non-Philidor Sales
Valeant will likely take the posture that it had nothing to do with Philidor's aggressive sales tactics. Nonetheless, it benefited from them. Its rapid sales growth and stock market valuation were partially due to its affiliation with Philidor. Valeant's second best-selling medicine was Jublia; the treatment for toenail fungus reported $106 million in Q3 sales. Philidor accounted for 44% of those sales. If pharmacies wanted to punish Valeant, they could simply ban the sale of Jublia or other Valeant products throughout their entire network.
The Market Could Award Valeant A Lower Revenue Multiple
Valeant has grown its revenue and income via acquisitions. In this frothy market, revenue growth has benefited momentum stocks like VRX. With an enterprise value of nearly $62 billion, Valeant trades at 6.3x run-rate revenue (revenue through YTD September 2015 annualized). The impact of the Philidor debacle on Valeant's share price could be twofold. First, every $1 million loss in revenue could mean a $6 million decline in the company's $32 billion market capitalization.
Secondly, investors could award Valeant a lower revenue multiple -- amplifying the free fall in its market capitalization. A lower multiple could be warranted given the decline in revenue growth and [ii] if the company is no longer able to tap debt capital markets to continue its acquisition strategy. The robust revenue multiple is predicated on revenue and earnings growth that may now be a thing of the past.
Conclusion
In my previous article I highlighted how Citron did not need a smoking gun; it only needed a thread. That thread -- the R&O lawsuit -- led to another thread. The smoking gun -- evidence of Philidor's aggressive tactics used to boost sales -- then appeared. VRX is down over 35% since Citron's short thesis was published on October 21st. The stock could fall further as Valeant's entire business model could be called into question. Avoid VRX.