When the Wolves Bite

by Scott Wapner

  By August 2015, Valeant sure looked like another home run. That month, shares hit an all-time high of $263, more than double the price at which Ackman had first bought the stock.

  But while Valeant was making its investors and Pearson rich, it began to attract attention for a lesser-known but important part of its business model. When Valeant bought a new drug, it aggressively raised its price to consumers, even for life-saving treatments. In one case involving the heart drug Isuprel, it raised the cost for twenty-five ampules from $4,489 to more than $36,000 in just two years. It did the same thing after acquiring the diabetes drug Glumetza, hiking the cost of ninety 1,000-milligram tablets from nearly $900 to more than $10,000.24

  Finally, in September 2015, a chorus of critics, including the Democratic presidential candidate Hillary Clinton, had seen enough. At 10:56 a.m. on the morning of September 21, Clinton tweeted about another company on the high-price hot seat, Turing Pharmaceuticals, which had similarly raised prices exponentially.

  “Price gouging like this in the specialty pharma market is outrageous,” read the tweet. “Tomorrow I’ll lay out a plan to take it on.”

  At the very second the tweet hit the tape and media outlets mentioned it, the iShares NASDAQ Biotechnology ETF, the exchange-traded fund that tracked the sector, began falling, quickly losing more than 4 percent of its value.25 By late September, investors were growing more and more nervous, with Valeant shares losing a quarter of their value since the spring.

  At the same time, Pearson, who could be curt and abrupt with critics, appeared defiant on a company conference call when asked about the questionable price hikes.

  “We will act appropriately in terms of doing what I assume our shareholders would like us to do,” he said.26

  In the weeks that followed, Pearson’s communication skills would be put to the test again, only this time his company’s future would arguably hang in the balance.

  On October 15, the Australian money manager John Hempton, who’d bet against Ackman’s short in the Herbalife trade, sent an email to Ackman that said, cryptically, “I just want to say one word to you. Just one word. Philidor.”27

  Ackman had never heard the name before, nor did he have any idea what Hempton was referring to. Neither did anyone else.

  But on October 19, the Southern Investigative Reporting Foundation (SIRF), run by a dogged investigative journalist named Roddy Boyd, released an explosive report on its website titled “The King’s Gambit: Valeant’s Big Secret.”

  Inside the bombshell report, Boyd revealed Valeant’s ties to a company called Philidor Rx Services, a “specialty pharmacy” firm outside Philadelphia that almost no one on Wall Street had ever heard of, even though billions of dollars’ worth of Valeant products moved through its doors each year. Boyd claimed the businesses were virtually inseparable, all but intimating that Valeant owned the company.28

  If that were the case, why hadn’t Pearson mentioned it before? Boyd wondered as he noted Philidor’s stark and simple website.

  Philidor’s business worked like this: Instead of getting a prescription for one of Valeant’s expensive medicines the old-fashioned way—by going to a drugstore—patients were instead sent by doctors directly to Philidor’s mail-order service. Philidor would then fill the prescription and deal directly with insurers, removing the physicians’ need to haggle for reimbursements. The process also kept patients from getting prescribed lower-priced generic drugs, which in turn kept Valeant’s healthy profits rolling in, especially on its expensive medications.29

  Boyd’s SIRF report was carefully timed.

  Later that morning, Valeant was scheduled to hold its quarterly earnings call, which put Pearson on the defensive. Faced with questions about the business and its use of specialty pharmaceutical companies, Pearson admitted Valeant had purchased an option to acquire Philidor the previous year, and also revealed it had consolidated the firm’s financial results into its own since then.

  It may have been a shocking revelation, but Valeant’s use of Philidor wasn’t necessarily illegal, according to experts who opined on the topic. Still, the company’s lack of transparency and the escalating outrage over the issue of its drug prices only raised more skepticism with investors.

  Later that same morning, with chum already in the water, another attack came, this time from an antagonist in Los Angeles.

  Andrew Left had founded Citron Research out of his Beverly Hills house in 2001 and was known for his scathing, if not hyperbolic, research reports touting short investment ideas. Left was a fast-talking idea machine with a credible track record among stock market watchers. He had drilled for-profit education stocks in the past as well as a company called Longtop Financial Technologies, which was ultimately delisted from trading over questionable business practices that Left had highlighted.30

  Left liked to make a splash too, and when it came to Valeant he lived up to his billing.

  “Valeant: Could This Be the Pharmaceutical Enron?” asked the title of Left’s new report, alluding to one of the biggest corporate accounting scandals ever in the United States.31

  “Citron Publishes the Smoking Gun!!” splashed another line just below in bold red ink, along with a shocking $50 price target, almost $100 lower than where Valeant was currently trading.

  Left attacked Valeant for “covering up” its relationship with Philidor and another specialty pharma company like it, concluding that “Citron believes the whole thing is a fraud to create invoices to deceive the auditors and book revenue.”

  “Is this Enron part Deux??” Left asked.

  It was an explosive accusation that sent Valeant shares plunging as much as 39 percent in heavy volume.32 Valeant was suddenly reeling, and it put out a press release to refute Citron’s allegations line by line.

  “We categorically deny the allegations made in the Citron Report,” said a company spokesperson. “Citron’s false and misleading statements about Valeant appear to be an attempt to manipulate the market in an effort to drive down Valeant’s stock price.”33

  Investors were running for the hills, at least most of them.

  There was one in particular, though, who did the opposite.

  In the midst of the storm, Ackman jumped in, buying two million more shares at $108 apiece, revealing the news to me by phone, along with a claim that he still believed in the company. As proof, Ackman touted that he had not sold a single share of the more than twenty-one million that he owned.

  The news helped Valeant recover some of its losses, closing the day down 19 percent, at $118 a share.34

  Days later, the Valeant story grew even more salacious when the Wall Street Journal reported that employees from Philidor not only kept in close contact with workers at Valeant but also used comic book–like aliases to communicate.35

  Now Ackman was losing his patience, if not his mind. In the span of seven short months, his Valeant investment had lost more than $1.5 billion of its value, and he’d had it.

  According to a detailed Wall Street Journal account, on Tuesday, October 27, while in Toronto for a board meeting of the railway Canadian Pacific, Ackman emailed Pearson and several members of Valeant’s board, early that morning from his hotel room, to voice concerns about where the company was heading.36

  “Your reputation is at grave risk,” Ackman wrote to Pearson. “Valeant has become toxic.… Even we are concerned,” he said.37

  After reading the email, Pearson invited Ackman to join Valeant’s board meeting by phone later that morning, which he did, urging that, according to the Journal, “management needs to come clean.”38

  Ackman encouraged the company to hold a conference call that day, which the company declined to do. Ackman then called Valeant’s lead director, Robert Ingram, to raise an issue that once would have been unthinkable—whether Pearson should remain as the company’s CEO.39

  One week later, on Friday, October 30, Ackman held a four-hour conference call with more than nine thousand investors and reporters listening in
. Ackman explained why he’d bought even more Valeant shares and continued to believe in the embattled company.40

  Earlier that morning, Valeant announced it was severing ties with Philidor altogether, which was just as well with Ackman, who had criticized Valeant and Pearson for not being more transparent about the specialty pharmacy, admitting he didn’t know of its existence when he originally bought shares back in March.41

  Ackman pointed to other hedge funds that were still in the stock as validation for his support, calling shares “tremendously undervalued.”42 Indeed, ValueAct, a San Francisco–based investment firm run by Jeffrey Ubben, was still invested, and he said defiantly on CNBC that the scrutiny was nothing short of a witch hunt.

  “The short-sellers and the media are dying for some new crisis like Enron,” a frustrated Ubben told the CNBC host Kelly Evans.43

  Ackman went even further, saying shares had an “89 percent upside” and could even be worth $448 in three years.

  “Life will go on for Valeant,” Ackman said on his call while answering more than two hundred questions from the media and analysts. “While this has been a very damaging moment for the company,” he said, “we think the Valeant business is quite robust.”

  Others weren’t so sure and began to worry about the hit Ackman was taking—both in the media and in his portfolio.

  On November 4, Whitney Tilson wrote Ackman a personal letter, pleading with him over several pages to sell the entire position immediately, just as he’d done in the depths of the JC Penney crisis.

  “I had tried talking to him and that didn’t seem to work,” said Tilson of the letter. “There were a lot of obvious red flags, and it still looked like the stock had plenty of downside, and I just wanted to warn him.”

  Tilson had done his own in-depth analysis of Valeant’s balance sheet, identifying several worrisome signs he suspected Ackman was ignoring, including Valeant’s high debt level.

  As much as Tilson tried, the intervention failed. Ackman made it clear he wasn’t selling.

  “I tried to be the truth teller to Bill, but it didn’t work,” Tilson said.

  To make matters worse, even Herbalife, which hadn’t been one to engage Ackman directly in the press, couldn’t resist taking a shot at the investor while watching the Valeant massacre unfold.

  “I hope Bill Ackman has done more research on Valeant than he did on Herbalife, Target, Borders, and JC Penney,” said Herbalife’s executive vice president, Alan Hoffman, referring to some of Ackman’s more infamous misfires.44

  Hoffman had joined Herbalife in August after leaving a public relations role at PepsiCo. He had also previously served as Vice President Joe Biden’s chief of staff and knew a thing or two about advocating against an opposition party. Though friends questioned his sanity for making the move from Purchase, New York, where Pepsi was headquartered, to Los Angeles and into the thick of the Herbalife war, Hoffman figured he was up for the challenge.

  He also had a plan. Hoffman thought Herbalife had been too soft on Ackman and decided it was about time to change tactics.

  The new hardline strategy had actually begun behind the scenes at the start of the year, when Ackman had traveled to Chicago to personally appear at an anti-Herbalife rally sponsored by the Waukegan chapter of LULAC. Ackman was slated to show up at a church in the city to hear from local Herbalife distributors who’d lost money. Herbalife wanted to mount a counteroffensive so that Ackman wouldn’t get a free pass to control the narrative.

  On the morning of January 10, 2015, Herbalife held a conference call, with Hoffman trying to convince other company bigwigs to support the public pushback.

  It wasn’t an easy sell.

  Some of the executives were reticent to expose Herbalife’s members to Ackman directly. Later that morning, Hoffman emailed Ibi Fleming, an Herbalife vice president who was one of the apprehensive executives.

  “This is about supporting the company,” Hoffman all but pleaded. “And during these times, folks have a tendency to band together. And to be honest the number matters. We need to show that we have significant support. They will have 100 and if we have 500, the press will report that. Finally, if [Ackman] is successful in this forum, we can expect others. We need to do everything possible to ensure that this does not happen.”

  “Why would we want our newest members exposed to this?” Fleming wrote back.

  “They need to do this for the health of their businesses and the company,” responded Hoffman. “This is going to be big news and not demonstrating that the company has support will have an impact on their sales. This is in their interest.”

  The pleas worked. Hundreds of Herbalife supporters braved freezing cold temperatures and snow, showing up outside the church with signs protesting Ackman and his assault on the company.

  Buoyed by the turnout and the enthusiastic support the company had received at the rally, Herbalife executives felt they had reached a tipping point in their campaign to fight back against Ackman. President Des Walsh even suggested afterward that the company take out an open letter in USA Today, with Michael Johnson pushing all that Herbalife had meant to people while blasting Ackman for his JC Penney and Valeant support, saying the companies had lost jobs.

  In June, Herbalife unveiled a website called The Real Bill Ackman. “Bill Ackman has made some jaw-dropping mistakes,” the home page read, offering people a chance to “read and watch what people are saying about Ackman’s blunders.”

  The company didn’t stop there.

  On July 20, attorneys for Gibson Dunn, Herbalife’s outside counsel, wrote to the US Attorney for the Southern District of New York and the SEC alleging “suspicious trading” ahead of a story in the New York Post that was critical of the company.45

  The confidential memo, first reported in the Huffington Post, highlighted the purchase of ten thousand put options contracts purchased on June 25 in the minutes before the story appeared on the publication’s website.46 The contracts would become profitable if Herbalife shares fell over the next two months.

  “If true, we believe that this is market manipulation,” Gibson attorney Barry Goldsmith wrote. “To the extent that you have not done so already, we would, therefore, respectfully ask that you investigate who is responsible for these (and other) large, suspicious put option trades and what their connection is to Mr. Ackman and/or Pershing Square.”47

  A Pershing Square spokesperson called Herbalife’s accusations “false,” but there was no denying that Ackman was squarely on the defensive.

  By the fall, Valeant shares had lost nearly 50 percent of their value, with most on Wall Street expecting even more pain in the weeks ahead.

  “There is a lot of headline risk there for investors,” said Mark McCabe of KDP Advisors Inc. “And the tip of the iceberg? You just don’t know. So there will be more pain in the short term.”48

  Ackman did whatever he could to stop the bleeding. On November 5, he sent an email to Pearson, pledging his continued support.49 The note read:

  From: William A. Ackman

  Sent: Thursday, November 05, 2015 2:03 PM

  To: J. Michael Pearson

  Subject: You

  Dear Mike,

  In light of recent press reports, I thought it would be helpful for me to communicate my thoughts on your leadership of Valeant. We share the board’s confidence in you and your leadership.

  While I have strong views on Valeant’s communication strategy and would have taken a different approach, you and the board should not interpret this as a negative reflection on my view of you as the CEO of the company. I understand that the company’s counsel and the board may have different views on what can be communicated in light of regulatory scrutiny. This is indeed a judgment call, and I respect the board’s decision in this regard.

  You are one of the most shareholder-oriented CEOs I know. You have assured me that you and the rest of the board are considering any and all alternatives that would benefit shareholders and other stakeholders. That is ve
ry comforting to us.

  Sincerely,

  Bill50

  The damage was mounting. In the third quarter, Valeant alone caused a nearly 5 percent drag on Pershing’s overall performance, and to make matters worse, Herbalife continued to wreak its own havoc on the portfolio. By November, Herbalife shares had climbed more than 50 percent on the year.

  Michael Johnson hoped to keep the pain coming.

  On November 12, 2015, in a letter that has never before been made public, Johnson wrote directly to the SEC’s chairwoman, Mary Jo White, asking her to join the FBI and US Attorney in investigating Ackman and his associates for manipulating Herbalife’s stock price.51

  “For the past three years,” Johnson wrote in the two-page letter, “Ackman has engaged in a multimillion dollar campaign to manipulate and drive down the price of Herbalife stock, including by repeatedly ‘putting out false information’ relating to Herbalife, both directly and indirectly and through his paid operatives.… I respectfully urge the SEC (to the extent that it is not already doing so) to investigate Mr. Ackman’s sustained and well-financed campaign to introduce false information into the market and manipulate the price of Herbalife stock.”52

  As much as Ackman tried to hide it, there was no denying that the year had taken a toll on the usually unflappable investor. On December 15, a contrite Ackman wrote to his investors with the sober reality setting in.

  “If the year finishes with our portfolio holdings at or around current values, 2015 will be the worst performance year in Pershing Square’s history, even worse than 2008 during the financial crisis when the funds declined by 12% to 13%,” Ackman wrote.53

  There was a bright side, Ackman said, as redemptions from angry investors in the fund had been modest. Ackman could thank himself for that.

  Years earlier, Ackman had protected against large drawdowns by putting an eight-quarter “gate” on his investors’ money, meaning if anyone wanted to redeem, they had to give two years’ notice, in writing. The move was made to help protect for moments like these. Ackman had also taken his firm public back in 2014, doing an initial public offering (IPO) in Amsterdam. Pershing Square Holdings, as Ackman called the new vehicle, raised billions of dollars in so-called permanent capital that could never be withdrawn.