Wednesday, November 30, 2016

Valeant, Salix, sales force and asset sales

Valeant put out a press release today about expansion of sales force for their Salix business:
Valeant Announces The Initiation Of A Primary Care Sales Force For Xifaxan® And Relistor®
LAVAL, Quebec, Nov. 29, 2016 /PRNewswire/ -- Valeant Pharmaceuticals International, Inc. (NYSE: VRX and TSX: VRX) ("Valeant") today announced that it has initiated a significant sales force expansion to focus on potential primary care physician (PCP) prescribers of Xifaxan for irritable bowel syndrome with diarrhea (IBS-D) and Relistor for opioid induced constipation (OIC.)  With the launch of the expanded sales force effort over the coming weeks, the company expects to reach a significant majority of likely Xifaxan and Oral Relistor primary care prescribers.  The costs of this program were considered in previously announced guidance for the full year 2016.
"Our goal in building a primary care sales force is to maximize opportunities for Xifaxan and Relistor to help our products reach full potential. Xifaxan and Relistor are integral to our gastrointestinal franchise which remains a core asset for future growth potential in the hands of Valeant," said Joseph C. Papa, chairman and chief executive officer. "With approximately 70% of IBS-D patients initially presenting with symptoms to a primary care physician, our dedicated PCP sales force will be better able to reach the patients in need of IBS-D treatment and in doing so will further advance our mission to improve people's lives with our healthcare products."
There are several implications.

First the stories that say Valeant is selling Salix are almost certainly false. These stories are responsible for the stock rising 30 percent recently.

Secondly it puts the acid to the idea that Mike Pearson (Valeant's former CEO) was good at cutting costs. As this story makes clear Salix had a Primary Care Sales Force when Valeant acquired it. However they were debating whether to keep it. (Obviously they gutted it and are now being forced to reinstate it.)

This happened all over Valeant. Lots of businesses are melting ice cubes where the sales force has been neutered or where drugs have had prices pushed up to levels that create umbrellas under which competitors will flourish.

Finally they can't sell Salix for anything like what they paid for it (and that was the single most obvious sale candidate). Other sale candidates will have bigger separation problems.

Debt outstanding is roughly cumulative acquisition cost. This won't wind down nicely.

Indeed bankruptcy looms. Late next year probably.

Long shareholders, by now you ought to be feeling sick. But let me offer a solution: opiates. Just drug yourself out so you don't feel the pain.

And if you get opiate-induced constipation Salix/Valeant can help you out. That is what Relistor is for.

And now a Primary Care Salesman will visit your doctor and explain the benefits. Mr Papa (Valeant's CEO) is making sure that happens.

Sure Valeant will charge your insurance company plenty for the drug. But it is for a good cause.


Tuesday, November 29, 2016

On the freight train - how do you value Adidas?

I own a position in Adidas - the German athletic shoe and fashion company.

Given how well it has performed the position is nowhere near big enough.

I wish all my longs had performed this well.

But it poses a fairly typical investment problem for which I have no real answers.



I will give you a very stylised history of how we got here.

Herzogenaurach in Germany is a funny (and small) town quite close to Nuremberg - and a couple of hours drive north of Munich.

Once upon a time two brothers started a sports shoe company (and it was successful). The brothers split up and one brother started another sports shoe company.

Those companies are Adidas and Puma. And for a long time they considered each other the enemy.

Then along came Nike and especially the Michael Jordan partnership and basketball shoes - and exposed Herzo for what it was - an out-of-touch German backwater.

Bluntly the fashion path in shoes was from (mostly African American) street wear, to middle-class white street wear to China (where the affluent to a surprising extent mimicked American fashion). And basketball shoes were the path to cool.

Sure there were some people I knew who went to Wharton who thought Puma was some kind of Euro-elite cool - but frankly the Germans just missed out.

I went to Herzo to visit these companies because they were super-cheap (and for no other reason).

How did I measure cheap?
These stocks were just cheap against revenue really. Nike - by far the leader - has a market cap of $85 billion down from well over $100 billion.

It has a bit of net cash (reflecting how insanely profitable it is) and about 33 billion of revenue. The price is about 2.5 times sales - but when I went to visit Herzo Nike was trading over three times sales.

By contrast Puma (which is essentially in the same business) has a market cap of €3.5 billion and sales of about the same. It is roughly 1 times sales. When I went to visit Puma was trading at about 0.6 times sales.

Relative to sales Nike had something more than five times the valuation of Puma. This gap has now closed a lot.

But then again Nike was (and remains) insanely profitable and Puma just wasn't.

Adidas was somewhere in the middle of these valuations.

If Adidas or Puma could sell shoes at something like Nike's effective margin then the German companies would go up. A lot. An insane lot. Like 5 baggers were on offer.

But then Adidas and Puma had just missed the boat. And whilst they had decent positions in European fashion (driven by strong positions in what Australians and Americans call "soccer") they had meaningless positions in America and weak positions in China.

Now fashion is not an area I have any expertise. This is obvious if you see how I dress.

So I was not likely a buyer. Just kicking the tyres.

The Puma shop in Beijing

But I still wanted to kick the tyres. After all cheap is fun - and I am a value investor. So I did make a point of walking around Puma and Adidas shops in various locations, and even counting customers vs. say local Nike shops.

Most the shops however are like shops on "Fifth Avenue". They are meant as much as anything to be brand advertising rather than to make a profit in their own right. So this is still only marginally useful research.

That said I went to the Puma flagship shop in Beijing - and - with a translator - interviewed the staff. I wrote out the impressions in an email to Michael Lämmermann, Puma's CFO - but mostly because I had his email somewhere in the system. Here is that email:

I have just come back from a work trip to China. 
I wanted to leave you impressions of the Puma Shops in Beijing and Shenzhen which I spent some time looking at. 
Beijing is a disaster area - very badly run by surly staff. 
This is a fitness company and the staff were fat. Not obese - just pudgy - but they did not look like they used the products and they did not present an image that would sell the product. 
We asked them (in Chinese) how they were employed - and it was from a local staff pool. They were Beijing locals (more expensive) but that was the end of it. 
This is a country where it is legal to ask women to send in photos with their job applications and to just choose the prettiest one.  
Whatever - fat staff in a sporting good shop is a really bad image - and you need to fix it.
Fat and rude staff is just unforgiveable. 
Shenzhen (Dongman district) was better. The kid behind the counter (only one of them - shop was small) looked the part - and was wearing your shoes and looked young and fit. 
He was also helpful to our (very fluent) Chinese speakers in the group.
However he was wearing non-Puma track clothes. Just saying. 
For the record - I have not been convinced enough to buy your shares - but they look cheap. 
This was just observation.
I did not get a reply.

And I have never touched Puma stock.


Enter Kasper Rorsted at Adidas

Adidas got an activist shareholder - one with a longer-than-average time horizon. This was Groupe Bruxelles Lambert - the holding company of Albert Frere and the late Paul Desmarais. I have watched GBL for some time.

GBL are soft-cooperative activists in the Northern European sense. They tend to get what they want cooperatively and slowly - often very slowly.

GBL agitated for and got a new CEO at Adidas - a Dane named Kasper Rorsted.

We knew him. And I have thought him pretty darn good for a long time. He was the longtime CEO of Henkel (a Munich based industrial glue and consumer goods conglomerate). Henkel was the second biggest stock at the foundation of Bronte Capital - and we have held it continuously. [Regrettably I sold too much on the way up.]

Kasper might not walk on water. But he is still in the top league of CEOs. 

So we bought Adidas stock purely on the speculation. After all Kasper had experience in American consumer goods, was a generally good guy and the stock was cheap enough on a price to sales basis that the upside was large.

And the stock has gone up.

In all honesty I do not begin to understand what Kasper has done that has made this company better - but it sure shows in the numbers.

Here is an extract from the last quarterly presentation - you can find the link here:

This is a little hard to see - so I encourage you to download the original. But note really nice sales growth in all jurisdictions and sales growth above 20 percent in both the USA and China. 

There is clearly a fashion element here. Adidas has a deal with Kanye re shoes. I am so out of popular culture I needed to educate myself as to who Kanye was. (No I am not joking.) 

But it can't just be Kanye (as the new Michael Jordan no less) because Reebok shoes (also owned by Adidas) are having similar sales volume growth. 

Whatever - Adidas is now growing explosively. 

Take your 20 percent volume growth and stick into a valuation spreadsheet and see what you come up with. This sort of net present value worksheet is like Hubble telescope. Tweak the directions of various variables even a tiny bit and you wind up in a different galaxy. 

So we can't value it. We have no idea.

But we own the stock. The position is still not enormous (the original holding was a suck-it-and-see speculation on the new CEO) but the position is getting bigger and bigger because the stock is doing well.

I don't want to get off the train. At least until I see something negative. So I am looking for negative. Comments wanted.

Sports rights - the new and increased negative

A re-energized Adidas is the best thing ever if you are high profile sports player looking for a shoe-deal. 

There are now two rich companies wanting to put shoes on your feet and logos on your body. And that means bidding wars.

The insane war for the four big brands of Spanish football (Barcelona, Real Madrid, Ronaldo, Messi) is getting just bizarrely expensive

This is great for people with innate ball skills (which is most certainly not me). It is bad for both Adidas and Nike shareholders. I watch in horror.

But apart from that I can't (yet) see the negatives. But then I have no fashion sense (at all) so I might be the last person to see.


Friday, November 18, 2016

Valeant and Philidor after the criminal charges

On 15 October 2015 I posted a brief post which was (I believe) the first public reference to Philidor, the now notorious speciality pharmacy business at Valeant.

I had known about Philidor since February and had told many people including Roddy Boyd and Andrew Left but I did not understand in any comprehensive way how Philidor worked and why Valeant had gone to such lengths to hide it. Jim Chanos (entirely separately) had I believe also found Philidor.

On 19 October 2015 Roddy Boyd published the seminal journalist article explaining much of the mystery. Roddy's article was the main piece in the undoing of Valeant's stock. I am still amazed how much of the story Roddy worked out. This was one great piece of journalism.

Today one Valeant executive and the Phildor CEO have been charged in a fraud and kickback scheme. That is more than a year later.

It is however worth revisiting Valeant's first major Philidor disclosure.

On 26 October 2015 Valeant had its first conference call to explain Philidor. This conference call dumped almost the entire board into this mess. Board members were at this call and it was made plain that they understood how Philidor worked. Moreover Board members toured Philidor before Valeant agreed to buy an option to purchase Philidor.

Given that criminal charges have now been laid those board members should now be considering their position.

You can find a full transcript of that call here, but I just quote a pertinent part.

Seana Carson Valeant Pharmaceuticals International, Inc. - Chief Compliance Officer 
Thank, Tanya. Good morning. I'm Seana Carson and I am Valeant's Chief Compliance Officer. At this point I will share with you some information regarding the diligence conducted by Valeant prior to entering into its option agreement with Philidor, as well as details regarding Valeant's oversight and rights. 
All agreements between Valeant and Philidor have been reviewed or drafted by legal counsel. Our legal, compliance, regulatory and business diligence was conducted in connection with the purchase option and distribution services agreement with the assistance of our external advisors. This included multiple site visits. 
Furthermore, Valeant negotiated representations, warranties, indemnities and ongoing covenants for its protection. The diligence conducted covered legal, regulatory, and compliance matters, including but not limited to corporate structure, pharmacy licensing, federal healthcare program requirements, privacy, pharmacy practices, and IT security. Last year the majority of Valeant Board, including the entire Audit and Risk Committee, went to tour the Philidor facility in Pennsylvania in person, ahead of completing the transaction. 
Turning to Valeant's rights under its options, as mentioned, Philidor operates independently from Valeant. Valeant has contractual rights to inspect Philidor's books, records and facilities. Further, Philidor must give Valeant prompt notice of any events that result in a material breach of its covenants or could reasonably expect to result in a breach of its representations and warranties. 
Valeant also has the right to appoint employees to Philidor, including a head compliance officer and an in-house lawyer. The option agreement also provides for a joint steering committee, composed of members from Valeant and Philidor, the purpose of which includes the exchange, assessment, and discussion of matters relating to compliance of Philidor with applicable laws, material contractual obligations, and Philidor's internal policies and processes. 
We maintain regular contact between business and functional leads. Pursuant to our rights in the option agreement, Philidor, with input from Valeant, hired both an in-house lawyer and a head of compliance with relevant experience. As mentioned, Philidor is included in Valeant's SOX 404 internal control testing and internal audit program for 2015. In addition, on October 2, a big four accounting firm with asked to prepare plans for an internal audit of Philidor. The scope was intended to include an assessment of operation and data systems, quality and regulatory practices, adjudication and reimbursement practices, contractual compliance, government pricing, as well as prescription level testing and sampling. 
Because of the nature and volume of inquiries related to Philidor after our October 19 earnings call the audit has been delayed to revise scope accordingly. Additionally, we understand that Philidor and its network pharmacies have complied with several hundred desk audits from payers and have participated in more than two dozen live audits involving major pharmacy benefit managers.


The boss of Philidor, Andrew Davenport, is one of two people charged today. Here is a video of him being interviewed by a State Senator about Philidor. I wonder whether he was this evasive when the Valeant board went to visit him.


I am not going to list the board members who went on tours of Philidor. It is up to other people to ask them questions.

I remain short some Valeant.


PS: For completeness here is a video of Gary Tanner applying for a pharmacy license along with Philidor's old pharmacist in charge. It is pretty clear from the description that this was also to serve the same dermatology market as Philidor.

Monday, November 14, 2016

You might not like the TPP. You are going to like the alternative less.

The Trans-Pacific Partnership - the mega-trade treaty - is dead.

I am not going to opine on the merits of various provisions in that trade treaty. (There were several I did not like...)

However lets take the thirty year helicopter view.

Thirty years of an aggressive trade and investment treaty (like the TPP) results in your economy becoming intertwined with your partners' economies.

And with the TPP there is a dominant party - the United States.

Your economy becoming intertwined with a dominant economy has a name: hegemony.

The TPP would have eventually meant sustained US hegemony.


But that is dead.

The TPP did not die in a vacuum. A bunch of countries north of Australia want to have guaranteed open access to big markets and they will wind up signing a trade treaty. This time they will sign with the economy that will honour their commitments: China.

And in thirty years time there will for the countries of Australia's north be a hegemony: a Chinese hegemony.


At the moment the Chinese border is ten hours flying time north of Australia.

Look forward thirty years and we have a border of Chinese hegemony at Indonesia.

I would prefer a democracy having hegemony. I think most of my readers would too. But we have that choice no longer.


PS. This thought is not original. The US Defence Secretary stated that the TPP is as important as another aircraft carrier. He is not wrong.

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The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.