ValueAct’s Valeant return hints at value trap

By Robert Cyran

ValueAct’s valiant return to Valeant Pharmaceuticals hints at a value trap. The departure of the activist fund led by Jeff Ubben from the drug company’s board in May set off a slide in Valeant stock, the currency so critical to its M&A-driven strategy. ValueAct is rejoining the board, and may buy more shares. Some good investments, it seems, are harder to leave than they are to make.

The San Francisco activist hedge fund is in large part responsible for Valeant’s success. It helped appoint Chief Executive Michael Pearson and drew up the lucrative compensation scheme that encouraged him to go on a massive shopping spree, which Valeant then capitalized on by slashing R&D and other spending at its targets. Wall Street loved the story, sending the stock up about 10-fold.

While Ubben’s fund has done extraordinarily well, cashing out may be proving problematic. Valeant is now a $43 billion company and saddled with lots of debt – to bag the big game it needs to grow, it needs to use its stock as currency. About 60 percent of its proposed $50-billion-plus takeover of Allergan comes in the form of equity. If Valeant’s stock weakens, so does the appeal of the deal.

Ubben says his fund never sold any stock. He has consistently defended Valeant’s business model. The perception that the smart money was considering cashing in, however, encouraged a self-reinforcing spiral downward – helped by criticism of Valeant’s business model by short sellers such as Jim Chanos, and Allergan’s bruising defense.

ValueAct’s return, and its promise to buy more stock, will dampen these attacks. Valeant’s stock rose 3 percent on the news. Yet Valeant’s business still needs big acquisitions to grow -and that requires a strong stock. Leaving may be just as difficult – maybe even more so – when ValueAct does actually decide it’s time to move on.

Published on Sept. 20, 2014

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