Last week, shares of pharma roll-up firm Valeant Pharmaceuticals (VRX), which had already been punished in September’s health-care rout, were slammed by accusations of fraud made by short-sellers. From its August 8 peak to the time of this writing, the stock has shed almost 60 percent of its value.
|Valeant’s Dizzying Fall From Grace|
As we have commented in recent letters, political criticism of health care expenses has been heating up, sparked by comments from Democratic front-runner Hillary Clinton after “pharma bro” Martin Shkreli’s company drastically hiked prices on an off-patent drug his firm had acquired. Ms. Clinton’s rival Bernie Sanders shares her concern -- and Republican contender Donald Trump used the occasion to lambast profiteers in the industry.
(Readers may be interested to know that Mr. Shkreli looks poised to get a comeuppance from the free market rather than from regulators, and sooner rather than later. A competitor, Imprimis Pharmaceuticals (IMMY) has announced its intention to offer an alternative to Shkreli’s drug at 0.1 percent of his price. We are happy to see it happen.)
Valeant (VRX) Under Pressure
VRX has been controversial for some time due to its strategy -- acquire companies, slash research and development expenditures, and raise prices on their legacy drugs. This strategy already made the company politically vulnerable in an environment where drug pricing is under scrutiny. The accusations made by short sellers, though, add another layer of worry for investors.
We are not prepared to comment on the merits of the short case. However, we note that in its broad strokes, VRX’s alleged misdeeds are not fundamentally different from strategies being used elsewhere in the pharma industry in an attempt to shore up revenues from insurance companies.
Techniques used by Valeant are also used by some other drug manufacturers. Some of these techniques allow drug companies to encourage doctors to prescribe much more expensive branded versions of drugs that are available as generics. We have seen cases like that of the drug Duexis, manufactured by Horizon Pharma (HZNP), which is simply a combination of ibuprofen and famotidine, probably known to readers by their brand names Motrin and Pepcid. Buying those drugs over the counter, a patient might pay $40 a month -- but she would pay $1500 for a month’s worth of Duexis. Understandably, many insurers refuse to pay.
But by using the specialty pharmacies, drug companies sometimes succeed in getting higher reimbursement from insurers. The consequence, ultimately, is higher drug prices for everyone -- which will eventually find their way into higher insurance premiums.
This is also the gist of the accusations made against VRX. Whether or not regulators conclude that anything fraudulent was happening at VRX is immaterial (except for holders of VRX shares, of course). The bigger picture is that a variety of strategies and tactics common in the pharmaceutical industry are being exposed and condemned in the court of public opinion, and that is just one more weight on the industry’s near-term prospects.
We were biotech bulls for a long time, and fundamentally -- in terms of the importance of the work of real biotech innovators for human health -- we still are. However, whether or not fraud is demonstrated in the case of VRX, all pharma and biotech companies will need to tread extremely carefully. This caution will pinch earnings, even leaving aside the distant prospect of real price control legislation under a future Clinton administration.
Investment implications: With a few high-profile cases in the public eye, and election-year politics in full swing, pharma and biotech are becoming the industries that everyone loves to hate. While we do not believe that price controls are a clear and present legislative prospect, pharma and biotech shares will likely remain under pressure as long as the rhetoric is hot -- and companies will become less aggressive in deploying some strategies that have boosted earnings over the past several years. In spite of the recent bounce, we are still staying away from the industry.
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