October 23, 2015 / 6:35 PM / 4 years ago

Valeant woes underline problems for pharma

NEW YORK, Oct 23 (IFR) - The pharma sector needs more than medicine to get over its latest malaise.

Shock allegations this week concerning Valeant’s business practices poured oil on the fire in the pharmaceuticals sector, which has gone from hero to zero in little more than the blink of an eye.

Pharma enjoyed a long run as a capital markets darling, delivering robust returns - in both bonds and equities - and churning up huge fees for bankers through waves of M&A.

According to data from Bank of America Merrill Lynch, up to this week US high-yield healthcare bonds had returned 2.79% in the year to-date versus 0.023% from BAML’s broader high-yield index.

Still, that is small beer: Valeant shares were up an eye-watering tenfold in the five-year period to August.

But the wheels began to come off the wagon the following month, when Martin Shkreli, a former hedge fund executive and the founder of Turing Pharmaceuticals, jacked up the price of an Aids drug Turing had acquired from US$13.50 per pill to US$750. Hillary Clinton, making a White House run, immediately vowed to cap drug costs.

In a flash, the goose that laid the golden returns was cooked.

Biotech stocks have been hammered, losing some 15% since Clinton’s announcement. The seven life sciences companies that have gone public in the US since then all did so at valuations below where they were marketed.

Bankers trying to sell a high-yield bond issue to finance Concordia Healthcare’s US$3.5bn acquisition of Amdipharm Mercury earlier this month were unable to do so, and they had to offer steep discounts on a loan backing the deal to get the buyside on board.

Across the sector, issuers have had to sweeten spreads dramatically.

“People made good money in healthcare (before this),” one high-yield investor told IFR last week. “They viewed it as safe.”


As it happens, Shkreli was merely taking a page from the playbook at Valeant, whose business model has been to buy drugmakers, halt their R&D, slash jobs and then raise prices. Other pharma companies have adopted similar tactics.

While sector returns were soaring, complaints were relatively few and far between.

But now sentiment has changed, and the allegations against Valeant from short-seller Citron Research appeared to hit especially hard.

Valeant’s most actively traded bonds - its US$3.25bn 6.125% April 2025s, sold in March to help finance its purchase of Salix - were bid as low as 81.5 this week. They had been trading at 103.5 just five weeks earlier.

On the equities side, some US$17bn of Valeant’s market cap was eradicated in one fell swoop.

Citron accused the company of using phantom so-called “specialty pharmacies”, which often handle only one or a handful of drugs, and falsely recording transactions with these companies as sales. In particular, it pointed to Valeant’s relationship with Philidor Rx and R&O Pharmacy.

Valeant said the Citron report was “erroneous” but also said it owned an option to buy Philidor - and that it had incorporated Philidor’s inventory into its own balance sheet.

That was clear as mud, and the market noticed.

“We have concerns over what is apparently a murky world of distribution and the extent to which (Valeant) might be operating outside of industry norms,” CreditSights analysts said.

“The market is likely to be very unforgiving in the event Valeant’s senior management team fails to get very specific on all issues.”


The company may do just that, promising a conference call on Monday to address the fraud allegations. That helped its bonds find a floor late on Thursday, with the 2025s bid back up to 86.

But other companies have been punished all the same, including in related sectors such as hospital operators.

Community Health’s 6.875% 2022 bonds dropped around five points to 100.5 on Thursday, while Tenet Healthcare’s 6.75% 2023s shed 4.4 points to 96.5.

“It’s a bloodbath across the sector,” one analyst said.

To make matters worse, the latest brouhaha came just days after Valeant disclosed that it had been subpoenaed by US prosecutors over its drug pricing and other practices.

According to CreditSights, other major pharma names such as Allergan and Endo were quick to disavow any affiliation with specialty pharmacies.

This may all prove to be nothing, of course. “At the least,” CreditSights said, “it sounds problematic.”

Yet even a relatively benign outcome should still cause some soul-searching on the buyside, not least among the major hedge funds and institutional investors that hold significant stakes in Valeant and other pharmaceutical credits. They might wonder how diligent their due diligence has really been.

This story features in the October 24 issue of IFR Magazine, a Thomson Reuters publication (Reporting by the IFR team; Writing by Marc Carnegie; Editing by Matthew Davies)

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