Charlie Munger’s Comments on Valeant Pharmaceuticals Intl Inc (VRX) — ITT and Harold Geneen
Valeant Pharmaceuticals Intl Inc (NYSE:VRX)(TSE:VRX) has been a hot topic for investors as the company has witnessed a meteoric rise from just over $13 when J. Michael Pearson became CEO in February 2008, to $201.38 as of close on Monday, March 30th, 2015.
“Valeant is like ITT and Harold Geneen come back to life, only the guy is worse this time.” -Charlie Munger
Recently, Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE:BRK.B)’s Vice Chairman, Charlie Munger, commented, comparing Valeant Pharmaceuticals Intl Inc (NYSE:VRX)(TSE:VRX) to ITT and Harold Geneen. He even went further saying ‘the guy is worse this time.’ What is the story of ITT and Harold Geneen and why is he drawing parallels with Valeant?
The comments of Berkshire’s Munger came on the heels of Valeant Pharmaceuticals Intl Inc (NYSE:VRX)’s emergence as a pharmaceutical giant, on the heels of a multitude of acquisitions. This might have made Munger reminiscence of the days of Harold Sydney Geneen, who left the world in November 1997. The similarity between ITT and Valeant starts with the acquisition spree that both companies engaged in to fuel amazing rates of growth.
ITT And Geneen
For those unfamiliar with Geneen, a quote from the NY Times in his obituary provides a introduction
“Along the way, Mr. Geneen stretched his people and his company to the legal limits, scarring the company’s image to the point where it became a popular symbol of corporate arrogance and insensitivity.”
The reason for reminding about the International Telephone and Telegraph Corp., which exists today as ITT Corp (NYSE:ITT), was that the company grew mainly through 350 acquisitions, besides mergers in 80 countries. This included Avis-Rent-A-Car, Sheraton Hotels, Hartford Fire Insurance Company, and the company that made Wonder Bread, Continential Baking. The company was headed by Geneen, between 1959 and 1977, as its President and CEO. He was credited for taking the company to the multinational level with sales turnover of $17 billion in 1970 from a middle-sized company with $765 million in sales turnover in 1961. Geneen frequently used debt to pay for acquisitions and the number of the companies’ shares outstanding increased ten-fold. Debt from before Geneen arrived in 1958 was $199.5 million compared to a working capital of $234 million, but by 1969 it was $1.6 billion against working capital of $773 million. Geneen used the acquistions to take the company to different sectors from its conventional manufacturing of telegraph equipment. Real estate management, hotels, and insurance were among the major areas he diversified the company into through acquisitions.
Geneen was with ITT till his retirement in 1977, as its President and CEO. He was the chairman of the board till 1979 and remained on the board for a further period of four years. His successors inherited a company laden with debt, which had been hit by a number of scandals. In 1979, CEO, Rand Araskog, resorted to divesting parts of the business. Araskog divested nearly $2 billion in assets from 1979 to 1984, paying down the companies’ debt. Araskog later split ITT into three independent firms during the period of 1979 – 95 when he was the CEO. As a result, ITT Corp became a separate unit with a focus on the hotel and gaming business, while ITT Hartford was a stand-alone insurance firm. Another entity was ITT Industries, with a collection of manufacturing units.
The Geneen Idea
Geneen was known for pushing his company to the limits of legality in pushing growth for his company. The Geneen idea (from the Economist) was based on the concept that a company could successfully invest in any sort of business anywhere, if it imposed discipline on those units and set strict financial targets. When he first joined ITT, he was appalled by the lack of discipline, control, and management. Geneen divided ITT in divisions and empowered managers to be fully responsible and accountable for financial performance. He believed in using facts to make logical decisions. Geneen took these principals and applied them to acquisitions.
Valeant’s List Of Acquisitions
J. Michael Pearson became CEO in 2008. Valeant Pharmaceuticals Intl Inc (NYSE:VRX)’s acquisition desire appears to have started in 2008, when it bought Coria Laboratories, Ltd for $95 million. This was followed by two smaller acquisitions of Derma Tech and Dow Pharmaceutical Sciences, for $12.6 million and $285 million respectively in November and December the same year. The company also divested its Eastern and Western Europe branches to the Swedish-based, Meda AB, for $392 million.
In the following year, it acquired a Mexican generic firm, Tecnofarma, and Laboratoire Dr. Renaud. The deal making seemed to have sped up in 2010. Valeant Pharmaceuticals Intl Inc (NYSE:VRX) purchased Brazilian’s generics and OTC, besides the manufacturing plant, for a total consideration of $56 million. This was followed by Valeant’s subsidiary acquisition of Vital Science for $10.5 million in April. In the following month, Valeant purchased Aton Pharmaceuticals for approximately $318 million. A few months later, in September 2010, Biovail was brought into the fold of Valeant Pharmaceuticals Intl Inc (NYSE:VRX). The company’s CEO, Michael Pearson, said in September 2010 that it made approximately 25 smaller deals a year, with most of them too small for financial reporting.
30 Deals after Biovail
Similarly, in the year 2011, the company acquired PharmaSwiss S.A., purchased 87.2% stake in Sanitas Group and acquired iNova, besides a unit of Sanofi. However, the company failed in its attempt to buy Cephalon Inc. for $5.7 billion.
As far as the big acquisitions, Valeant Pharmaceuticals Intl Inc (NYSE:VRX) purchased Medics Pharmaceutical Corporation for $2.6 billion in 2012 and Bausch & Lomb for approximately $8.7 billion in 2013. The New York Times reported that the company had reached 30 deals after the transaction of Biovail in 2010.
In the current year, the company disclosed that it will buy Salix Pharmaceuticals, Ltd. (NASDAQ:SLXP) for $14.5 billion. It made an unsuccessful bid for Allergan, Inc. (NYSE:AGN) in 2014 for $46 billion, backed by hedge fund manager, Bill Ackman.
The strategy Valeant CEO, J. Michael Pearson has used on Valeant is based upon diversified operating units led by empowered entrepreneurs who will execute well-thought-through business plans and continue new growth opportunities through disciplined acquisitions. The goal being to increase cash flow. Pearson uses a decentralized model for Valeant and created the role of Company Group Chairman, each of whom will have a set of distinct but disparate set of businesses and functions reporting to them. The company intends to do more with less than their competitors and operates disciplined units.
It seems that the market has liked the way Valeant Pharmaceuticals Intl Inc (NYSE:VRX) has been conducting itself on the aggressive purchase tactics, since the stock has witnessed quite the ascent. However, the risk of a serial acquirer biting more than what they can chew cannot be forgotten. One of the analysts termed the acquisition of Salix as not an attractive one at all, considering that Salix delivered a 94% drop in revenue in the fourth quarter. On top of this, Salix also stopped settling its frontline drugs.
Gimme Credit’s Vicki Bryan has reportedly indicated that Salix’s core products were witnessing weakness signs before the issue of inventory cropped up. Similarly, Valeant Pharmaceuticals Intl Inc (NYSE:VRX)’s recent acquisition, Provenge, also delivered disappointing sales numbers for years. The analyst expects Valeant to face the most difficult execution risks ever. Bryan noted that the company’s debt will climb close to $30 billion and sees the company missing its cost savings estimations for both Salix, as well as Dendreon.
Berkshire’s Munger commented on ITT and Geneen returning, he might have been right in expecting that more and more acquisitions via debt could run the risk of putting more into your mouth then you can swallow, eventually leading to divesting businesses to handle the debt load. Munger’s comments could also be interpreted that the acquisition spree could only provide short-term gain and that, for the long-term, it might be difficult to sustain. Valeant’s ability to grow could also be hampered like ITT was once interest rates began to rise, making debt more onerous.
While few are suggesting anything like the tricks of Tyco in the 1990’s, where accounting games were used to write down assets and set up a reserve that could be released to meet or beat earnings expectations, Valeant’s non-GAAP Cash EPS has come under fire from detractors. However, at least so far, detractors have been proven wrong. In an unusual year that was marked by a failed acquisition of Allergan instead of true acquisitions, GAAP earnings and Cash EPS have begun to converge.
That being said, there are definitely some parallels between Geneen and the discipline and concepts J. Michael Pearson uses to extract extra cash flow from divisions. Both companies use the decentralized model, in fact, so does Berkshire Hathaway. Though unlike Berkshire, both Valeant and ITT are very aggressive with growth.
In our next Valeant article, we will take a look at the bull case on Valeant. While you have some heavy hitters in Charlie Munger and James Chanos (short) pointing out negatives, you have some very smart value orientated individuals like Bill Ackman, Jeffery Ubben of ValueAct, and the Sequoia folks in the pro Valeant camp.
Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
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