Valeant Pharmaceuticals has not been having a great month.
Ever since a Wall Street Journal report came out earlier this year noting that the pharma giant had hiked the prices of two common heart drugs by more than 200% and 500%, the firm has drawn scrutiny from lawmakers and media organizations. And the situation only deteriorated after Martin Shkreli and his 5,000% price hike on a 62-year-old medication at Turing Pharmaceuticals placed a big, fat spotlight on some major players in the industry's strategy of hiking older drugs' prices for reasons many found inexplicable.
Valeant has been one of the main subscribers to this tactic, and the renewed media attention on price hikes has been accompanied by a pair of subpoenas from U.S. attorneys in Massachusetts and Manhattan. They're aiming to glean more information about Valeant's pricing model and distribution strategy (and that's in addition to requests from Democrats on the U.S. House Government and Oversight Committee for documents from Valeant and testimony by CEO J. Michael Pearson).
Media reports also revealed that Valeant has, in some cases, used price hikes for the express purpose of bolstering revenue to make up for falling demand on older drugs. Under siege, the company is openly contemplating major changes, such as a sale of its neurology unit and a shift in pricing model.
And then, Wednesday happened.
A group known for criticizing Valeant, Citron Research, released a report dubbing the company "the pharmaceutical Enron" and alleging that Valeant uses a series of "phantom captive pharmacies" to store and shift inventory that it then logs as sales.
Investors were apoplectic, sending Valeant's stock into its worst spiral since at least 1994. Shares fell by as much as 32% day-over-day and closed down 20%, at a 52-week low, even after Valeant responded to and refuted the allegations. (Shkreli, meanwhile, tweeted that he had gone long on Valeant.)
There are still a lot of moving parts to this story, and more information is bound to emerge over the coming days and weeks. But here's what we know about the convoluted imbroglio so far.
What is Citron Research, and who runs it?
Every allegation has a source, and this case, the accuser is one that has an obvious vested interest in tarnishing Valeant's reputation (although that's not to say their claims should automatically be dismissed). Citron Research is run by Andrew Left, a known short seller who also has a history of Valeant-bashing.
The group's website describes Citron as "one of the longest-running online stock commentary websites" whose goal "is and has always been to provide truthful information in an entertaining format to the investing public." Left is described as "a private investor with 17 years trading experience," and the site also notes that he's been "sued four times by companies claiming a variety of damages as a consequence of his postings," including by GTX Global.
You can read Citron's full report here for yourself. As you might notice, the group's approach isn't exactly subtle:
What are the allegations?
Citron's report centers around a specialty mail-order pharmacy called Philidor Rx that the group alleges Valeant uses in an accounting scheme to record sales transactions that never really occurred.
The scheme that Citron describes involves another specialty firm called R&O Pharmacy. But the marquee claim is this: Citron believes that Philidor and R&O Pharmacy are actually one and the same and both controlled by Valeant—or, as the report puts it, "Citron believes the whole thing is a fraud to create invoices to deceive the auditors and book revenue. PHANTOM ACCOUNTS." Valeant has denied that claim.
Part of the information used to support this claim is that Philidor and R&O list the same toll free phone number for their privacy officers and share board members. The report also says that it's suspicious that Valeant announced during its Q3 earnings call on Monday that the firm had purchased an option to acquire Philidor (whose sole client is Valeant) and has been consolidating Philidor's financials with its own.
Complicating matters even further, Valeant is currently suing R&O for $69 million, claiming that the pharmacy "is improperly holding significant amounts it received from payers." And on top of all of that, news broke later on Wednesday that Philidor, while not having a direct equity ownership in R&O, "does have a contractual right to acquire" R&O and other pharmacies in its affiliated network. It's entirely possible this is all above board—but the chain of acquisition options between Valeant, Philidor, and R&O is raising some eyebrows.
Citron repeatedly compares these alleged practices to Enron—an attempt to create the impression of market demand and sales out of thin air by shifting inventory around a shell distribution network (again, it's worth noting these are merely Citron's claims at this point, and the firm may have obvious ulterior motives for painting such an analogy). In fact, the report goes on an extended, heavy-handed riff comparing statements made by Valeant chief Michael Pearson and Enron chairman Ken Lay.
How has Valeant responded?
After its stock spent much of Wednesday taking a vicious hammering, Valeant came out with a vigorous denial of all the accusations.
"We categorically deny the allegations made in the Citron Report," said the company in a statement several hours after the allegations were published. "Citron’s false and misleading statements about Valeant appear to be an attempt to manipulate the market in an effort to drive down Valeant’s stock price.
"As disclosed in our third quarter earnings presentation and further today, Valeant has a contractual relationship with Philidor and properly accounts for sales to, and inventory at, Philidor and Philidor’s network pharmacies. We are confident in our full compliance with all applicable accounting rules, regulations and laws."
Valeant also had an explanation for the common phone numbers listed between Philidor and R&O, saying that Philidor provides a bevy of back-end services to other specialty pharmacies in its network (including R&O) and that this explains the shared customer service number.
The company vigorously defended its accounting and bookkeeping practices. "All shipments to Philidor and other pharmacies in the Philidor pharmacy network, including R&O, are not recorded in Valeant's consolidated net revenue," read the statement.
"Sales are recorded only when the product is dispensed to the patient. All sales to Philidor and Philidor network pharmacies are accounted for as intercompany sales and are eliminated in consolidation. They are not included in the consolidated financial results that Valeant reports externally."
What's the deal with these specialty pharmacies? And how has the news affected other pharma companies?
At least two major pharmaceutical companies were forced to issue statements on Wednesday regarding their relationships with specialty pharmacies: Allergan and Endo. But the new Valeant allegations (while an obvious impetus) aren't the only reason behind those statements.
Before the Citron report set the Internet ablaze on Wednesday, The New York Times published a piece earlier in the week describing how certain pharma companies, including Horizon Pharma and Valeant, use specialty pharmacies to "sidestep barriers on pricing." The reason, the Times reported, is that these specialty pharmacies (which were originally meant to distribute specialty medications) lower pricing pressure on patients, since pharma companies often pay out the co-pays on consumers' behalf while the specialty pharmacy gets the medicine to a patient directly, and quickly, via mail or direct delivery.
Now, companies have been using these channels to distribute non-specialty drugs. And the argument goes that, since patients often don't feel the pinch of their co-pays when receiving medication through specialty pharmacies and get their drugs with minimal hassle, drug makers feel free to hike up the prices they charge to insurers.
Is Valeant's stock still radioactive?
Valeant shares fell another 18% within the first two hours of Thursday trading (as of this writing, it's fallen to less than $100 per share, or about 60% less than where it was trading three months ago). Furthermore, longtime Valeant bull analysts BMO Capital downgraded the company on Thursday, saying that the firm "cannot defend the specialty pharmacy structure." So it's probably safe to say that investors remain wary of the stock until more information emerges about the whole situation.
Not everyone is dumping their shares, though. Bill Ackman, whose hedge fund Pershing Square already owns a large stake in Valeant, announced on Wednesday that he'd picked up another 2 million shares of the company and has faith in the pharma giant. And as previously mentioned, Shkreli also made his position known.
What happens next?
That's the multi-billion dollar question. Federal authorities are probing Valeant's pricing model and distribution network, while politicians sense blood in the water in a time when drug prices are under intense scrutiny.
Valeant is, in all likelihood, going to have to continue to assure investors that everything is on the up-and-up when it comes to the company's accounting and bookkeeping practices, and that it doesn't have to resort to shoddy tactics to inflate revenue and sales numbers. But for the moment, with so much still unknown about the whole affair and Valeant already under siege, even those assurances may not prove to be enough.