How one of the smartest minds on Wall Street was blinded by belief and abandoned due diligence
VRX, CP, MTN, HLF, CMG
Welcome to Mind Over Money. I’m Kevin Cook, your field guide and story teller for the fascinating arena of Behavioral Economics.
I’m back after a 3-week bout with bronchitis. I’ve got a funny story about what I learned at the doctor that ties into a great neuroscience topic: how we acquire new skills. But first, let me preview our main topic for the show today...
As 2016 winds down, I want to re-cap one of the biggest stock market implosions of the past 18 months and the big name investor who last week began some tax loss selling after a 95% drop in the shares.
The stock is that of Valeant Pharmaceuticals (VRX). And the big investor is Bill Ackman of Pershing Square Capital Management. His funds have lost billions of dollars because the Valeant implosion. And the story I am going to tell you will definitely interest you if you are at all curious about how smart people make really disastrous decisions.
Okay, so what happened at the doctor? As part of my exam, they gave me a chest X-ray to check for pneumonia. The good news is that I didn’t have pneumonia. The more interesting news the doctor shared on her way out… “Oh, by the way,” she said. “You have two cracked ribs.”
Be sure to listen to today's podcast to hear where those cracked ribs came from and what it has to do with "carving" new neural pathways. I'll give you a clue: I had to retire from snowboarding at the ripe young age of 37.
The Valeant Implosion
Valeant Pharmaceuticals stock was trading around $260 per share at its peak in the summer of 2015. Today, it’s trading $15. The story of the collapse has to do with an ambitious CEO named Mike Pearson and his company’s strategy to quickly become one of the top 10 pharmaceutical corporations in the world. Buying Bausch & Lomb for over $8 billion dollars was solid proof that they were very serious.
Pearson’s stated goal was actually to get Valeant in the top 5, among the likes of Pfizer, Johnson & Johnson, Novartis, and Merck.
I know a little about this story because I was an investor in VRX in 2013 and 2014, catching several pieces of its rise from $65 to $145. The fundamental growth story, both in terms of sales and profits, was impressive. But I was also following on the coattails of some of the smartest money on Wall Street, including legendary investors like Ruane, Cunniff, and Goldfarb who ran the Sequoia fund.
In many investments, I often trust the research skills and judgement of several big investors more than my own analysis. Based on Pearson’s goal, he would have to grow Valeant from a $20 billion company, in terms of its market capitalization, to a nearly $200 billion company. That would be a 10X feat. Everything I saw showed that he might have a shot.
And the only reason I didn’t ride the stock higher in 2015 when it vaulted from $145 to $175 in a few weeks was because I was waiting for a pullback to get in.
Enter Bill Ackman who, it was revealed through SEC filings in February of 2015, was acquiring a sizable nearly 10% stake in Valeant and partnering with the company to buy another pharmaceutical firm, Allergan. Shares of VRX shot up to $200 in late February and never looked back until they peaked in August of 2015 just over $260.
So what happened? Why did Valeant, as an investment and as a company, begin to fall apart? The details of the collapse are complicated and part of a much longer story that involved accounting irregularities, egregious drug pricing practices, and questionable pharmacy partners cooperating in questionable sales reporting practices.
In the Mind Over Money podcast I share a timeline of the events of August through October by Stephen Gandel writing for Fortune magazine on October 31, 2015.
And the most interesting questions I'm trying to answer are about how Bill Ackman ignored the clues about Valeant's messy business practices and rode the stock -- with a position in the tens of millions of shares -- to stunning losses.
Not only that, even when the wolves were out, from Congress to research firm Citron, and shares were quickly collapsing to $100, all Bill could think of was massively increasing his position by buying tens of millions of dollars’ worth of options.
You can learn more about those options strategies in this video...
Synthetic Stock: How Ackman Double-Down on VRX
This whole Valeant-Ackman saga will be studied for years for its lessons in behavioral finance and decision-making. I hope I've helped you understand it better so you can see how we can all be blinded by our hope and greed.
Kevin Cook is a Senior Stock Strategist for Zacks Investment Research.
