J. Michael Pearson is not your typical drug executive. The head of Valeant Pharmaceuticals built his company into a moneymaking machine by acquiring other drug makers and products, not by investing in research and development. The approach contradicted longstanding industry doctrine, but it won high praise from investors. For years, the Canadian drug company’s stock went nowhere but up.
A slew of questions about its business practices has turned Valeant from a Wall Street darling into a Main Street poster child for questionable behavior. Federal prosecutors have issued subpoenas. Lawmakers are conducting investigations. Pharmacy benefit managers stopped doing business with a company that was important to Valeant’s operations. And now, many investors are bailing. The drug maker’s stock has lost more than 60 percent of its value since the beginning of August.
Even activist investor Bill Ackman, who heads the Pershing Square hedge fund, which owns about 5 percent of Valeant’s stock, conceded the company has stumbled. During a marathon four-hour conference call Friday, he noted that the drug maker was not forthright about disclosing some activities. Still, Ackman insisted Valeant can recover, arguing that its mistakes were tactical, not strategic.
That’s a generous interpretation. It’s true that the company has generally done a poor job of explaining its moves, but Valeant’s stumbles in recent weeks speak more to the shortcomings of Pearson’s strategy of eschewing R&D in favor of near-term financial gains. And Valeant’s questionable practices now threaten to undermine confidence in the wider health care system.
“Valeant typifies a larger problem when it comes to delivering medicines to Americans,” said Steve Brozak, who heads WBB Securities and tracks the biopharmaceutical industry. “Our [health care] system is not only complicated, but in some cases it can also be unsavory.” Seeing Valeant’s business practices, Brozak added, “is a bit like watching how sausage is made.”
Valeant did not respond to a request for comment.
The two fundamental issues plaguing Valeant are pricing and insurance reimbursement. In order to juice revenue, the company has slapped huge price increases on newly acquired medicines. Earlier this year, for example, Valeant bought the rights to the heart-rhythm treatment Isuprel and the blood-pressure agent Nitropress. It then boosted the price of the drugs by 525 percent and 212 percent, respectively.
There was nothing illegal about this, but the tactic inflamed consumers, doctors, and insurers. It also invited scrutiny from lawmakers. Suddenly, Valeant was at the center of the escalating national debate over prescription drug costs.
Yet another firestorm emerged two weeks ago, when Valeant unexpectedly disclosed ties to a mail-order pharmacy called Philidor Rx Services. Philidor, based in Pennsylvania, ran a network of pharmacies, and Valeant was its only customer. Late last year, Valeant paid $100 million for the option to buy the pharmacy for free at any time in the future.
Since Philidor only accounted for 7 percent of Valeant revenue, the drug maker maintained it didn’t have to disclose the relationship with the pharmacy. But the failure to do so any sooner raised questions about whether Valeant was inappropriately using the pharmacy to promote its own dermatology drugs and creams over cheaper alternatives. Other charges of fishy behavior include using Philidor to keep copayments low while collecting as much insurance reimbursement money as possible.
If all this wasn’t confusing enough, a company created by Philidor agreed to buy R&O pharmacy, which is based in California. And people affiliated with Philidor purchased a stake in West Wilshire Pharmacy, which is also based there. This happened after California regulators denied a permit to operate in the state. The apparent purpose of the transactions was to circumvent regulators and ensure that prescriptions could be filled from one of the biggest markets in the nation.
Short sellers exposed some of these developments in reports and blog posts that alleged questionable accounting. The media provided details that underscored how Valeant was not forthcoming about its practices.
By late last week, the cumulative effect of these disclosures took a toll. The nation’s largest pharmacy benefits managers — CVS Health, Express Scripts, and OptumRx — stopped doing business with Philidor. Valeant then ended its relationship with Philidor, which, in turn, plans to shut down.
What happens next is unclear. The Valeant board created a committee last week to examine the company’s ties to Philidor. Regardless of the findings, still more government probes appear likely.
Valeant’s business model may not be broken, but it is under pressure. During his conference call last week, Ackman suggested that the days of buying “mispriced” medicines and then marking them up to unforeseen heights are “totally gone.”
Whether this ultimately adds up to a reversal of fortune remains to be seen. Some investors see a buying opportunity. But Valeant may have to rely on a more conventional approach to the pharmaceutical business: investing in finding new drugs instead of manipulating prices and insurance payments.
That wouldn’t be such a bad thing. After all, that’s what the prescription drug business is supposed to be about. Instead of making sausage, Valeant could be making medicine.
Editor’s note: This first appeared today as the weekly Pharmalot column in The Boston Globe.
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