Thursday, October 22, 2015

Some comments on the Valeant conference call

Background: Roddy Boyd wrote a fine article about Philidor - a speciality pharmacy tied to Valeant. You can find the article here. Some of the conference call addresses that article. However I want to start in the Q&A.  

Valeant recently purchased Salix - a company that focused on gastrointestinal disorders. Xifaxan - a drug from Salix - is now the largest drug by sales in the Valeant portfolio. 

The conference call (transcript here) includes this exchange on Xifaxan.

Alex Arfaei - BMO Capital Markets - Analyst 
Sure. Just trying to figure out -- you said [Salix Revenue] was going to be about $300 million, you're recognizing $460 million. So, I'm just trying to figure out what changed since you provided that guidance.
J. Michael Pearson - Valeant Pharmaceuticals International, Inc. - Chairman and CEO 
I think a couple things. One is we don't know exactly -- we know what the inventory is with the big three, we don't know how much inventory there is in some of the other distributors because there were no agreements in place to tell us that. What we're not doing is providing any discounts or any incentives for people to buy Salix products
Also, the inventory was not sort of -- it wasn't that everyone had like five months of extra inventory of everything. It really varied by product. So, there might have been a year's worth of one product and four months of another product. That's why it's taking time. It's taking time to reduce those inventories. 
But I think the sales, the fact that sales have increased -- again, there's no sales incentive, I think it's all growth. The products continue to grow above what we had forecasted in our deal model. And, as Rob mentioned, we're going to continue to try to be conservative. We don't want to get ahead of ourselves.
Then integration costs, the integration costs we've exceeded --."
I have highlighted the key sections.

The CEO of Valeant is stating that there are no discounts or any incentives for people to by Salix Products - and that the growth in the sales is thus organic - a result of market demand - and possibly their superior marketing ability. This was repeated multiple times. 

So I just googled Xifaxan Coupon and found this - on Xifaxan's own website

Now these are coupons. But whether they are "discounts or incentives for people to buy Salix products" I will leave to you to decide. 

However I am reminded of the famous exchange in Through the Looking Glass

“When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’
'The question is,’ said Alice, ‘whether you can make words mean so many different things.’  

You would think however at this time that the CEO of Valeant would be precise - lawyered up - regarding what they said about their incentive programs. After all just last week they received subpoenas on those programs. To quote their press release:

Valeant recently received a subpoena from the U.S. Attorney's Office for the District of Massachusetts and a subpoena from the U.S. Attorney's Office for the Southern District of New York. Most of the materials requested by the subpoenas relate to documents with respect to our patient assistance programs, and also include requests relating to financial support provided by the company for patients, distribution of the company's products, information provided to the Centers for Medicare and Medicaid Services, and pricing decisions.

And indeed the patient assistance programs, and Valeant's relationship with a speciality pharmacy called Philidor Rx services is central to this - and was addressed for the first time in the conference call.

What is Philidor Rx Services?

 Philidor Rx Services is a mail order specialty pharmaceutical company distributing almost entirely Valeant products and whose use is pushed by Valeant sales reps. It does not report its prescription data and hence analysing Valeant based on standard prescription data services gives erroneous results. [This led to some disagreement when Valeant tried to buy Allergan where Allergan were giving sales numbers and Valeant was denying them.]

Here is some sales and marketing material left by Valeant sales reps - including referrals to Philidor.

Note that the phone number for the Valeant access passport and for Philidor are identical.

Philidor is very large - and has grown very rapidly. [State] Senator Stewart Greenleaf recently filmed an interview with Andy Davenport of Philidor and put it on his facebook page.  That video is below:

The interview at no point indicates that Philidor is tied to Valeant. Andy Davenport state they partner with "manufacturers to help bring their branded medications to market as cheaply as possible". He says "manufacturers" plural but in reality they are captive by a single branded good manufacturer. He also says they chose the best manufacturers for the products on the market.

It stated that they have 635 employees nationally - and they think they will get something near to 1000 employees in 2015. They thought they would be 12-15000 prescriptions per day by the end of 2015.

The word Valeant never appears in this video. Similarly the word Philidor never appears in anywhere in the SEC filings for Valeant even though it is probably a double-digit percentage of Valeant's sales. That is right - there is simply no mention of it in SEC files.

Moreover Philidor has gone to some extent to hide its ownership. Here is the "whois" data on website ownership with the key details given:

Registry Domain ID: 1774229314_DOMAIN_COM-VRSN
Registrar WHOIS Server:
Registrar URL:
Updated Date: 2015-07-21T19:49:11Z
Creation Date: 2013-01-17T19:57:48Z
Registrar Registration Expiration Date: 2016-01-17T05:00:00Z
Registrar IANA ID: 2
Registrar Abuse Contact Email:
Registrar Abuse Contact Phone: +1.8003337680
Domain Status: clientTransferProhibited
Registry Registrant ID:
Registrant Organization:
Registrant Street: 12808 Gran Bay Parkway West
Registrant City: Jacksonville
Registrant State/Province: FL
Registrant Postal Code: 32258
Registrant Country: US
Registrant Phone: +1.5707088780
Registrant Phone Ext:
Registrant Fax:
Registrant Fax Ext:
Registrant Email:
Ownership it seems is deliberately hidden.

Indeed  Philidor appears to commit criminal offences to hide who their owners are.

The California Board of Pharmacy denied them a license to operate in California and in a court filing stated:

On July 24, 2013, in Respondent's application for licensure, Respondent made a false statement of fact with the intent to benefit Respondent, in that Matthew Davenport certified under penalty of perjury in section "E" of the "Parent Corporation or Limited Liability Company Ownership Information" application form that there were no entities with 10% or more ownership interest in Respondent. In fact, at that time, there was one (1) individual and one (1) corporate entity with more than 10% ownership interest in Respondent.

There are many other allegations of perjury by Philidor or its offices. Most of this [government alleged] perjury was designed to obscure who the owners of Phildor were.

What is Philidor's business model?

Philidor's business model is - as far as I can see - to facilitate the sales of Valeant products. They do this by being flexible about copays and aggressive about filling refills. When I first hinted at Philidor I got several responses from readers that knew precisely what I was talking about - primarily because they had been Philidor customers. This is a typical response:

John, I enjoy your blog very much.  I happened to see your cryptic message and I think I know what it is. 
I'm no expert on Valeant, but I just so happened to have been prescribed one of their pharmaceuticals about 6 months ago.  It was a foot cream to treat athletes foot called Luzu. What was strange was that the podiatrist suggested that the prescription be set up with a "by mail" pharmacy, telling me that they would cover  the co-pay for the first prescription. 
I went ahead and had the podiatrist sign me up with Philidor and the prescription was delivered.  A few weeks later, I got a call from Philidor.  They offered to cover the co-pay for all of the remaining refills, which was maybe 3 more refills.  What is important is that this really isn't the type of prescription that would normally require constant refilling.  I probably wouldn't have never ordered these refills if someone else hadn't offered to cover my cash costs. 
I found this to be a pretty aggressive marketing tactic, which certainly could be used to attempt to stuff sales and bilk insurance companies.  I do understand that Philidor was either created by or strongly associated with Valeant.  
Well, not sure that is exactly what you were getting at with the cryptic message but that's what I got out of it..... 

I asked (and you will see why I asked later) who the insurance provider was and got this response:

The provider was Anthem, 
I'm not versed in the Healthcare world but I just found it so strange and aggressive that it made me question the efficacy of the practice. What was perhaps the most strange was that the doctor seemed to have been incentivized to steer me towards Philidor, and was at least somewhat aware of the relationship between Valeant and Philidor. It made me wonder what perks the doctor may have been receiving to plug Philidor and Valeant drugs.  
With all that said, I now have a least a few years supply of athletes foot cream, haha
It is also easy enough to find complaints online (by former staff) about Philidor auto-refilling prescriptions without appropriate customer approvals. [To do this you obviously need to waive copays.]

There are multiple reports online about Philidor robo-calling people and sending them prescriptions. Some reports state that the prescription arrives without approval.

Philidor it seems was established with a great deal of assistance from Valeant sales people. Here is the citation on an award Valeant gave to one of its drug reps. [The rep in question is a former major league baseball player - and a copy of all the awards can be found here.]

It states clearly that the rep helped launch Philidor in six states.  This is what is rewarded in sales at Valeant.

Efforts to find out who really owns Philidor

We made extensive efforts to work out who owns and who facilitated Philidor. As we noted the website gave no clue. As of 24 June 2014 (according to the Great State of California) there was one individual owner and one corporate owner with more than a 10 percent stake.

So we dug and dug.

Philidor Rx Services LLC is a Delaware LLC that was formed in early January 2013.

The head office is in Pennsylvania, and it formed an LLC in Pennsylvania a few weeks later.

As Philidor operates in a number of states, it needs pharmacy licenses and "foreign" incorporation in several of those states. One of them is North Carolina, where Philidor Rx Services registered as a foreign LLC in late 2014.

Helpfully, North Carolina's registration lists some of the people involved in the LLC. (This is a bit nuanced, as North Carolina law indicates that all "members" aka owners of an LLC are automatically considered managers, unless the Articles of Formation state otherwise. So we can't prove using this document that the people listed are definitely legally the owners, but it's a pretty strong bet. Some of this is explained here:

Anyway you can find a list of the "members" of Philidor here which for convenience I have cut-and pasted as a picture.

In early 2015, something changed, for reasons we are don't quite understand. At that time, all on roughly the same day, each "manager" listed in the NC filings above had an identical UCC filing placed on their holdings in Philidor in their respective home states of PA, NJ and NY. We think this corresponds to a mortgage or lien over the shares. There should be a similar lien in Florida but we have not found it yet.

The lien covers all equity interests of any type that the individuals would acquire. Here is one such filing.

You can find the original filing here.

The lien was filed 24 February 2015 and is in favour of KGA Fulfilment Services.

KGA Fulfilment Services was easy to find. They exist in the SEC database only once - as a subsidiary of Valeant in an attachment to the last annual accounts.

So here we have it. A company that (at least in 2015) looks to be financed by Valeant but where management have gone to the extent of [alleged] perjury to hide who the underlying financiers are - and who auto-refill prescriptions waiving copayments.

There are also very big accounting issues with financing your customers [and not disclosing it] and we were very interested in the scale of this financing.

The new disclosure in the 3Q 2015 conference call

We have been poking around Philidor for some time now. Other people have too - as I have been sent things by other people. Roddy Boyd almost certainly tried to get answers from management when he wrote his (above-linked) article.

The conference call was the first time in any correspondence that Valeant has disclosed their relationship with Philidor. Here is the core slides from the conference call presentation.

They specifically state that they purchased an option to acquire Philidor in late 2014 and that they now consolidate Philidor as a variable interest entity. Normally that would be disclosed at least by name. Buying what was probably your biggest customer usually requires disclosure.

Whatever, Valeant say the effectively purchased Philidor in 2014 - but then the question is why there was no charge over Philidor holdings until late February 2015. It is hard to enforce an option if you do not have security over the shares.

R&O Pharmacy

R&O is a relatively small local and mail-order pharmacy operating in Ventura County California. I suspected originally and possibly even now that Valeant used R&O because Philidor did not have a license to operate in California.

This first came to my attention when The Skeptic tweeted a picture of a demand letter sent by Valeant demanding almost $70 million in payment from R&O. Here is a link to the demand letter and below is a picture.

This produced one of the most bizarre court filings I have ever seen. R&O simply deny [under penalty of perjury I presume] that they have received any relevant invoices from Valeant. You can find the filing here - and the key text is below:

On September 4, 2015, R&O received a letter from Robert Chai-Onn, Valeant’s Executive Vice President, Chief Legal Officer and General Counsel. In the letter, which was the first correspondence that R&O had ever received directly from Valeant, Mr. Chai-Onn claimed that R&O, a small licensed California pharmacy, owed Valeant over $69,000,000. However, R&O has never received a single invoice from Valeant in any amount and until September 4 had never received a single demand for payment from Valeant. R&O has requested copies of the invoices, but to no avail. Indeed, it seems that Valeant has no evidence whatsoever to back up its claims.
Therefore, R&O believes that one of two things must be true: 
1. Valeant and R&O are victims of a massive fraud perpetuated by third parties; or 
2. Valeant is conspiring with other persons or entities to perpetuate a massive fraud against R&O and others. 
The purpose of this action is for R&O to get to the bottom of this, avoid accrual of avoidable damages, if any, and secure an early adjudication without waiting until Valeant sees fit to file suit.
To say this was puzzling is understating it. It seems vanishingly unlikely that R&O (a licensed pharmacist) would rush to court to commit perjury regarding a $69 million amount. But essentially that is what Valeant stated in the conference call. To quote Mike Pearson (Valeant's CEO):

Next question: Why did Valeant's General Counsel send a letter to R&O? R&O is one of the specialty pharmacies in our network, and Valeant has shipped approximately $69 million at wholesale prices to them. This represents approximately $25 million at net prices. Any products R&O dispensed to patients were recognized as our revenues, and are reflected in our receivables. Any products still held by R&O are reflected in our inventory. R&O is currently improperly holding significant amounts it receives from payers. We will refrain from comment on active litigation, and look forward to showing in court that we are owed the money.
This is a pretty big difference you might think. R&O says that they have never received communication directly from Valeant and Valeant says that they are one of the speciality pharmaceutical companies in their network and they have been shipping them material for some time.

The problem is that neither of these explanations make much sense to me.

Here is the limited stuff that I can find out about the relationship between Valeant and R&O and (dare I say it) our old friend Philidor.

First there is a name server associated with Philidor's website. You can find all the domain names on the same name server at this link. Here is the list:

Domains hosted on as62559

DomainIPv4 Address
Now note this. There is a website for an on the same name server as Philidor.

But - and this is really strange - it is a different R&O Pharmacy from the website that received the supposedly spurious demand for roughly $70 million.

These are the two websites for an R&O [or an R and O] pharmacy. Here they are.


Only the latter one of these has the same name server as Philidor. Here - before they disappear - are pictures of the front page of both websites.

The seemingly non-related website:

And the one that shares Philidor's web server:

You will notice if you poke around the website that the phone numbers are also quite different. The Philidor associated website has used the same method to hide its ownership as Philidor. Its domain register as follows (edited):


However the website contains a privacy policy. You can see an original here, or a copy here or a picture below.

Now if you read it says this:
 It’s Your Information. This Notice describes your rights concerning your health record. 
The law requires health organizations, such as Philidor Rx Services, to
-maintain the privacy of your health information
-provide you with this Notice of our legal duties
-describe our privacy practices
-notify you if we have an information breach 
We know your health information is very personal and we are committed to protecting your privacy.

Look at that highlighted section: says the law requires organisations like Philidor to do things.

You see this pharmacy has revealed itself. This R and O pharmacy is Philidor or at least a closely associated related party to Philidor.

And now I have a theory about what happened in this law suit. Valeant has sent product to and then sent demands to The latter has responded by telling Valeant that they are the victim of a major fraud.

R&O Pharmacy [the one that received the demand letter] appears to right. Valeant appears to be either involved in or the victim of a major fraud.

But alas again it is not so simple. I phone the phone number on the website and got what sounded like a fax machine. [There was no personal contact and the number didn't work for a telephone pharmacy.]

So I rang the phone number on the website [805 319 7260)] out of California hours. They could not take my phone call right now.

However they offered a button to push (the number 1 on my keypad) if I wanted to fill a dermatology prescription.

Philidor Pharmacy answered the phone.

I asked only one question - which was to assert that I lived in California and to ask whether they would ship to me. The answer floored me:

"Yes Sir the whole US of A".

You see the problem. Philidor was denied a non-resident pharmacy licence in California with the Californian authorities alleging perjuryBut they ship to California anyway.

We are still trying to work out who is committing fraud on whom. There is clearly some going on but who the victims and who the perpetrators are is not obvious.

But what we have is Philidor (a Valeant consolidated entity) selling pharmaceuticals unlicensed in California and with a fake website for They do this despite being specifically denied a license in California.

However R&O Pharmacy - the real one - clearly has a strong link with Philidor. You can call R&O's phone number and be transferred to Philidor.

It is entirely possible that R&O thought they had no relationship at all with Valeant until the demand letter came. They clearly knew they had a relationship with Philidor - but Philidor and Valeant carefully shielded their relationship and it only became public in the conference call.

One possibility is that Philidor sold scripts in the name of R&O [which would explain the double-website] and kept the money itself - telling Valeant that the money was sitting at R&O and was owed by R&O. I guess other possibilities are also possible and I have no way to handicap them.

Whatever: Mike Pearson has a very big problem and it extends beyond the more $50 million he will need to write off. It is possible - even likely - that some people associated with a variable interest that Valeant consolidates [and I have limited idea which people] have set up an entirely new - and have defrauded either Valeant or possibly some insurance companies of almost $70 million.

Valeant has

(a) booked the revenue and
(b) told everyone that they will win in court.

It is does not have decent operational or financial control over Philidor. And Valeant collecting this money seems unlikely.

Trying to work out which Valeant/Philidor/R&O officers committed the fraud - evidence from domain name history

A fraud has been committed here but I can't tell who by. And I can't tell who is the victim of this fraud.

We wanted to see if we could work out in more detail where the fraud was committed - at least for the purpose of telling the relevant Attorney Generals who to subpoena as part of their inquiries.

We went looking for the domain history of and we found some useful material. Specifically here was the registration history for 13 May 2015 edited to the core details:
Whois Record on May 13, 2015
Tech Name: RX Services, LLC, Phildor
Tech Email: ffcjfc@gmail

This proved that for about one day - 13 May 2015 - the domain was registered to Philidor Rx Services (which we now know is consolidated into Valeant and is effectively Valeant). The probability that Valeant needs to sue itself looks stronger. [You can find the entire domain history here.]

There is also at tech contact email there ffcjfc@gmail. That email it seems belongs to Fabien Forrester-Charles as we discovered from the website of Emily Weaver Photography.

Fabien Forrester-Charles is a name that we had come by in our research and will be known to Valeant
 Management. He is a part owner of Philidor and had pledged his shares to KGA Facilitating. The document by which he pledged his shares is copied below.

Mr Forrester-Charles appears on several domain name registrations. He may not be the person who established the phoney but it is likely that he knows who that person is. [The US Attorneys who have subponead Valeant would do well to ask Mr Forrester-Charles for information.]

Valeant's linked specialty pharmacies - the key to their growth - have been compromised

The tied specialty pharmacies and their rather aggressive copay sales tactics - which are the key to Valeant maintaining sales for some often marginal products whilst raising their prices look compromised.

There is a possibility that the biggest one - Philidor - contains fraudsters who set up fake associated pharmacies and then don't pay their bills. I can't tell whether this is junior staff or senior staff - and I can't tell whether the parties being defrauded are just Valeant or a combination of private insurance companies, Valeant and or Medicare/Medicaid.

The biggest specialty pharmacy (Philidor) is clearly delivering product to California despite being specifically (and pointedly) denied a license to operate in California and giving false statements under penalty of perjury by the Government of the Great State of California.

When you have subpoenas outstanding from two US Attorneys offices into the practices of these pharmacies this is going to matter.

Moreover I demonstrated at the beginning of this post that Mike Pearson does not actually know how the incentive programs work on the ground. He repeatedly (and falsely) stated that Valeant does not use those programs on Salix products.

The reason he largely does not know is the incentive programs are outsourced to specialty pharmacies (and as we will see below) also to some charities. And the key specialty pharmaceutical company appears to have a fraud problem (although we do not know the full nature or extent of that problem).

Copays and copay fraud

The two US Attorneys who have sent subpoenas to Valeant asked specifically as follows:

[D]ocuments with respect to our patient assistance programs, and also include requests relating to financial support provided by the company for patients, distribution of the company's products, information provided to the Centers for Medicare and Medicaid Services, and pricing decisions.
[This was quoted above...]

It is worth understanding what the criminal offences they might be investigating are. They relate mostly to copays.

Copayments for drugs exist for good reasons. Firstly and obviously they recoup some of the costs of the drugs from patients. But far more importantly they verify that (a) there is a patient and that they are a real patient, (b) that they actually want the drug at least enough to make a small copayment.

Australia used to have an entirely free pharmaceutical system for people eligible for the pension. A $2 copayment was introduced. This trivial copayment had a surprisingly large effect on the demand for a drug.

Whether it is legal to waive copayments depends on the relationship between the insurance company and the pharmacy. [In many instances waiving of copayment has been deemed to be fraud.] However critically it is a criminal offence to systematically waive copayments when the insurer is Medicare or other Government programs. This is not something to take lightly - the Government does not like to be defrauded.

If the Valeant tied specialty pharmaceutical companies systematically waive copays for Medicare patients then there is considerable doubt whether Valeant can survive. A criminal charge against an entity with $30 billion in debt is likely to be fatal.

Moreover we have found direct evidence that Philidor sells pharmaceutical products in the Great State of California despite being pointedly denied a licence to do so. [Integrity is a question here.]

We looked hard and alas we found no direct evidence that Philidor waives copayments on Medicare insured pharmaceutical products. Indeed if you have a look at any Valeant coupon advertising it specifically states that these coupons are not available for medicare or medicaid patients. Here for example is a picture of the Jublia coupon page. Jublia is an ointment with an 18 percent chance of reducing toe-nail fungus and a cost of over $8,000 per course of treatment:

The relevant text is this: "This offer is not valid for prescriptions reimbursed in whole or in part by Medicaid, Medicare, federal, or state programs (including any state prescription drug programs)."

We have found similar text on every Valeant coupon page.

Drug companies however are a creative lot. They have found a way of ensuring that many Medicare patients are not out-of-pocket on pharmacy purchases. They fund "copay charities". The charities (and you hope they are genuine charities) tend to be funded by many pharmaceutical companies and will make copayments on branded drugs subject to means tests. They are - for obvious reasons - not allowed to be specific to one company's drugs.

Mr Pearson in the conference call was keen to indicate that Valeant was compliant with the law regarding copays. After all this is what the US Attorneys are looking at. To quote:

Valeant's patient assistant programs are administered by a reputable third party, and we fund outside foundations that have multiple donors. Eligibility is determined by the independent foundations. It is also important to note that eligibility for our in-house commercial access programs is limited to patients not covered by government programs. Looking at history, our commitment to patient assistant programs has grown at an annual compound rate of 128% from $53 million in 2012 to approximately $1 billion we expect to spend in 2016.

He specifically says that the "in-house commercial access programs is limited to patients not covered by government programs" and that they use outside foundations with "multiple donors". These programs will of course be the subject of some inquiries by the US Attorneys.

There is a minor contradiction in the statements by Mr Pearson on the call. Earlier in the call he stated that Philidor provides "administrative services for our copay cards" and we now know that Philidor is consolidated and not a "third party".


The question of course is whether these lofty standards are upheld in practice. That will be the subject of the US Attorney's inquiries. And there is a problem - we have identified serious issues at Philidor and Philidor provides administrative services for Valeant's copay cards. We have no idea how this will work out - but we suspect there may be some difficulties.

The size of Valeant's "patient assistance" programs and what it says about Valeant's business model

In the above quote Valeant states that their patient assistance programs are growing at 128 percent per annum. They will spend approximately $1 billion in 2016. This will be a high single-digit percentage of revenue and it looks like almost all of their products will have patient assistance for most of their sales.

This is extraordinary. Valeant has long said that they have avoided products which are dependent on reimbursement. If you google the phrase "significant cash pay component" you find literally dozens of Valeant presentations that harp on that as being an advantage of the business model.

That seems to have been a smokescreen. Valeant plans to spend a billion dollars in 2016 so that patients do not have to cash pay for most of their products.

The rest of the call

I could wander through Valeant's numbers in some detail. They are always moderately funky. This time for instance they touted their GAAP profit however did not point out that they had pre-tax losses and their profit was entirely from a sharply negative tax rate. As usual they did not provide a balance sheet anyway - so that is unusually hard to to on the day results are released. However after the

(a) demonstration that the CEO is not on top of the copay program [for instance he falsely denied that the company offers patient assistance on Salix products],
(b) the demonstration that their core distributor (Philidor) has (according to the Great State of California) perjured themselves
(c) the demonstration that they went to extraordinary levels to hide their funding and later effective ownership of Philidor
(d) the likelihood that people at Philidor have been involved in defrauding Valeant by impersonating R&O pharmacy
(e) the demonstration that Philidor sells drugs in California despite being pointedly denied a license to do so
(f) the likelihood that that fraud extends to the programs that are the subject of investigation by two US attorneys and
(f) the demonstration that the company has been misleading about its business model ("significant cash pay") for years

anything I will say about the numbers will be churlish.

I am short this stock. The US Attorneys are actively involved and somehow I think that is bearish.


Thursday, October 15, 2015

A cryptic post: no comments will be accepted as this is intended to remain cryptic (for a while anyway) (#timestamp)

Me: I just want to say one word to you. Just one word.

Graduate: Yes Sir

Me: Are you listening?

Graduate: Yes, are you?

Me: Philidor.


Alibaba - yeah right Jack

Jack Ma - the Founder Chairman of Alibaba - released a letter in response to recent movements in the stock and fears about the Chinese consumer.

Linked here (and quoted below) is the Business Insider story about that letter.

“All in all, China’s economy has immense potential. It will not be easy, but China’s future ‘economic miracle’ will lie in its ability to boost productivity and its use of big data and Internet technology to stimulate domestic consumption and generate exponential development opportunities,” wrote Ma. 
Alibaba is a massive retailer in China. The company estimates that there are 367 million users on the service spending around $US1,056 per person annually.

The GDP of China in 2014 is $10.3 trillion.

The population of China is (estimated) at roughly 1.4 billion people.

This makes for GDP per capita of roughly USD 7,350.

China is also a country which has a very low private consumption rate. The World Bank estimates a domestic consumption rate of about 36 percent of GDP. This is the flip side of China's huge saving rate.

Calculate it: household consumption per capita is roughly USD 2,650.

So the Alibaba amount of spending per user (USD 1,056) is almost 40 percent of that number.

Yeah right Jack.


PS. I figured there would be a few objections to this. So lets go through them.

Here is the original Jack Ma letter. He states explicitly that the marketplace does 3 trillion RMB of gross merchandise value. With 6.35 RMB to the USD this says that the gross merchandise value is USD435 billion. This is a bit over 4 percent of GDP or almost 12 percent of all household consumption.

The number of consumers is not stated in that letter - but the number of customers of Alipay is (that is 400 million) and Alipay has more customers than Alibaba. Alibaba's 367 million customers are widely reported. This calculates at about USD1,185 per customer. The 40 percent number estimate above becomes an even more outrageous 44.7 percent.

You may object that the 367 million customers are richer than the average Chinese person - and you would be right. However they cannot be 4 times richer because then the average income of the billion people who are not Alibaba customers would be below zero. They may be twice as rich plausibly, three times as rich if you really stretch it. But that is stretching it and the really rich in China do a lot of non-online spending (luxury cars, watches, travel etc). The 44.7 percent number calculated above is an overestimate - but however you estimate it the number will seem strange.

I report. You decide.


Friday, October 9, 2015

Financial pyramid schemes on Main Street

I can't resist this video - right down to the bullets put on the stack at the end.

A true pyramid scheme.

As the guys with guns, dogs and bad haircuts would say #keepstacking.


Monday, October 5, 2015

Pershing Square modifies their performance numbers with an eight day week

Pershing Square (the hedge fund associated with Bill Ackman) has a European listed closed-end fund called Pershing Square Holdings.

Pershing Square Holdings has a website on which it discloses weekly and monthly net asset value and performance.  This performance matches the returns of Bill Ackman's hedge fund.

They also disclose funds under management at Pershing Square (that is all assets under the strategy).

This is the website:

Pershing Square Holdings reports both weekly numbers and monthly numbers.

According to prior press releases the numbers were released in the following pattern.

(a) Weekly numbers were reported as per the close of business Tuesday and made public the following Thursday (except when there are holidays).

(b). Monthly numbers are reported for the close of the month two days after the close of the month.

On Friday 2 October I took a screenshot the results. Here is that screenshot.

The observant will notice that the reporting dates are 

1 September,
8 September
15 September
22 September and 
30 September.

The last reporting date should - if the pattern were continued - be 29 September. Instead they reported data for 30 September. 

That last week has eight days.

The results as reported on the 30th of September were bad. Pershing Square scored minus 12.5 percent for the month.

However they were
 worse as per 29 September than 30 September. Valeant rose 12-13 percent that day. Valeant is Pershing Square's biggest holding. The vast bulk of the book moved in Pershing Square’s favour during the last day of the month.

The rough calculation is that Pershing Square's performance was almost $800 million worse on September 29 than September 30 - which a cynic might say provides an incentive not to report September 29 results. Of course I would say that Pershing Square is being (extremely) modest about their fantastic day on the 30th of September. 

A portfolio calculation is Appendix A.  [Our estimate is a $777 million swing between the 29th and the 30th of September. The only position that is not disclosed is the size of the Herbalife short. We have a fairly accurate estimate of the size of this position but it does not matter much for this calculation.]

Pershing Square was - it seems - would normally have report a minus 16.6 percent number as a month to date number, but possibly in innocent error did not make this (rather shocking) disclosure. 

There are plenty of stories in the press about Pershing Squares bad month (see hereherehere). I know that Pershing Square is a remarkably open institution. Mr Ackman is the king of the three hour press conference. It is unthinkable that he would not tell the world just how good their day was on the 30th of September.

So I will. 

Pershing Square - my estimate - was down 16.6 percent month to date as per the 29th of September but had a miraculous day on the 30th of September and finished down a mere 12.5 percent. 

The press reported about Pershing Square's terrible month but could have equally reported about their fantastic day. Without reporting the fantastic day I suspect the press is treating the Baby Buffett unfairly.

The new footnote

There was a footnote that explains the reporting data on Pershing Square Holding's website. Here it is in text and photo...

Weekly net asset value (“NAV”) is calculated as of the close of business on each Tuesday and posted on the following Thursday. In the event that Tuesday is not a business day, the Company will calculate the close-of-business NAV as of the business day immediately preceding that Tuesday. In the event that Wednesday or Thursday is not a business day, any such weekly NAV will be posted the next business day following that Thursday. End-of-month NAV is calculated as of the close of business on the last day of the month and will be posted within two business days thereafter. In the event that month-end falls on a Wednesday, the Company will report the month-end NAV on Thursday, and not report the weeklyTuesday NAV. In the event that Wednesday or Thursday is not a business day, any such month-end NAV will be posted the next business day following that Thursday...

In summary it says in the footnote says if the month ends on a Wednesday we will not bother reporting the Tuesday numbers. 

And the photo:

If you are really observant you will note the typo in the footnote. It says weeklyTuesday without a space in the text. This was deeply suggestive that the footnote is recent because Pershing Square's presentation material is usually highly polished and without typos. 

This footnote, with its sloppy and atypical typo was almost certainly written by a junior. [As you will see the footnote has been modified within days of its appearance.]

I wanted to confirm the footnote was recent. Did they just do it to hide the fantastic day they had on the 30th of September (or a cynic might say their bad month until 29 September) or did they have it all the time?

The way to tell is to check old months.

The last time that a month ended on a Wednesday is December 2014. 

If the rule applied then we should see a data point for December 31 and no data point for December 30.

Confirming recency Pershing Square Holdings had both a December 30 and a December 31 data point. They were still on the website. Here is a picture. 

This it appears this month is the first time Pershing Square have applied the month-end-on Wednesday rule. 

A cynic might say that this is a ham-fisted attempt to hide an extremely bad month-to-date data point. However I just think someone wanted to hide the spectacularly good performance on 30 September.

But don't worry - we will report Pershing Square missing data point for you.

On our estimate Pershing Square month to date on 29 September 2019 was down 16.6%. For the month to date. And then in brilliance they had a great day and finished the month much better.

They had to muck around with the calendar not to report to you the wonderful day they had on the 30th of September. [A cynic might suggest they mucked around with the calendar to hide bad results - but Mr Ackman would not do that.]

More changing footnotes

I sent this material to the Financial Times. I copied it to Bill Ackman. I think it was also handed around fairly widely. Within a few hours of market open Pershing Square had released a press release about their new market disclosure rules.  You can find a PDF version of that press release here

The new rule was as follows:

Pershing Square Holdings, Ltd. has made two changes to its NAV reporting policies. Weekly and monthly NAV reporting will now be provided on a one-business-day lag rather than a two-business-day lag. For weeks that include a month-end NAV report, PSH will provide only month-end performance. As a result of the changes, investors will now receive more timely NAV reporting, but only one NAV report each week.
Now the company will not report weekly results for weeks in during which the month ends.

The short-lived "if the month ends on a Wednesday" rule has gone and has been replaced by another footnote - the picture of which is here... The NAV page has also been reformatted.

The month end on a Wednesday rule was absurd. If there was no reason to give the data point for a Tuesday when the month ended on a Wednesday you could argue there was no reason for a Tuesday data point when the month ended on the Monday.

That suggests yet again they changed it on the spot so that they did not have to report the fantastic data on the 30th of September. [A cynic might suggest that they did it so they did not have to report an atrocious month-to-date data point on the 29th - however Bill Ackman would never risk being so needlessly deceptive.]

Whatever: the [Pershing Square] will not report a weekly number if the month ends on a Wednesday rule is now gone. They will no longer report weekly data in any week that a month ends.

This rule also has problems which indicate it was thought up on the fly. What for instance happens when the month end occurs on a Friday? Do they not provide any results that week (preferring instead to wait to the following Tuesday)?

Pershing Square changed its rules on the fly inventing and thinly disclosing an 8 day week to hide their wonderful performance on the 30th of September. The new rules are a confused and made up to support their modesty.

So we will report again. As of 29 September 2015, a date that Pershing would normally have reported, the funds were down 16.6 month to date. And they had a great day on the 30th.

Eight days a week

For the moment though Pershing Square thinks it is okay to - without prior notice - report on an eight day week. Sure they did it so they could modestly hide the fantastic performance on 30 September. But the motivation is not the issue here.

Having an eight day week opens Bill Ackman up for allegations of deception - allegations that Bill should neutralise immediately by reporting the interim data point as originally planned.

I would expect nothing less.


And just because eight day weeks are fun I should finish with a song for Bill Ackman.

As per the Beatles: "I ain't got nothing but love babe, eight days a week".



Here are the holdings and prices as we estimate them at Pershing Square. The holdings other than Mondalez and Herbalife are from the last quarterly form.

The Mondalez holding is from recent filings.

The Herbalife estimate (which does not matter much for this calculation) is from our own estimate. It does not matter for this calculation as the Herbalife price was almost entirely unchanged on 30 September.

It is clear that Pershing Square had truly miraculous performance on 30 September. A cynic would say the month-to-date that they did not disclose (the month to 29 September) was terrible. I prefer to think of 30 September as wonderful.


CompanyTickerHoldingPrice 29 SeptemberPrice 30 SeptemberGain on 30 sep
Valeant PharmaceuticalsVRX19473933$158.08$178.38$395,320,839.90
Air ProductsAPD20549076$125.82$127.58$36,166,373.76
Canadian PacificCP13940890$138.14$143.57$75,699,032.70
Restaurant BrandsQSR38003984$34.71$35.92$45,984,820.64
Platform Specialty ProductsPAH42737394$12.06$12.65$25,215,062.46
Howard Hughes CorpHHC3568017$112.52$114.74$7,920,997.74


Hat tip to The Skeptic - and there was discussion with him via email. The core 8 day observation was his. The footnotes and their changes over time was my observation. 

Sunday, October 4, 2015

Friday, October 2, 2015

Sun Edison - some comments and a way forward

Bronte has taken a long position in Sun Edison. We did this after the first and indeed second stages of the collapse in that stock. The stock decline here is spectacular. First Solar and Solar City have had issues - but nothing like this.

Until about a week ago we were showing (small) profits on the position. Then it took yet another leg down. I know the cliche about trying to catch falling knives - but we think this is a quite good bet - and would be a better bet if the board took decisive action to fix immediate and pressing problems.


Sun Edison develops huge and highly capital intensive solar and wind project where the power is largely pre-sold and where separate financing is developed for each project. These projects are then sold to [“dropped down to”] semi-captive yield companies sold to mostly to yield sensitive investors.

There are several issues. Big solar projects are massively capital intensive – think of utility scale power generation where you have to pay for the next 25 years of fuel upfront. The projects have huge debt but also reliable high margin cash flow.

Secondly there is a pretty obvious conflict of interest in the “yield co” drop-downs. We have successfully shorted a few companies where we think that overpriced assets were being sold to captive vehicles. In the end they these were good shorts - if you can't treat the investors in the drop-down vehicle fairly you will eventually wind up with fewer investors, less access to capital and less underlying profitability.

Thirdly, because of the related parties and the copious amounts of different types of debt these companies have complex and even scary accounts. At Bronte we are quite good at getting to the bottom of complex accounts. But we have a problem with these.

In a meaningful fashion Sun Edison is a “trust me” story.

Whatever, the problems Sun Edison and its yield cos have been smashed. Once fairly obscure solar developers have become a major topic of discussion on Wall Street.

It took us a while to understand why they have fallen so hard. The argument comes down to complex accounts, lots of debt and a peculiar acquisition of door to door marketing company(Vivint).

But there is also more than the usual amount of rumour and innuendo. On Twitter there are arguments we know to be wrong and arguments that are simple fear-mongering (calling Sun Edison “Sun Enron” is one such appeal). Sure the company is highly levered and complex but it is almost certain that the past deals have been good deals. Any solar farm deal you put in place 3-5 years ago has worked out. Both solar panel prices and interest rates are lower than you would have baked into your cash flow models. We would be enormously surprised if the past deals of Sun Edison did not work out.

Whether the future deals work out is however an open question. Low solar panel prices and low interest rates are not exactly a secret – and the funding cost for solar panel farms has risen with this panic. Bluntly we think unless the company repairs its relationship with capital markets it is unlikely to be able to generate good deals in the future and it will wind up in run-off.

There is a deeper problem with the way these companies [yield cos and their parents] see themselves and communicate with investors. That comes down to the fact that many have their roots in semiconductors where operating leverage is everything. You disclose your costs, your variable versus fixed, capacity expansion and so forth because if you make solar modules, wafers or chips that stuff matters a very great deal to your business. Investors use and demand that information because simply put, it matters and drives the profitability of the business.

A yield-co is a completely different business – it is a non-bank financial company.

Non-bank financials “blow up” for one of three reasons, (i) credit risk, (ii) duration mismatches and (iii) and unstable funding. If you want to assess TerraForm Power (Sun Edison’s yield co) you need to assess whether the credit risk on the projects (the counter-party) is okay, how the contract and funding is (eg floating/fixed etc) and all the ways in which project development funding is able
to roll into long-dated funding.

A friend put this to a yieldco and the management balked at providing that level of project detail. My friend's response: “well, are you Northern Rock?”

And that is the guts of the issue and the market fear. We have gone to considerable effort to convince ourselves Sun Edison is not Northern Rock with solar panels. We have talked to several people who have organised funding for these things and it seems okay to us. Specifically all construction finance automatically can be termed out as project finance (over the life of the project and linked to the project) when the construction is done.

If this is true the market fear for this company cannot cause insolvency. Given that the company is priced as if insolvency is likely this stock should produce a good return from here.

Alas we could be wrong here. We can’t see all the funding (the disclosure is complex) but the bits we have seen have this character. We checked through several sources and we don't think the company can have a “run on the bank”. The Northern Rock outcome is unlikely.

Now of course we have not seen and understood all of the finance deals. Only the ones we can find. But that is sufficient to know we are probably right. And that is the case for buying. The old projects are good and they should run off at an attractive clip.

The Vivint Acquisition

That said this company does not behave like a financial institution, they have been rash and callous in their treatment of capital markets. This is dumb. Capital (not solar equipment) is the main input in this business. And capital is cheaper if people trust you.

Moreover management did a really foolhardy acquisition and explained it badly.

Vivint (the target) is a door to door marketing scheme selling solar systems. Some suggest multi-level marketing scheme characteristics but I cannot find the contractual terms that indicate it is an MLM. [Contra: friends have done research on the numbers of complaints at State agencies concerning Vivint.]

Moreover the product it is selling door-to-door (financed solar systems) is not a bad deal for customers. Customers put the solar panels on their roof and their power bills go down. Whether the solar system is owned by the household or some corporate structure what is effectively going on is a loan to the householder where the householder will repay the loan by splitting the utility bill saving with the solar company. Things can go wrong in this deal – but those things are not very likely.

That said, there are good reasons why roof top solar is less attractive than utility scale solar farms. The main one is that rooftop solar gets under-priced use of the grid. The grid is essential here – unwanted solar is sold to the grid and the grid provides electricity when the sun doesn’t shine. My business partner was once a utility CEO. He has an instinctive skepticism of rooftop solar. He thinks – correctly – that people with rooftop solar underpay for grid services.

In Northern California this is becoming explicit. Pacific Gas and Electric is proposing changes which explicitly charge households with solar panels more to access the grid. Whilst we have no view on the size of the charge the direction is probably right. This will become a trend and make roof top solar less attractive in the future.

The Vivint acquisition - which looks strange - was poorly explained and was bundled with a few details that indicated that the margins on projects dropped down to the captive yeild-cos are declining caused a run on the stock. Moreover there were lots of hedge funds who had oversized positions in Sun Edison before the collapse. There clearly was a rush to the exits.

And in capital market terms those can be self-fulfilling. The equity and debt cost for Sun Edison has risen substantially and this seriously impedes the economics of the company. Its that strange thing about financials that lower prices for equity and debt reduce the future cash flows.

The current situation and the way forward

Sun Edison has lost about 80 percent of its value without the slightest hint from the management team that there is a problem. The credit default swaps have moved against them and it will be far more difficult to grow whilst the situation is like this.

There really is one issue here. Can they find and develop new solar plants and drop them down into project financed bankruptcy remote vehicles and (a) make a profit and (b) ensure the new owners of those vehicles make enough return to keep them coming back for the next vehicle? [At the moment there is a fairly strong private market for solar projects - people like large pension plans - but the same concern applies to them too. They got to trust you.]

If they can't develop and sell either growth stops dead or the company becomes a ponzi.

Alas with market distrust it becomes unlikely that future projects can meet the required return hurdles. The private market for completed projects will also have the same concerns about the management.

The best case here is that the company has become a melting ice-cube. It is worth something (I think a fair bit more than the current price) but every drip of cash that comes off in the end goes either for debt repayment or is returned to shareholders.

The whole project development team - the raison d'ĂȘtre of the company - ceases to have any use. They should all be fired. Yes - all of them. [If you work for Sun Edison it is your job too. And that will eventually include the board. Them are the stakes. If the current board doesn't do something about this it is eventually your job.]

There is an alternative - an alternative I think the company should take. They should pay their contrition to the market - and give the market what the market wants.

What the market wants here is a clear vision of financial control and responsibility. They want to know that Sun Edison is not Sun Enron.

Stocks don't just fall 80 percent in a vacuum. Someone has to be held responsible - and the board needs to ensure that happens to ensure Sun Edison has a future.

That person is the CEO.

Ahmad R. Chatila

Ahmad R. Chatila (Sun Edison's CEO) is a visionary. Indeed Mr Chatila is the reason for Sun Edison's success to date. I have heard managers describe him in glowing terms - amongst the best CEOs in America.

And I don't disagree.

Except that he should be fired. Pronto. Now.

Sun Edison - through the vision and drive of Mr Chatila has become a financial institution. One with a lot of run-off value. One which I think has improved the world a great deal.

Vision, drive and competence are usually great things for a CEO.

Not in this case.

I am an old fashioned kind of guy. I do not think visionaries should run financial institutions.

Visionaries running financial institutions end in disaster.

Mr Chatila has built an institution for which he is profoundly unsuitable to run. The market has made that abundantly clear.

Pay him out

I have mostly been unsympathetic to firing executives and leaving them with a big payout. Mr Chatila is an exception.

Mr Chatila has not done much that is wrong. He has created - from very little - a worthwhile, valid and large business. He has achieved much.

He has not done very much that is wrong except create a business which he personally is a woefully inadequate CEO for. For this he should be rewarded: as recognition of (a) what he has truly created and (b) for going quietly and constructively.

Calculate his payout, add thirty percent and fire him.

Who to appoint?

There is a core criteria on picking the new CEO.

They need to be boring and from a control culture. The idea CEO would be someone from (say) the risk management department of Goldman Sachs. What you want is a dull suit occupied by someone whose job it is to pull wings off butterflies. Someone whose job it is to ensure - and be seen to ensure - that bad projects are not funded.

The market wants someone who will get on an earnings call and talk about asset liability matching, FX risk mitigation and basically sounds like the CEO of a mortgage REIT, not a semiconductor visionary.

You want risk aversion above all other things.

And you want it for another reason. Mr Chatila has populated the senior ranks of Sun Edison with people like himself. Ambitious go-getters - people who get things done. It is notable that all of the ex Goldman hires at Sun Edison come from the banking and advisory side. They are deal people. Deal people do deals and are not happy if they are not doing deals.

The people Mr Chatila have hired have got things done. Alas if you are going to have people like this in a financial institution (and Goldman Sachs is full of such people) then you need a counter-balance. Someone who stops you doing silly things and has the intellectual horsepower to work out what is silly and what is not. There are plenty of such people around and if Sunedison can poach deal centric Goldmanites then perhaps it can pick up a few slighly more salty risk managers too.

There is an alternative of course. But that is harder. You could keep Mr Chatila. Have a visionary running your financial institution - but then you need to beef up the risk management culture of the place to an extraordinary degree. You need to sack the CFO, half the board need to resign (and be replaced by hard-headed financial types) and you need to remove about half the go-getters that Mr Chatila has installed.

Easy and difficult routes to dullness

This company has got to become dull and predictable and it has to get there fast. Anything short of dull and predictable will end badly.

There is a fast route to dull and predictable (the one I prefer). Start at the top. Sack Mr Chatila. Appoint someone who will embody the new (and boring) Sun Edison. And this guy is going to give the market the sort of information they need - that is

(a). Power purchase agreements and their counter-parties (the analog of credit risk for a non-bank financial institution),

(b). Contract terms for the above PPAs - eg fixed, floating, renewal terms and also for the debt for the projects (the analog of whether there are mismatches in funding), and

(c). The funding details (to ensure that there are not mismatches in the duration of funding).

There is the second route to dull and predictable. That is to leave Mr Chatila in place but sack half the people around him and replace them with people who will control his ambition. This is - in this case - a worthwhile option as Mr Chatila really is a visionary - someone who really has created value.

Whether you can keep the good parts of Mr Chatila (vision, drive) and also keep the market happy has yet to be seen. I have my doubts.

The third way to dull and predictable - and one which will be forced upon the company shortly if the board does not react sensibly is just to put this into a form of run-off. Fire everyone in project development. Just do it. My guess is that they have to start firing now - but a few is not going to do. In runoff they have to fire all the interesting people, leave a skeleton maintenance staff and send us (now suffering) shareholders lots of cash.

My guess is that the board will settle on the first option or Carl Icahn or some equivalently effective activist investor will buy a big stake and force the third option on them.


General disclaimer

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.