The headquarters of Valeant Pharmaceuticals International Inc., seen in Laval, Que., on Nov. 9 2015.Christinne Muschi/Reuters
Michael Pearson was reading his iPad on the Valeant Pharmaceuticals International Inc. corporate jet during a flight to China on Sept. 21 when he learned his company's stock was in free fall – all because of a tweet.
"Price gouging like this in the specialty drug market is outrageous," the tweet stated. It linked to a story that said drug makers had jacked up some prices by 200 per cent or more. And it was posted by U.S. presidential hopeful Hillary Clinton, who promised to do something about it. Within an hour, the Laval, Que.-based company's stock had tumbled by 9 per cent to $221 (U.S.).
"You spend a lot of time trying to build shareholder value," Mr. Pearson, Valeant's chairman and chief executive officer, said in an interview this week. "And to see it disappear instantaneously is not a great feeling."
It had been a steep ascent for the London, Ont.-born CEO. In just seven years, Mr. Pearson had transformed a minor, unprofitable drug company into an emerging industry powerhouse and deal machine that had shaken up the rich and powerful pharmaceutical industry, surpassed Royal Bank of Canada as Canada's most valuable company and made him a billionaire.
But as Ms. Clinton thrust the issue of runaway drug price increases into the U.S. political spotlight, Valeant stood out as one of the industry's most prolific and aggressive price-raisers – and investors were taking note.
It was the beginning of a hellish ride for Mr. Pearson. In the three months since, he has become one of North America's most vilified CEOs. In addition to widespread criticism for Valeant's price hikes, his credibility has been attacked by short sellers for the allegedly questionable practices of mail-order pharmacy affiliate Philidor, rival pharma bosses have pilloried him for slashing research and development spending and investment veterans have questioned the company's opaque accounting and aggressive acquisition pace.
Regulators and law enforcement agencies are probing Valeant and a board committee is investigating the now defunct Philidor. Valeant stock is down almost 60 per cent from its August peak, which erased nearly $50-billion of the company's value. Class-action litigants are amassing.
"We are greatly distressed at what has happened to our shareholders and to our employees," Valeant director Ronald Farmer said in an interview. "There is no positive spin you can put on this, nobody wanted this to happen and nobody is very happy about it."
Now Valeant is out to heal its battered reputation, and has altered its corporate strategy in an effort to do so. The company has called a near-halt to its frenetic acquisition pace for one to two years, rolled back some controversial price increases and signed a distribution deal with a major U.S. pharmacy chain.
But it's far from clear that the new Valeant can regain its previous growth and stock-price momentum. By taking itself out of the merger and acquisition game, it is suspending one of the central strategies that made it an industry maverick. One of Valeant's biggest challenges is a legacy of its blistering growth: a balance sheet saddled with $31-billion of debt.
Still, Mr. Pearson expressed no doubt that a comeback is in the offing.
"We're very confident in the performance of this company," he told investors on Wednesday. "You'll see it quarter by quarter by quarter."
The 56-year-old CEO presented Valeant this week as a kinder, gentler company than the one in the headlines. The company says its deal with pharmacy giant Walgreen Co. to replace Philidor will lower health-care system costs. Hundreds of employees have received retention bonuses, and Mr. Pearson is hitting the road to reassure doctors who prescribe its products that all is well.
There remain widespread doubts about the ability to turn things around. The Philidor debacle has impaired Valeant's U.S. dermatology business and it's unclear if the Walgreen deal can replace what was lost. It's also unknown what associated punitive actions, if any, could yet arise, either from the committee or regulators. And the U.S. price rollbacks will dampen the company's earnings power.
"We have a couple of clouds hanging over our head that have to get moved away," Mr. Farmer says. "You tell me – is it two quarters, three quarters, four quarters of cash flow against plan? The market has to tell you that."
Investors loved Valeant when it was buying companies. Now, as he presses pause on the very strategy that made him an industry player, can Mr. Pearson continue to hold their interest as he sets about on the blander task of getting his financial house in order? Unfortunately, there's no magic pill for that.
A giant's rise – and stumble
Mike Pearson had been prescribing tough medicine to Big Pharma CEOs for years when Valeant called in 2007. Mr. Pearson, then head of McKinsey & Co.'s global pharmaceutical consulting practice, hadn't heard of Valeant, but he knew its chairman, former client Robert Ingram, a drug industry veteran. Mr. Ingram asked if Mr. Pearson could help the struggling company.
Valeant had lost money for years and Mr. Pearson soon diagnosed the problem. It was trying be just like Big Pharma, but the modest-sized company was spreading itself across too many countries and spending heavily to develop a blockbuster drug.
The approach wasn't working for giant drug companies either. They were spending increasing amounts on R&D with decreasing levels of success. Mr. Pearson saw it as a poor way for large, bureaucratic drug companies to spend shareholder capital, but he could never get his clients fully onside with his views: "There was a feeling the market valued a stock partly based on how much they were spending on R&D" rather than the outcomes.
Instead, Mr. Pearson felt pharma giants could more effectively use their cash to buy drugs that were in advanced development or already on the market from venture-backed developers, just as established giants in industries like technology or mining did.
Mr. Pearson told directors that Valeant should focus on geographical and therapeutic areas that had long-term growth prospects, and on niche specialty drugs such as acne treatments where Valeant wouldn't be competing against Big Pharma and where payers were primarily consumers and private benefits plans, not cash-strapped governments.
Mr. Pearson suggested using the money saved on R&D to buy companies. With each purchase, Valeant could cut deep and squeeze cash from the acquired business. The directors, impressed by his blunt, results-oriented approach, hired Mr. Pearson in February, 2008, as CEO and put his plan to work.
He received a compensation package that was more aligned with shareholder interests than most public company CEOs: If he could deliver 30-per-cent or 45-per-cent annualized returns over three years, Mr. Pearson could double or even triple the amount of equity granted as part of his pay, enriching himself alongside shareholders. If average share gains fell below 15 per cent, he'd receive none of it. From then on, his overwhelming focus would be on generating shareholder returns.
Mr. Pearson quickly sold far-flung operations, cut jobs, and focused on North America and a few overseas markets. He centred Valeant's product portfolio on dermatology and branded generics, slashed R&D spending and made three acquisitions. By the end of 2008, the stock was up 70 per cent and The Wall Street Journal touted him as one of the year's best CEOs.
A key part of his strategy was to engineer a reverse takeover of a non-U.S. company. Freed from the U.S. corporate tax regime – the costliest in the developed world – a foreign-based Valeant could take advantage of more flexible, tax-lowering rules elsewhere and shift its intellectual property and profit centres to low-tax jurisdictions.
His chosen partner was Biovail Corp., the Canadian specialty drug maker that was also in turnaround mode. The companies merged in September, 2010, and most of Biovail's senior team was soon gone, along with the company name. Valeant moved its headquarters to the Montreal area but Mr. Pearson managed the company out of modest offices near his New Jersey home. Valeant's tax rate fell to the mid-single digits.
The company's focus on acquisitions, fuelled almost exclusively by debt, intensified from there. With every deal, Valeant targeted an internal rate of return of 20 per cent and a payback period of six years. Mr. Pearson almost always hit his targets by delivering steep cuts swiftly and remorselessly.
If the acquired company was American, there was the added bonus of huge tax savings. For example, after the company bought eyecare specialist Bausch & Lomb for $8.7-billion in 2013, it cut 3,000 jobs (B&L had 4,100 employees), and stood to reap $3.6-billion in tax savings over 10 years .
Valeant expanded into gastrointestinal treatments, ophthalmology, podiatry and dermatology, with Mr. Pearson flying around the world to negotiate deals and conduct due diligence himself, in just days or weeks rather than months. He kept a minimal staff at head office and relied on just one person to handle both the company's public and investor relations.
"We're non-bureaucratic so we invested next to nothing in PR, IR or government relations, [considering them to be] non-value-producing activities," Mr. Farmer said.
Mr. Pearson was backed by a board that often seemed more like an extension of the management team than seasoned overseers. Directors played an integral role in developing strategy, meeting with investors and acquisition targets, and attending conventions with salespeople.
"When we bought Medicis [a dermatology company, for $2.6-billion in 2012], I went to 10 dinners with cosmetic surgeons and dermatologists across America, because [Mr. Pearson] wanted the board to understand the business and he wants the companies we buy to understand the board is committed to the growth proposition he's put forward," Mr. Farmer said.
Board members were expected to be available for calls with Mr. Pearson late into the night and on short notice. The finance and transactions committee of the board regularly reviewed deals in development so that when Mr. Pearson was ready to pull the trigger, he could get a quick sign off.
"Mike viewed the transaction committee as being incredibly important to his biggest strategic advantage, which was speed," said a source close to the company. They periodically invited outside consultants, shareholders or critics in for "challenge sessions" to put the company's strategy under a critical microscope.
Directors admired their CEO for what they describe as his tireless devotion – some worried that he worked too hard – towering intellect and his transparency.
"Sometimes as a director you have to play Sherlock Holmes, trying to find out what is going on with the company," Mr. Farmer says. "That is simply not the case with Valeant."
Long-time investors were equally enamoured of his tough style and solid results. "He has been aggressive every step of the way," Robert Goldfarb and David Poppe, the leaders of one of Valeant's largest investors, Ruane Cunniff & Goldfarb, wrote to clients in October. "Pearson is honest and extremely driven. He does everything legally permissible to maximize Valeant's earnings."
Because the company was perpetually doing deals – it has closed about 150 transactions under Mr. Pearson – it was hard for outsiders to track its financial performance. The company fashioned customized financial measurements to help investors assess its progress, but these yardsticks were subjective and confusing.
Despite several moves by the company to improve disclosure, many analysts remain puzzled and continue to question Valeant's real underlying growth. "It's a tough company to understand," Mr. Farmer admits. By under-explaining its inner workings, "I think we've set ourselves up to be criticized by the folks that believe that we're a house of cards," he says.
Drug-pricing turmoil
As Valeant grew and made increasingly larger deals, it was bound to knock on the door of the Big Pharma establishment that had ignored Mr. Pearson's warnings. In 2014, Valeant senior executives were told their compensation would depend in part on doing "at least one significant deal that creates substantial shareholder value," according to company filings. Unable to finance such a deal on his own, Mr. Pearson asked activist hedge fund manager Bill Ackman for help. That April they launched a hostile $45-billion bid for Botox-producer Allergan Inc.
The pursuit was unsuccessful – Allergan ultimately found a white knight in Dublin-based Actavis PLC – and bruising. Allergan CEO David Pyott decried Valeant as a roll-up play, an asset stripper and a destructive force in the industry, saying his would-be acquirer mowed down R&D budgets, recklessly slashed jobs and forced other American pharma businesses to sell to tax-advantaged foreigners. And he has even unkinder things to say about Valeant's CEO.
"I think he probably in his heart despises Big Pharma … [and has] become a very objectionable person," Mr. Pyott said in an interview Wednesday. "He's realized that anybody running a public company who receives a call from Valeant [would say], 'Okay, all hands on deck, we have the pirates'" approaching.
Valeant was beginning to plunder in other ways. By 2013, the company had found a new way to increase revenue: By dramatically increasing wholesale prices on a range of established specialty drugs in the United States. It is the only developed country where prices aren't regulated, leading in part to soaring health-care costs. And it spelled big potential gains for Valeant. Mr. Pearson went hunting for "mispriced assets," as he calls them, buying drugs on the cheap and then jacking up their prices. "This was not uncommon," he says, matter of factly. "It was something that has been done in the industry by others and created shareholder value."
According to Deutsche Bank analyst Gregg Gilbert, however, Valeant was far more aggressive in its pricing actions than others. Valeant increased the price on one drug, Solodyn, by 60 per cent in 2012. The next year, it raised the price of 17 drugs by at least that much, and more than doubled the price of five drugs. It then more than doubled the price of 19 drugs in 2014. According to Deutsche Bank, Valeant's price increases not only exceeded those of most other specialty pharma companies, but the gap over its peers widened each year. As of two months ago, Valeant's average price increases for 2015 were 73.3 per cent, more than four times the rate of the sector. (Valeant disputed Deutsche's findings two months ago, saying price increases this year were only 36 per cent).
Valeant jacked up prices on some drugs multiple times, including Cuprimine, a treatment for a genetic disorder that can attack the liver and nerves. Its list price increased by 224 per cent in 2013, 158 per cent in 2014, and 330 per cent this year; The New York Times reported that out-of pocket costs for one patient increased this year fivefold, to $1,800 a month. Valeant also attracted criticism for doubling and quintupling the prices on two vital heart drugs used by hospitals, Nitropress and Isuprel. "Valeant became really aggressive, even arrogant," says Veritas Investment Research analyst Dimitry Khmelnitsky. "They deviated from the original strategy of buying established drugs and milking them to buying and then massively raising prices."
Public outcry over drug prices continued to grow and Valeant's stock kept falling after Ms. Clinton's tweet and subsequent proposal to curb drug spending in part by capping out-of-pocket costs for some patients. Meanwhile, other pharmaceutical companies singled out Valeant for gouging and not investing in R&D, to deflect the fact they also raised prices, though not as much.
"It's terrible that certain companies are taking advantage of the system," Merck & Co. CEO Ken Frazier told The Globe and Mail in October. "You can do what some of these companies are doing that are buying drugs, firing scientists and jacking up the prices – they're simply saying how much will the market bear? I happen to think that's the wrong way to think about pricing drugs."
Mr. Pearson realized from stockholder reaction to Ms. Clinton's tweet that "the environment in the U.S. around pricing has shifted," and immediately began working on a plan to cut prices, which he unveiled this week. By October, Valeant had been slapped with a federal subpoena over its drug-pricing strategy, patient-assistance programs and distribution practices. Senate hearings on the recent dramatic price increases in off-patent drug prices were planned. At the same time, the U.S. Federal Trade Commission began sniffing out Valeant's vast control of the rigid gas-permeable contact lens market.
Although any clampdown on pricing would require new legislation out of a gridlocked Washington, Mr. Pearson appears glad to have gotten ahead of any real threat to his company.
"In retrospect, if we could have predicted all this, we probably would have spent our capital elsewhere" rather than on mispriced drugs, Mr. Pearson says. He points out that the price increases were only in a small division of the company that accounts for 10 per cent of sales, adding that in large part the company pushes to expand revenue from its broad array of branded products through marketing, not price hikes. That said, "clearly it wasn't the right decision in retrospect, and we'll not do it again."
What came next was even more devastating. A swarm of short seller and media reports in October revealed Valeant's previously undisclosed ties to Philidor, a U.S. mail-order pharmacy that accounted for 7 per cent of revenue. The reports alleged several abuses of the insurance reimbursement system.
The alleged scandal read like a spy novel with purported employee aliases, webs of undisclosed partners and businesses named for chess moves. Investors grew skittish, the stock cratered and big-name pharmacy benefit managers (PBMs) – administrators of drug plans – said they would terminate their dealings with Philidor.
Mr. Pearson said he had no knowledge of any of the alleged wrongdoings, but Valeant initially tried to conceal its ties to Philidor – including an option to buy it – which he later admitted was "stupid." Although the board commissioned an ad-hoc committee to look into Philidor, Mr. Pearson wasn't ready to wait for the results.
"I hope [Philidor management] were telling me the truth that they were doing none of these things," he says. "But we run a public company and sometimes you have to make decisions based on risk. We had a lot of investors telling us, 'Let's move beyond this.' "
Valeant severed ties to Philidor, which later shut down entirely, and offered free or discounted drugs to patients while it searched for an alternative. It caused a costly disruption to its dermatology business. With his company doing damage control, one of Mr. Pearson's first moves was to offer retention bonuses to 700 employees to keep the company together. "Most companies pay people a little bit more when they go to an emerging market … Our emerging market's in the United States," Mr. Pearson cracked this week.
The way forward
Mr. Pearson seemed in good spirits as he faced investors at a theatre in downtown Newark, N.J., on Wednesday morning. The typically gruff CEO managed a few lighthearted comments, noting that "unless someone figures out how to reverse the aging process, this is going to be a great market" for Valeant's macular-degeneration drugs. "And everyone has two eyes, so that's good too."
If investors were expecting a mea culpa, it never came. Instead, Valeant executives sought investor optimism with detailed growth plans for the company's diverse businesses in eyecare, dermatology, gastrointestinal ailments and branded generics. They made the case that its R&D efforts, although relatively small compared with competitors, were more effectively managed and had yielded a pipeline of new products. When the presentation ended, the stock was up about 9 per cent.
Still, analysts wonder about Valeant's growth prospects. That's especially true of the new distribution deal with Walgreen in the United States, where Valeant will reduce prices – in some cases by more than half – to match generics on the market. In exchange, Walgreen will distribute Valeant's branded products to more customers through its 8,000 pharmacies.
"You sell a lot more at a somewhat lower price. You may make a slightly lower margin, but you'll generate more cash," Mr. Pearson says. He also says there is work to do to mend "trust-based relationships" with doctors who prescribe Valeant medications, "reassuring them that we're here for the long term."
"Investors will want to observe the performance of and understand the implications of the [Walgreen] distribution model," Deutsche Bank's Mr. Gilbert said in a note to clients. He added that the relationship with the retail giant would be a big factor in the company's ability to meet or exceed its financial estimates next year.
Two beneficiaries of the deal will be Canadian manufacturing facilities in Laval and Steinbach, Man., where Valeant is looking to add 130 full-time jobs to keep up with increased demand for dermatology treatments. Right now, Valeant has about 1,000 employees in Canada.
Some PBMs who cut off Philidor have voiced concerns. CVS Health, a large PBM as well as a Walgreen competitor with a vast network of pharmacies in the United States, was critical of the deal. "We think this is another example of Valeant attempting to circumvent PBM plan design for payers," Larry Merlo, CEO of CVS, said at the company's investor day.
Standard & Poors credit analyst David Kaplan also warned that the Walgreen deal could lead to price wars with generic opponents, and that regulators might raise competition issues. Others, including Mr. Khmelnitsky, remain skeptical about the company's ability to generate strong revenue gains from its existing businesses, despite the rosy projections offered Wednesday.
Valeant plans to use its cash flow to pay down $2.25-billion in debt, and Mr. Pearson indicated it could be two years before it can do another big acquisition, the likes of which have fuelled share-price growth. That could lead fickle hedge funds, which account for more than one-quarter of its stockholders, to find the stock less appealing.
Even when it's ready to do big deals again, Valeant will face an altered landscape: The company has relied on cheap debt to fund its $40-billion, seven-year acquisition spree. But rising U.S. interest rates and a volatile high-yield debt market could make it costlier for Valeant to borrow.
Mr. Pearson hasn't considered ceding control and the board has been supportive, he said. He considers the pricing issue behind Valeant, and says the company will make up the revenue by "shifting to more of a volume-based strategy in the U.S."
Mr. Pearson still holds to the core thesis that has driven him for years: That the old pharma model is broken and that Valeant's approach to investing only in high-growth countries and therapies, rationing out R&D dollars and buying up businesses remains the way forward.
"I've developed a strategy, there's been a lot of people who worked like crazy … [and] I feel I have a responsibility" to carry it through.
He must now prove that Valeant has softened where it counts, without erasing its trailblazer DNA.
"If the company had answered all of its critics, then the stock would be trading on the fundamentals" – and at a much higher price – said Valeant director and former chief financial officer Howard Schiller. "What the company has to do is perform, be a good corporate citizen, stay out of the news in a negative way, and with time … the stock will trade on fundamentals and shareholders should be happy."
