Valeant Pharmaceuticals (VRX) has been a popular short for several months now. The stock currently sitting at $27 per share, down from a high of over $200, but there is still more downside in this bad pharmaceutical company.
Market Risk, Short Selling Philosophy
I do not usually short stocks. This is because of the efficient markets theory, and because the upside of a short position maxes at 100% while the downside is theoretically limitless.
Currently, the market faces downward pressure from the looming threat of a rate hike before 2017. This is enough downward pressure to hedge my short, and the following thesis is made in the backdrop of this fact.
Why Short VRX?
On Tuesday the NYSE ARCA Pharmaceutical Index (DRG) fell 1.3%, Valeant crashed 3.8% on the same day.
There is strong negative sentiment surrounding this company, and any bit of bad news sends the nervous longs running for the hills.
Image by Ann_San / Pixabay
Valeant is still unable to contain its debt, the company has a total of $30 billion, yes billion, in long-term debt. The company's enterprise value is a mere $39 billion. This makes the probability of an acquisition practically zero, no matter how far the stock drops. A potential buyer would have to take on $30+ billion in debt, even if the equity was free.
It is well known that Valeant has done some sketchy things in the past- namely price hikes of its drugs and its relationship with Philidor.
What many don't realize, is that Valeant had sketchy relationships with more than just Philidor. The company's popular anti-depressant Wellbutrin, a drug over 30 years old with generic competition, still manages to sell over $90 million per quarter. Why?
Enter Direct Sucess and the Valeant Wellbutrin XL Guarantee Program. Direct Success is a specialty pharmacy promising patients the popular brand name Wellbutrin for no co-pays. This allows the pharmacy to turn around and gouge the insurance companies. The drug costs $1,400 a month, while the generic is only $30. Total sales were over $300 million in 2015, almost double what they were in 2013.
Can the pipeline save Valeant?
In can be argued that Valeant's pipeline will be the saving grace for the company, and this is a strong argument. The company plans to launch 20 new products in 2016, however getting FDA approval is time consuming and expensive. If any of these drugs get rejected it could send shares plummeting.
I also have skepticism about Valeant's R&D competitiveness. As part of its strategy as a roll-up, Valeant historically spent very little on its own product development. I believe its current line-up was intended to be backup revenue, instead of the backbone of the entire company.
The overall trend of the market is negative in my opinion, this can be used to hedge a risky short position. Valeant is a good short because the company has not shown convincing progress bringing down its debt. Some of its best assets are unstable because their growth was due almost entirely to price hikes, and this behavior is facing increasing regulatory scrutiny. Wellbutrin, one of Valeant's most reliable assets, is practically worthless without these unpopular pricing policies.
The company completely depends on its product pipeline, but I do not think these drugs will be enough to save the stock from further decline.
Published on Sep 23, 2016By Will Matte