Valeant Shares Sinks on Longtime Bull's Downgrade

  • BMO analyst downgrades stock, says questions have been raised
  • `Cannot defend the specialty pharmacy structure,' analyst says

Valeant Pharmaceuticals International Inc. shares plummeted for a second day after a BMO Capital Markets analyst who has advised buying the stock for more than two years downgraded the shares, citing questions about its close ties to pharmacies that distribute its drugs.

Valeant shares fell 13 percent to $102.71 at 10:22 a.m. in New York, after dropping 19 percent on Wednesday.

Scrutiny of the company is intensifying after Valeant denied a report by Citron Research, a stock commentary site, that accused the company of inflating sales using the pharmacies, which sent the shares plummeting. The companies, known as specialty pharmacies, dispense drugs to patients and handle many aspects of reimbursement to insurers. Drugmakers encourage doctors to send patients to the pharmacies because they can get a higher rate of prescriptions filled.

“We cannot defend the specialty pharmacy structure,” BMO analyst Alex Arfaei said in a report Thursday. He downgraded Valeant’s shares to “market perform."

"We’ve been strong, vocal Valeant bulls," Arfaei said. "However, we find Valeant’s arrangements with the specialty pharmacy Philidor as not just aggressive, but questionable."

Arfaei, along with analysts at JPMorgan Chase & Co. and other banks, said that the report from Citron Research hadn’t supported its claims of fraud. But some said Valeant’s distribution arrangement is unusual and difficult to understand.

Valeant disclosed this week that it has an option to buy one of the pharmacies in question, Philidor RX Services, a relationship other companies don’t appear to have, said Mark Schoenebaum, an analyst with Evercore ISI. He said that Pfizer Inc., Amgen Inc., Gilead Sciences Inc. and seven other drugmakers of comparable size don’t have such arrangements. Horizon Pharma Plc and Endo International Plc., two other specialty pharmaceutical companies, said they don’t have ownership interests in the pharmacies they work with.

Short Report

In its report Wednesday, Citron Research, published by short seller Andrew Left, claimed that Valeant had recorded fake sales to phony customers, using closely associated specialty pharmacies to help drive the business. The site said Valeant is using Philidor RX Services to store inventory and record those transactions as sales. “Is this Enron part deux?” the report said. “These similarities are too close to ignore.”

Arfaei said that argument doesn’t hold up. “Proof of a questionable business practice is not proof of financial wrong-doing,” he said. “Our analysis of Valeant’s cash flows does not support Citron’s Enron-like thesis; in fact it supports the opposite conclusion.”

Valeant called Citron’s accusations “erroneous” and denied the report.

“There is no sales benefit from any inventory held at these specialty pharmacies,” Valeant said in a statement Wednesday afternoon. The company said that sales are recorded only when drugs are sent to patients.

The episode is raising larger questions about Valeant’s business, Arfaei said. “Valeant’s structure may not be illegal, but we find it aggressive and questionable,” the analyst said.

Working with an in-house specialty pharmacy lets a drugmaker make higher profit margins and keep patients on its drugs longer, said David Galardi, co-founder of closely-held Apogenics Inc., a pharmacy consultant. The specialty pharmacy monitors patients for side effects, fights to get the medication covered by payers, and works to make sure that people are taking their drugs. That all adds up to longer-term patients, he said.

"What Valeant is doing is effectively taking the specialty model, putting it in-house and putting the services under their own control," Galardi said by phone. Drugmakers’ previous attempts to manage pharmacies have ended in failure, he said.

"Do you want to be a research-based pharmaceutical company that focuses on making medications and marketing them, or do you want to be a combo company where you are a pseudo-provider?" Galardi said. "The market generally does not like when manufacturers become providers."

Autorite des Marches Financiers, the Quebec markets regulator, is watching the Valeant situation "very closely" and checking to see whether the company complied with provincial securities regulation, Sylvain Theberge, an AMF spokesman, said Thursday by e-mail. While the AMF can’t provide more detailed comment on the alleged irregularities for now, the allegations are "worrisome," Theberge said.

“The downside from here is not limited to the specialty pharmacy business in question (we estimate that is priced in); it is dependent on the impact of the residual uncertainty on the rest of the business,” BMO’s Arfaei said. “We believe most VRX investors didn’t know about Philidor; what else is out there that we don’t know?”

Gregg Gilbert, an analyst with Deutsche Bank, said he also had questions about Valeant’s future performance -- notably over scrutiny the company has received on its high prices for drugs.

“We remain cautious on the stock given uncertainties related to the US drug pricing environment, Valeant’s specialty pharmacy distribution model, and related government inquiries,” Gilbert said. He has a hold rating on the stock.

Before it's here, it's on the Bloomberg Terminal.