Once everybody’s favorite stock, Valeant Pharmaceuticals Intl Inc (NYSE:VRX) is now one of the most hated names on Wall Street. Given that the same money managers who sang its praises at its highs are now mostly gone, I’ll admit the temptation to take a contrarian perspective and buy VRX stock.
But sometimes the conventional wisdom is right, and I find it difficult to argue otherwise with Valeant.
As of December 2016, VRX had $30 billion in debt but only $2 billion in operating cash flow and $3 billion in equity.
I don’t think the firm will be able to climb this mountain of debt.
With Valeant’s reputation, its past, investigations and debt profile, I can’t help but label VRX stock as speculative. With that in mind, let’s dive a little deeper into each of these issues.
Four Reasons VRX Stock Is Terrifying
The smart money has exited Valeant stock
When professional fund managers start heading for the exits, Valeant stockholders should start to worry. They generally know more than we do and are in close contact with the management.
We shouldn’t worship such figures (with the possible exception of Warren Buffett), but neither should we discount what they say, or more importantly, what they do, especially if they have skin in the game and are risking their own money.
And most of the smart money types have left VRX stock. Valeant once was the darling of Wall Street, owned by most of the big names. But last year, the Sequoia Fund (a New York mutual fund, not the Silicon Valley venture capital firm) sold its stake in VRX. Valeant cost the fund $1 billion and ended manager Robert Goldfarb’s 45-year career.
But that’s not all. Recently, VRX’s biggest defender, Bill Ackman of Pershing Square Capital Management, exited as well. Ackman’s fund bought the shares at an average of $196 a share, and sold them at around $11 a share, a whopping 94% loss. The fund lost $2.8 billion on Valeant, one of the biggest losses in hedge fund history.
It looks like the smart money looked at Valeant, realized they made a mistake, decided VRX stock was unsalvageable and sold it now to recover whatever money they could.
Only a few remain, including John Paulson, Francis Chou of Chou Associates and ValueAct Capital, which has a long history with the firm (going back to 2006). ValueAct helped install Valeant’s former CEO, the controversial J. Michael Pearson, and recently boosted its stake in VRX.
Jim Chanos hates Valeant
If Jim Chanos is short something, stockholders should worry. Chanos is perhaps the most renowned short-seller and contrarian investor of our time. He has a talent for spotting problems in regulatory filings that others overlook, shorting companies at peak hubris. When he shorts a company, many people call him crazy, since these companies look great and Wall Street loves them.
Eventually, however, reality catches up with the company, the stock falls back to earth, and Chanos pockets his gain. Instead of buying low and selling high, he shorts stocks at high prices and buys them back at low prices.
As I mentioned in an article in January, Chanos successfully shorted Enron stock at the turn of the century. Enron was one of Wall Street’s favorite stocks, but eventually collapsed. Chanos also cast doubt on China in early 2010, calling China’s economy unsustainable at a time when everyone thought it was unstoppable.
Chanos was short VRX stock as of November, and compared the company to Enron. He began shorting Valeant when it was trading at $100 a share. At the time, he noted Valeant’s lack of organic growth, its constant acquisitions and aggressive accounting. Chanos also warned Ackman about VRX stock in 2014, sending him a 26-page report.
Valeant, under its previous CEO, J. Michael Pearson, had a controversial business model. VRX didn’t do much drug research; R&D spending made up around 3% of sales, not 15% to 20%, the norm among pharmaceutical companies.
Instead, Valeant would take on debt, buy existing pharmaceutical companies, slash R&D spending to cut expenses and hike the prices of the drugs they acquired. Sometimes patients couldn’t live without these drugs, such as heart medication. VRX executives defended this practice by arguing that drug costs would be borne mostly by the insurance companies and not the patients.