Too Clever To Be Legal

August 6, 2014 2:15 PM

For the past several months, Allergan has been fighting a take over by its competitor Valeant. While mergers and acquisitions are far from unusual in the pharma world, this may be the first time that a public corporation has combined efforts with an activist investor (Bill Ackman of Herbalife fame) in a bid to buy another company. Last week, Allergan sued both Valeant and Ackman, claiming their actions go beyond regulatory arbitrage and enter the realm of insider trading. At risk is Allergan's R&D operation- while Allergan spends roughly 17% or revenues on research (in line with the industry), Valeant, run by McKinsey alum Mike Pearson, spends under 3%.

Valeant has been called a house of cards by its own bankers. Its business model is centered around buying companies with successful products, strips out costs, and raises the prices of those products. This practice has been called unsustainable and potentially harmful to the economy and society while others think the strategy may make sense in some situations.

The fighting has been ugly, even in the context of a hostile takeover. In the lawsuit, Allergan alleges that:

Valeant "Contacted Allergan sales representatives and welcomed them to Valeant," "Visited Allergan customers, announcing that they were Allergan’s new sales representatives" and "Offered rebates on both Allergan and Valeant purchases."

The Financial Times (registration) takes a particularly uncharitable view of the company. Referring to a presentation where Ackman compares Valeant CEO Pearson to Katharine Graham of the Washington Post, the author states:

That analogy would work if Graham had fired most of the Post newsroom, including Bob Woodward and Carl Bernstein, who broke the Watergate scandal, and bought wire copy instead on the grounds that investigative journalism was a high-risk, low-return activity.

Regardless of the morality of Valeant's business practices, the novel acquisition strategy has raised a good deal of attention. An investment research firm recently produced a report about the acquisition titled “How Can It Be Legal?”

posted by exit (36 comments total)

In a former job, I had a look at how Allergan conducts its business. Much of what I saw is covered by NDAs, but I'm pretty sure I can share this personal opinion: I'm rooting for the injuries.
posted by gauche at 2:20 PM on August 6, 2014 [7 favorites]

Huh. I'm a pharmacy purchasing manager, and we have a product manufactured by Valeant that we buy very rarely, and every time I try and buy it they have cut down the number of authorized distributors, and I need to set up an account with a different company. Good to know my annoyance with them is well deserved.
posted by Rock Steady at 2:21 PM on August 6, 2014 [1 favorite]

Allergan has posted it's concerns regarding the take-over online. (pdf)

Valeant's offer. (pdf)
posted by exit at 2:23 PM on August 6, 2014 [2 favorites]

Some of Allergan's 17% on R&D takes place just down the hall from me. They were purchased by Allergan work on tissue regeneration. It would be a damn shame to see their work bought and shunted off because they happened to get bought by the makers of Botox.

(On which note, it doesn"t really seem fair to link Allergan solely to an article on Botox. Here's a Wikipedia page and their corporate website.)
posted by maryr at 2:27 PM on August 6, 2014 [1 favorite]

If corporations are people, it seems like Valeant is some sort of corporation-vampire.
posted by showbiz_liz at 2:29 PM on August 6, 2014 [5 favorites]

There's a very good, in depth, look at this this deal on Bronte Capital, which is one of the best blogs for serious financial analysis of companies. Its a bit technical, but if worth reading if you're seriously interested and don't mind googling a few terms.

Part 1

Part 2

Part 3

etc

(there are 9 parts in total)
posted by Touchstone at 2:42 PM on August 6, 2014 [5 favorites]

"Novel New Strategy"?

So it's Lemon Flavored Morganization, now with 10% less monopolization. Cause the ol Romney Turn and Burn is out of fashion at the moment. Fuck R&D, stupid nerds discovering stuff.
posted by The Power Nap at 2:44 PM on August 6, 2014 [2 favorites]

Wow, so someone took essentially the idea of a patent troll shell corporation and made it shittier.

I'm sort of impressed, in the same way i am when i see some new magnificent remote controlled killing robot or an enormous complex oil/gas extraction ship or something.
posted by emptythought at 3:31 PM on August 6, 2014 [4 favorites]

exit, thanks for posting that link to the slide deck. Very convincing arguments, I thought. Valeant sounds like a soul-sucking predator.
posted by GrammarMoses at 3:42 PM on August 6, 2014

PharmaCorp vs. PharmaCorp, it's like when the Valerie Plame thing had people sticking up for the CIA. In the end Allergan is still a large pharmaceutical corporation feeding off public research and scientist training with financials built around charging rent and regulatory arbitrage wrt patents, FDA etc.

If you hate the way intellectual property laws work in this country you should be rooting for Valeant. Let the system destroy itself.
posted by ennui.bz at 4:20 PM on August 6, 2014 [6 favorites]

So, If I understand correctly, The only way Ackman may possibly be slapped down is not because he is forcing a corporation to act against the public interest and it's own best interest, but because he created a "perception" that hedge funds have advantages over small investors.

What idiot thought he was playing on a level field with hedge funds?
posted by Megafly at 4:23 PM on August 6, 2014 [1 favorite]

Corporate mergers and acquisitions often bear an uncanny resemblance to the sex lives of parasitic insects.
posted by jamjam at 4:41 PM on August 6, 2014 [3 favorites]

Apparently we have now arrived at the "destruction" part of our "creative destruction" programme.
posted by GrammarMoses at 5:05 PM on August 6, 2014 [2 favorites]

Long since, actually.
posted by GrammarMoses at 5:05 PM on August 6, 2014

If you hate the way intellectual property laws work in this country you should be rooting for Valeant. Let the system destroy itself.

Oh, and all you people sick with things no one has found a cure for yet, quit lingering around like that and just die; we need to thin the herd a bit anyway.
posted by jamjam at 5:36 PM on August 6, 2014 [2 favorites]

If the Valeant business model becomes a trend - and, given the short term profits involved, it well might - it could have interesting long-term political effects. There are already plenty of countries which regulate the price of patented medications, or drive hard bargains with national bulk-buying, or simply refuse to grant patents for some drugs. The single politically effectively argument that pharmaceutical companies have against more of this sort of thing is the amount of money that they spend on research and development.

By slashing R+D and raising prices as high as the market will bear, Valeant is taking that argument away. They're acting like a generic drug maker, and it wouldn't be completely shocking if some governments insist they provide drugs for generic prices as a result.
posted by clawsoon at 5:59 PM on August 6, 2014 [4 favorites]

Would somebody be so kind as to write a few words or provide a link to describe what is meant by the term "activist investor"? This is the second time in a week that I've heard it; the first was in relation to a company pulling out of a natural gas liquefaction project. Despite the fact that the news was welcomed by environmentalists, I get the feeling that these investors are not exactly "activist" in that sense...
posted by Verg at 6:21 PM on August 6, 2014

Great links, Touchstone. I may have to take back what I said about short-term profits: So far, Valeant is drowning in losses, and it's only management's assurance that the big expenses are all "one-time" expenses ("one-time" expenses that have re-occurred every year since they started their new strategy) that's pushing the stock price up.

A billion dollars a year paid to bankers for merger and acquisition costs.

Three-quarters of a billion dollars a year for asset writedowns, i.e. "we paid too much for that company, oops."

Another quarter of a billion in each of the last couple of years for legal settlements and "other unusual items."

It's like the Tyco or Enron buying sprees, but without the fraud; they're being completely upfront about the fact that they're spending ridiculous amounts of money on stupid ("oops, worth a billion less than we thought") acquisitions. And investors are eating it up. Fascinating.
posted by clawsoon at 6:24 PM on August 6, 2014 [4 favorites]

Bronte is short VRX. I actually think he's right about the short and what he's doing isn't making a compelling case for why VRX is a short, so much as trying to get the longs to question their fealty to the non-GAAP earnings numbers VRX management is trying to get them to believe.

Its a page of the playbook used on any sort of acquisitive roll-up type biz like VRX. So read the blog posts, but know what's going on here.

I'm not sure how what Ackman did isn't insider trading from an economic perspective.

(An activist investor generally pressure publicly or privately for a company's BoD or CEO to make the changes they want to the business which they believe will increase the share price. There are many many ways to do this. Some guys - like ValueAct (dudes who forced out Ballmer at MSFT and underwrote VRX early days) or Relational (forced changes at HPQ) tend to be very thoughtful, intelligent guys who usually work privately if they can. The other end of the spectrum are the muppets who just tell management to sell themselves.)
posted by JPD at 6:29 PM on August 6, 2014

Tyco would be more the blueprint then Enron. No one is really saying its all fake, so much as they are saying the Non-GAAP #s overstate the successes of the roll-up
posted by JPD at 6:30 PM on August 6, 2014

Verg: Would somebody be so kind as to write a few words or provide a link to describe what is meant by the term "activist investor"?

In most companies, most of the time, investors are pretty passive. Management does what it likes; if investors think that management is doing a poor job, they simply sell the stock and forget about the company.

An activist investor does the opposite. If they think that management is doing a poor job - which virtually always translates to "not making enough profit" - they will attempt to buy up large numbers of voting shares and convince other investors to get rid of management or force them to do things differently. Since activist investors rarely have enough money to buy a controlling share of the company outright, they often engage in complicated and no-doubt-entertaining maneuvers to get control.

In theory, you could have activist activists who gain control of a company and use it to further social or environmental causes. I believe that might be nearly impossible in practise, though, because - someone please correct me if I'm wrong - minority shareholders can sue if controlling shareholders fail to keep the company focused on profits and thus crash the share price.
posted by clawsoon at 6:36 PM on August 6, 2014

Most activists don't try to get control, and a proxy fight is so ruinously expensive that its really only a last gasp effort and only makes sense for large funds chasing after large companies.
posted by JPD at 6:37 PM on August 6, 2014

JPD: Most activists don't try to get control

Thanks for the clarification. Would "influence" (or even "major influence") be a more accurate way of putting it?
posted by clawsoon at 6:42 PM on August 6, 2014

So, is this the only thing left for participatory capitalism? To cling to the surface of something you know for a fact is a bubble, and hope you get out before the rest of the suckers?
posted by mhoye at 6:45 PM on August 6, 2014 [2 favorites]

at the end of the day its a game of chicken where you need to credible threat of getting seats on the board but you don't want to take it that far.

Influence is a good term for it.

This isn't really a bubble. And I don't think VRX things its unsustainable regardless of what you or I might think.
posted by JPD at 6:49 PM on August 6, 2014

Rock Steady: I'm a pharmacy purchasing manager, and we have a product manufactured by Valeant that we buy very rarely, and every time I try and buy it they have cut down the number of authorized distributors, and I need to set up an account with a different company. Good to know my annoyance with them is well deserved.

Valeant calls those "significant operating synergies from reductions in sales and marketing".
posted by clawsoon at 6:50 PM on August 6, 2014 [5 favorites]

If you think R&D is just an expensed form of capital spending (it is) this is essentially the same thing as running a business for cash and stripping it clean if you think he's spending too little.

If you are VRX or its fans you think its a new paradigm and that all of that R&D was wasted money because the cost of R&D>cost of buying the product lines generated by that R&D.

Its not crazy per se. Its just really hard to figure out who is right.
posted by JPD at 6:53 PM on August 6, 2014

It's clear from how I framed this that it, I'm not sure- offends my sensibilities maybe, but it does make sense if you take Valeant's position at face value. Any large or mid-sized pharma or biotech I can think of is taking some sort of hybrid approach; that is, spending 10-25 percent of revenues on R&D while at the same time buying up promising research start-ups and other companies, selling/swapping product lines with competitors, etc...

When there is some sort of specialization, maybe it's in a disease state, a type of physician, a delivery mechanism. Valeant's specialization is in how it does research (it doesn't) focusing on buying and borrowing and liquidating to buy again. It reads so much like the script of Wall Street that it's difficult to not have a negative reaction to it, and those Bronte posts suggest that its also more of a shell game than I would have thought.

Rock Steady- I wonder if the shrinking ADR list has anything to do with the fact that they started booking shipments to McKesson as sales as opposed to actually waiting for, say, a purchasing manager to place an order before recording a sale.
posted by exit at 7:55 PM on August 6, 2014

again - I actually hate the VRX story, don't get it, etc etc.

But take those bronte posts with a grain of salt the size of a mountain. He's short the stock and he needs to break the longs confidence in order for him to get paid, because he believes VRX can just keep manufacturing the non-GAAP numbers. He needs to convince people the non-GAAP are BS so the short works.

The reality is that there are some very very smart people on the other side of the coin, People whose reputations are much better than Ackman's
posted by JPD at 8:00 PM on August 6, 2014

While you should take account of the fact that Bronte (aka John Hempton) is short, a "grain of salt the size of a mountain" is, in my view, overstating it.

Bronte is short, but he's totally upfront about it, bases all of his work on public accounts, and has been publishing this kind of work for many years with a great track record, particularly when it comes to spotting frauds.

Also the best analysts are nearly always practising investors, and the quality of their analysis is in a different league to anything you'll read in the press. Despite the fact they have an axe to grind, they are also putting their credibility and livelihood on the line in a way that journalists are not.
posted by Touchstone at 1:55 AM on August 7, 2014

I actually know him in real life a teeny tiny bit and am aware of his track record. I think he's right here, but I don't think he's actually putting forth his real thesis in these posts. I actually find many of his points correct, but trivial in the context of VRX's valuation and underwriting the roll-up strategy. I actually think he's intentionally doing something else, which makes sense in the context of how many people think about shorting.

But it just isn't the sort of clear cut forensic analysis of China frauds he usually blogs about.

If you want to keep discussing this particular angle I'd prefer to take it to MeMail.
posted by JPD at 5:30 AM on August 7, 2014

Fuck Valeant.

My fiance works at Allergan, so we've sort of been watching this happen from the inside. I can't speak to the intricacies of the situation, mostly since I don't understand it; I usually just laugh when my mister forwards me articles like the one where Pearson talks about cutting costs by getting rid of a golf course that Allergan doesn't even have. But Allergan is laying people off to try and increase profits to appease their investors so they help fend off the takeover, and now for a whole bunch of people there's this big looming question of whether you're going to lose your job now or whether you'll lose it later. So just fuck Valeant.
posted by alynnk at 7:03 AM on August 7, 2014 [2 favorites]

But take those bronte posts with a grain of salt the size of a mountain. He's short the stock and he needs to break the longs confidence in order for him to get paid

Ah, an activist derivitator then.

Or whatever you call an investor who specializes in derivatives. If there is a word for it already, I don't know it. If there isn't a word for it already, I am definitely nominating derivitator for the job, as it has the kind of flash and panache that anyone working in derivatives is going want in their daily life.
posted by flug at 8:01 AM on August 7, 2014

Sometimes I dream that Elizabeth Warren is president and that the Oval Office desk has a big red Revoke Corporate Charter button she can push when this kind of silliness goes on. Or even just a De-list From Stock Exchange For 1 Year button.

We are way too lenient in this country with "business for the sake of business". Companies need to produce a valuable good or service or GTFO of the economy.

Obviously this is a fringe position ... just ignore me, I've had a rough week.
posted by freecellwizard at 8:33 AM on August 7, 2014 [1 favorite]

And of course Valeant is Canadian.
posted by JPD at 8:44 AM on August 7, 2014

Metafilter: Stupid nerds discovering stuff
posted by hearthpig at 3:29 PM on August 7, 2014