For about two days, Valeant's (VRX) stock price was improving. After releasing its second-quarter earnings report, Valeant surged by more than 20%. This was despite missing Wall Street expectations.
But much of those gains were wiped out in after-hours trading on Aug. 10 by news that federal prosecutors will be investigating Valeant's ties to specialist pharmacy Philidor. Valeant's relationship to Philidor have been under scrutiny since last October, as Valeant may have used Philidor to defraud insurers by concealing ties between the two companies. This investigation could lead to criminal charges against Philidor executives and Valeant itself.
A criminal probe would normally be the biggest concern which investor have about Valeant, but the company has many other problems. Valeant has been the subject of criticism for massively increasing drug prices. Its business model is in a shambles and it has a mountain of debt.
There is no reason for investors to consider buying long, and Valeant is a decent choice to short if that is part of your portfolio.
A Debt Problem
Valeant has lost more than 90% of its market value compared to its high in July 2015, and the company has numerous problems both legally and financially. As noted above, Valeant in its earnings report admitted that it failed to meet expectations, getting $1.40 in adjusted earnings per share compared to expectations of $1.47.
Why did its share price increase after missing expectation?
Some investors may have believed that Valeant was close enough so that it could reach its yearly revenue and adjusted earnings goals. They may have been buoyed by Valeant's decision to start selling off major non-core assets to relieve its massive debt.
That debt is Valeant's biggest financial problem. Valeant has more than $30 billion in debt, but total sales of only $2.42 billion in the last quarter. Valeant acquired this huge debt due to constant mergers and acquisitions, from which it had hoped to recoup the costs by raising drug prices.
With companies taking out installment loans for financing, debt has become a big enough problem for many experts to predict another downturn, with downgrades and defaults similar to what was seen before the 2008 financial crisis. For Valeant, this strategy has backfired in the face of public opposition and it is in a serious pinch. The company claims that selling off non-core assets will get $8 billion, which it can use to pay off part of its debt. But buyers know that Valeant is desperate to get cash, which means that they can wait and try to get assets at a low price.
Paying off the debt as well as handling additional interest payments are a serious drain on Valeant's ability to recover. And while shareholders should expect it to limp on for the rest of 2016, some analysts worry that the company will struggle with repaying it by 2018.
Fighting off controversy
Valeant may be the most reviled pharmaceutical company in America. It has been blasted both by the media and lawmakers for raising drug prices to unfairly high levels. For example, Valeant bought the rights to a pair of life-saving heart drugs and then jacked up their prices by 525% and 212%, respectively. Valeant openly admitted that it did so to maximize profit to its shareholders.
This has prompted a backlash from the media, politicians, and other businesses. CVS Health announced that it would not be selling drugs which underwent a sudden high price increase, and Hillary Clinton stated in a March campaign ad that she would be "going after" Valeant for its "predatory pricing." A more populist-oriented Congress could increase the pressure on the company.
Public animosity and a refusal to buy Valeant's drugs at the new prices has hurt the company's revenue, which fell by 11% in the last quarter. Despite this outcry, Valeant has stubbornly refused to lower prices. This may be because Valeant needs to raise cash to pay off its debt.
Stay far, far away
Before the announcement of the federal prosecution probe, an argument could be made that Valeant was a decent buy. The company seemed confident that it could still make yearly revenue targets and stabilize itself. But the latest developments are a red flag. At best, bolder investors might short the stock. A better option is to stay away.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.