Wednesday, February 3, 2016

Valeant's 80 20 Rule

According to records received by the House of Representatives Committee on Oversight and Government Reform, on May 21, 2015, Howard Schiller (then Chief Financial Officer & currently Interim Chief Executive Officer) sent an email to Mike Pearson (then Chief Executive Officer and current Chief Convalescent Officer) about "price volume".

In the email Mr. Schiller wrote:
“Last night, one of the investors asked about price vs volume for Q1. Excluding marathon, price represented about 60% of our growth. If you include marathon, price represents about 80%.”
Then on September 28, 2015 (a scant four months later) Mike Pearson sent an email to EVERYBODY except Schiller (who by then had left Valeant and was settling in to his new job as Chief Not My Fucking Problem Anymore Officer at a private firm known only as "Nunya"). In that email Mr. Pearson wrote:
"After talking with a number of investors and observing the concerns and assertions in the media, I thought it would be helpful to give you my perspective on the two main issues worrying investors:

Concern that our business model and strategy is dependent upon large price increases in our U.S. pharmaceutical business,

Concern around our exposure to U.S. government drug price reimbursement. I can assure you that this bear thesis is incorrect on both accounts."
Then on October 19th, 2015 Valeant took it one step further when Mike Pearson guided Q3 Earnings call participants through a series of three key slides outlining Valeant's purported price and volume contributions to "organic growth" on a quarterly and YTD basis.

Looping back to Schiller's Q1 email, when you look at Valeant's earnings for that period which the company released three weeks before Schiller's email, Valeant reported a 16% YoY% increase in revenues from $1.89B to $2.19B. Luckily for us, Valeant also broke out geographic performance in Q1. Although they don't fully detail the U.S., they breakout topline for U.S. by segment and then report topline for ex-U.S. including Europe/Middle East($212M), Asia($125M), Latin America ($89M) and ROW Developed ($361M) totaling $787M in the quarter. They also provide respective growth rates for these areas. When you back out the baseline for each segment you see that total revs attributable to those same regions in Q1 2014 would have been $761M, which means in aggregate ex-U.S. grew 3.4%, or a total of $26M(queue the FX trolls).

If everything except the U.S. grew a total of $26M, the remaining $305M in growth came solely from the U.S. According to Howard's internal guidance, $61M of that growth came from volume whereas the remaining $244M of that growth came from price action

Using the information provided in slide 23 of their Q3 earnings(above), U.S. Branded Rx volume grew 15% YoY in Q1 of 2015, but net realized price per script increased 22.3%, ultimately increasing their US branded net by 41%.

Worse yet, Q1 2015 was Valeant's first quarter with Isuprel, Nitropress and Provenge ($72M, $62M & $30M respectively), which means Valeant's *real* growth was a measly $80M, or 3.7% of quarterly revenues. And what did it take to eek out the kind of growth you'd expect from ConEd?

Well, it took a $100M undisclosed option to purchase a shadow distribution channel through which they sucked $153M in quarterly revenues. Had it not been for Philidor, Valeant would have been looking at 9% growth (assuming they still took price), and had it not been for both price action and captive distribution, they would have been faced with a $66M decline in revenues (-3.4%). 

This brings us to two very serious implications about the Valeant Philidor relationship with respect to Valeant's future:
  1. Valeant consolidated Philidor so the revenue recognized by way of 3rd party sales (i.e., to customers) was a significant driver of revenue growth at Valeant
  2. Valeant limited a significant portion of U.S. distribution to Philidor, and simultaneously increased drug price as well as PAP support, which is why they were able to increase net realized price per script by 41%.
Take away Philidor and you're left with negative growth. Take away Philidor and you're left with lower net realized price per prescription.

And bringing it all back full circle, to answer Mike Pearson's email (subject line "You" of course) in light of Howard's disclosure that 80% of Valeant's growth is derived by price, you're damned right your business model and strategy is dependent upon large price increases in the U.S. pharmaceuticals business. So why then, when asked during the Q1 conference call by Goldman's Gary Nachman: 
"...if you could just quantify a little bit how much was price versus volume that contributed to growth in 1Q and what do you factor in your full-year guidance, price versus volume?"
Would Mike Pearson answer:
"In terms of price volume, actually volume was greater than price in terms of our growth outside the United States. It’s all volume. In fact, we have negative price outside the U.S. with FX. And in the U.S., it’s shifting more to volume than price. And we expect that to continue with our large brands.
A lot of our prices is, for most of our products, are negotiated with managed care. And there’s only a limited amount of price that we can take to [indistinguishable] of our consumer business is very little,... WalMart doesn't like price increases. If you look at our contact lens business, we’re not discounting contact lens. We’re keeping the prices the same."
More uncomfortably for Pearson though, is that in that quarter's 10-Q the company states:
"The growth in the Developed Markets was driven primarily by price, as significant volume increases in dermatology and eye health were offset by volume declines for certain neurology & other/generic products and for the Japan market."
The company continues:
"the incremental product sales revenue of $208 million (which includes a negative foreign currency exchange impact of $3 million), in the aggregate, from all 2014 and 2015 acquisitions, primarily from (i) the 2014 acquisition of PreCision Dermatology, Inc. ("PreCision") (mainly driven by Clindagel® product sales) and (ii) the 2015 acquisitions of certain assets of Marathon (mainly driven by Isuprel® and Nitropress® product sales) and assets of Dendreon (Provenge® product sales)." (empahsis added)

Oddly, sales of Clindagel declined in Q1 from $7M to $5M(so that is just a red herring), but we already know they jacked hospitals with absurd price increases in Isuprel and Nitropress.

It's completely absurd to think a company could publicly represent that price is 12%, 24%, or 15% of their "organic growth", but internally declare that price represents 80% of their growth. EIGHTY PERCENT! Layer on top of that that the 80% also includes Philidor and retail reimbursements through captive 3rd party sales.

It's hardly a newsflash, but Mike Pearson, Howard Schiller and the rest of the Valeant gang all have a significant credibility problem. Either they don't understand where their revenues are coming from, or they don't want us to understand where their revenues are coming from. And if Howard actually replied to that Q1 investor with any forthright description of price vs. volume, Valeant may also have a Reg-FD issue to deal with as well. I doubt it's Pershing though, because according to Ackman's perspective, Pershing believes the exact opposite of Howard Schiller, so good luck with that.

It's like the old joke about the guy that loses a dollar on every sale, but he makes up for it in volume. The key difference is that Pearson and Schiller appear to simply be making it up, period. Bagholders get your spoons ready. I hope that this Thursday will provide the candid insight into Valeant's business that all of its' investors deserve.

Neither Valeant, nor Mr. Schiller have responded to requests for comment at this time.

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