2017-03-29, 7:52 AMThe inside story of Valeant’s fall - The Globe and Mail

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2017-03-29, 7:52 AMThe inside story of Valeant’s fall - The Globe and Mail

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Inside Valeant’s fallHow an analyst, a hedge fundmanager and a journalist exposedthe fatal flaws in CEO MichaelPearson’s strategy and ended adrug-fuelled capital marketsrampage

2017-03-29, 7:52 AMThe inside story of Valeant’s fall - The Globe and Mail

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CHARLES WILLIAMS

BRUCE LIVESEYSPECIAL TO THE GLOBE AND MAILLAST UPDATED: WEDNESDAY, MAR. 29, 2017 6:33AM EDT

U.S. Senator Elizabeth Warren is renowned forpillorying captains of industry when theopportunity presents itself.

Such an occasion arose one cool, overcast day inApril of last year, when J. Michael Pearson satin front of a group of senators in a wood-panelled chamber on Capitol Hill inWashington, D.C. As the recently fired (but stillacting) CEO of Laval, Quebec-based ValeantPharmaceuticals International Inc., Pearsonwas appearing before the Senate’s SpecialCommittee on Aging to answer for Valeant’spenchant for jacking up drug prices to unholylevels. The room was packed with aides,reporters and anxious businesspeople.

Warren, a Democrat from Massachusetts, is aformer Harvard law professor with a rapierintelligence and a willingness to be blunt. At one

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point she drilled down on Valeant’s use of“patient assistance programs.” Warren felt thatsuch programs—which typically cover some orall of a patient’s co-payment—were a cunningway to keep consumers using overpriced drugsafter the company hiked prices.

“What is the return to Valeant on the moneythat you’re currently putting into the patientassistance program?” Warrendemanded pointedly.

Pearson, a fleshy 57-year-old with grey hair anda long puffy face, was looking rather whippeddespite his natty charcoal suit and burgundy tie.He slumped noticeably in his chair. “I don’tknow,” he replied. “In fact, for patientassistance programs, we don’t look at it asan investment.”

“Don’t tell me that you don’t look at it as aninvestment,” snapped Warren, waving her handdismissively at him. “The point I am trying toget to is this is obviously a profitableundertaking for your business, and I just wantto know what your return on investment ison that.”

“Senator, I’ve never seen a return on investmenton overall patient assistance programs,” saidPearson evenly.

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“Well, let me ask you a question in a differentdirection. Why don’t you use these co-payreduction programs with federal governmentprograms like Medicare and Medicaid?”

“Um, my understanding is we are notallowed to.”

“Yup,” responded Warren. “Because it’s illegal.And that is exactly the problem here. Theseprograms are illegal because Medicare andMedicaid understand that the programs arescams to hide the true cost of the products fromthe consumers and drive up the costs for all ofthe taxpayers.”

This encounter, and the allegations it spawned,marked another blow against Pearson and hiseight-year tenure running Valeant. By the timeof the Senate hearings, the company was in full-blown crisis, having been accused of operating ascheme to rip off the U.S. private healthinsurance system—and Valeant’s patientassistance programs played a critical role.Within months of Pearson’s appearance, mostof his executive team and Valeant’s board wereout the door.

Once a darling of Wall Street and Bay Streetinvestors and analysts, Valeant is now likely togo down in the history books as one of thelargest corporate debacles in North America.

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The drug company, which offers a wide range ofproducts in dermatology, gastrointestinalmedicine, eye health, neurology and cardiology,saw a swift and remarkable rise duringPearson’s tenure, to the point that it brieflybecame the largest corporation in Canada—evenlarger than Royal Bank—before it came crashingdown to Earth. Its stock rose from $50 a sharein 2012 to a high of almost $350 in the summerof 2015, and then collapsed to its current valueof less than $20, wiping out more than $112billion in investors’ capital in just over a year.“To put that into context, this was probably oneof the most widely held stocks in all of Canada,”explains Jerome Hass, portfolio manager atLightwater Partners Ltd., a Bay Street hedgefund. “The entire value of the Canadian hedgefund industry is about $30 billion. So aboutthree times as much money has been lost onthis one stock as the entire value of the hedgefund industry in Canada.”

Now Valeant is facing roughly a dozen separateinvestigations, including those by the U.S.Securities and Exchange Commission (SEC), theU.S. Department of Justice, U.S. Attorney’sOffices in New York and Massachusetts, andboth houses of Congress. It’s been hit withnumerous shareholder lawsuits, with currentand former Valeant executives and directors

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accused of securities fraud and insider trading.In mid-March, high-flying Wall Street hedgefund manager Bill Ackman, one of thecompany’s biggest boosters and shareholders,shocked the investment world when hesuddenly cashed out his position and resignedfrom the board. But the most seriousdevelopment came last November, when twotop executives at Philidor, a shadowy pharmacynetwork linked to Valeant, were indicted forfraud and conspiracy in connection withrunning a kickback scheme. If they’re convicted,it suggests that what was briefly the largestcorporation on the Toronto Stock Exchange hadstrong ties to executives who committed fraudon a massive scale.

How could such a thing happen? There’s plentyof blame to go around. But when we approachedthe analysts on Bay Street and Wall Street whoaggressively promoted the stock, they wouldn’ttalk. Former employees, many of whom werepaid severance packages to keep quiet, wouldn’tcomment. Michael Pearson himself, who wenton a strange extended leave at the height of thecrisis, has seemingly gone into hiding and hasn’tspoken to anyone. Only one group of peoplewould speak on the record: a small band oflargely ignored independent analysts, hedgefund managers and journalists who first noticed

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that something was rotten at Valeant and triedto sound the alarm.

CHARLES WILLIAMS

The outsider:Dimitry KhmelnitskyStanding all of 5’6”, with friendly elfin featuresand thick glasses, Dimitry Khmelnitsky wouldnot be described as an intimidating presence.But that doesn’t mean he isn’t feared in somequarters. His analyst reports—the first inCanada to warn that Valeant’s numbers didn’tadd up—can be credited with helping to expose

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the company’s flaws.

As vice-president of Veritas InvestmentResearch Corp., an independent equity researchfirm, the 39-year-old spends his days workingfrom a spartan office located on the 31st floor ofa downtown Toronto office tower, siftingthrough financial statements for telltale signs ofmalfeasance. But despite his central location,Khmelnitsky is an outsider—which perhapsexplains why he was one of Valeant’searliest critics.

Khmelnitsky’s facility with numbers runs in thefamily. He was born in the former Soviet Unionto a mathematician father, who moved thefamily to Israel to escape the collapsing socialisteconomy. In 1999, Khmelnitsky moved toToronto to study business at York University,where he met his future wife, who’s alsoRussian. He subsequently got a degree inaccounting, working at Ernst & Young beforejoining Veritas as an analyst in 2006. By then,Veritas was emerging as one of Canada’s topinvestigative accounting shops.

Khmelnitsky began looking at Valeant in 2011,not long after the company merged with BiovailCorp., a Canadian drug company. “We wereinterested in Valeant because it had a non-standard business strategy,” he says.

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Editor’s note: Bill Ackman’s big failAckman should have realized Valeant’s strategywould run into trouble. Eventually, you simply runout of desirable companies to buy.

That strategy, which involved investing next tonothing in developing new drugs, was thebrainchild of J. Michael Pearson, who joined thecompany as CEO in 2008. At the time he washired, the native of London, Ontario, was at thetop of his game. He’d come from a lower-middle-class background, and studied at DukeUniversity and the University of Virginia beforejoining the giant consulting firm McKinsey &Co., working his way up the ranks to become adirector. During his 23 years at McKinsey,where he was promoted to head up its globalpharmaceutical practice, Pearson becameconvinced that drug companies had bloatedcosts and most of their spending on researchand development was a waste of money,producing few new medicines. As Valeant’sCEO, he adopted an innovative strategy: acquire

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companies that had surefire products, chopR&D and then jack up the prices of existingdrugs before the emergence of cheaper generics.

With backing from Valeant’s board andinvestors, Pearson went on a corporate buyingspree almost as soon as he landed in the CEO’soffice. Between 2008 and 2014, he snatched upmore than 100 companies and licences and theeffect of this impressive string of highlyleveraged acquisitions on the company’s bookswas astounding: Annual revenues rose from$757 million (U.S.) in 2008 to $8.3 billion(U.S.). Debt eventually shot up to $31 billion(U.S.). By 2014, Valeant employed 17,000people around the world and sold 1,600products. Yet during this same period, Pearsonslashed research and development down to aslittle as 3% of sales.

Valeant’s most significant deal at the time wasthe 2010 acquisition of Biovail. Above all else,Pearson was attracted to the company’s offshoretax structure. This was an “inversion” deal, inwhich a company moves its headquarters to alower-tax locale. By merging with Biovail,Valeant went from being an American companyto a Canadian one, technically speaking, withone of the lowest drug company tax rates in theworld—as low as 3% in some years. (Biovailtook advantage of Canada’s tax treaty with

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Barbados, allowing it to be taxed at theBarbadian rate.) By 2014, Valeant had saved$2.5 billion (U.S.) in taxes as a result of theBiovail marriage.

Profits were soaring and analysts loved theValeant story. Heavyweight investors on Walland Bay streets were pouring tens of billionsinto the stock, with most of the 23 analystscovering it in the summer of 2015 rating it asa “buy.”

But as Khmelnitsky continued to follow Valeant,he began to see some alarming things. “If youtake some of their major assertions…and you tryto verify those statements with the informationin their audited financial statements andquarterly reports and other facts, they don’tcoincide,” he says. In 2012, for example, hefound the company had misled analysts aboutwhy sales had not met expectations, claimingthey were affected by seasonal changes. But itsannual report said differently.

In 2014, Khmelnitsky began setting up meetingswith institutional investors to warn them to stayclear of Valeant. But some of them didn’t wantto hear his message, and sometimes things gotchippy. “We would get kicked out in a nice way,”he recalls. “They would say to us, ‘Talk toValeant management—you guys are missing it,

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Valeant’s management is revolutionizing theindustry.’” Khmelnitsky was being made to feellike the boy who cried wolf.

CHARLES WILLIAMS

The maverick:John Hempton“Valeant is a Wall Street creation,” insists JohnHempton from his small office above ashopping centre in the suburbs of Sydney,Australia. Tall, toothy, brash and very smart,the 50-year-old spent years working as a taxpolicy officer for the New Zealand and

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Australian governments, helping them to crackdown on tax cheats. “I can explain DonaldTrump’s tax returns,” he jokes.

In 2000, Hempton went to work for PlatinumAsset Management Ltd., an Australianinvestment firm. He became a junior partner,buying into the firm at a low price, and when itwent public in 2007, its market cap quickly roseto $4 billion—allowing him to retire a wealthyman at age 39. But his wife soon tired of himlounging around their beach house. “She said ifI didn’t go back to work she would leave me,”says Hempton. So in 2009, he founded his ownhedge fund, Bronte Capital Management Pty.Ltd., which today has more than $100 million(U.S.) in assets.

Hempton sums up his investment strategy as“long on quality and short on crap.” Hedeveloped a reputation for carrying outmeticulous on-the-ground research to ensurecompanies he invests in are what they say theyare: He once visited a hair salon in Bangkok toinvestigate how Henkel AG marketed its hairdye, and has flown as far as the Middle East toconduct research. It’s paid off: He shorted Sino-Forest Corp. before it imploded, and he not onlyshorted but blew the whistle on LongtopFinancial Technologies Ltd.

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Hempton believes investors can tell a lot abouta company by the quality of the people in itsgoverning positions. One of the things thatconcerned him about Valeant was theappointment of Norma Provencio, a health-carefinancial advisory consultant, to the company’sboard in 2007, where she became chair of itsaudit committee. Two years earlier, Provenciowas overseeing the audit committee of acompany called Signalife Inc. that was faultedfor not having sufficient internal financialcontrols. Meanwhile, Signalife’s chief counselhad cooked up a scheme to illegally pump upthe company’s stock; he was eventuallysentenced to 17 years in prison.

But Hempton really bore down on Valeant inJune, 2014, a few weeks after the companyannounced it was going to make a hostile bid forAllergan Inc., a pharmaceutical giant famous forproducing Botox. At the time, Hempton sawthat Valeant was trading at 10 times its sales,which he says is “pretty ridiculous,” pointingout that Pfizer trades at four times sales andGoogle six times. “The number of companiesthat have traded at 10 times sales with morethan $1 billion worth of sales that have workedout all right for shareholders? You could countthem on the fingers of your hands,” he remarks.

Hempton shorted Valeant’s stock when it was

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$130 a share and started writing a series of blogposts about the company as he embarked on adeep dive into its financial statements. Hisfindings backed up his hunch. Hempton wroteincreasingly lengthy and snarky posts,questioning Valeant’s accounting, its tendencyto overpay for assets and even its use ofGulfstream corporate jets (“the fastest, longestrange and most expensive corporate jet on themarket”). Yet the stock kept climbing through2014 and into 2015. “It was an exercise in somedifficulty,” says Hempton. After all, if the stockdidn’t fall, he was on the hook to lose millions.

Valeant’s rising stock was being driven by aherd mentality on both Bay and Wall streets.Jerome Hass at Lightwater, whose firm beganshorting the drug company’s stock in 2015, saysValeant became an investment bank darlingbecause it was a serial acquirer. “Bay Streetloves firms that need to raise capital,” he says.“And serial acquirers raise capital regularly. Soif you are an analyst on Bay Street, quitefrankly, you have a lot of pressure tobe positive.”

Jay Strosberg, a Windsor, Ontario-based lawyerinvolved in a shareholder class-action lawsuitagainst Valeant, says Bay Street didn’t lookcritically at Valeant because “it’s not in theirfinancial interest to do so. What I mean by that

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is the underwriters make millions and millionsof dollars underwriting the stock—and theanalysts are working for the same [brokerages].”

Then, in early 2015, Hempton caught a whiff ofsomething so scandalous that even the mostbullish analyst couldn’t ignore it. He beganhearing more about a mysterious, little-knowncompany called Philidor that was linked toValeant. “We had no idea what it did,” he says.“But we knew something was wrong.”

CHARLES WILLIAMS

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The digger: Roddy BoydRoddy Boyd, who runs a one-man not-for-profitjournalism outfit called the SouthernInvestigative Reporting Foundation (SIRF), firsttook an interest in Valeant in 2014. That’s whenWall Street short seller James Chanos, who runsKynikos Associates LP, announced he wasshorting its stock due to the pharmaceuticalcompany “playing aggressiveaccounting games.”

Working from his small office in Wilmington,North Carolina, Boyd, formerly a reporter whospecialized in uncovering corporate fraud forThe New York Sun, New York Post and Fortunemagazine, began examining Valeant’s financialstatements, calling analysts and anyone elsewho would talk to him. He soon stumbledacross an online chat board for drug reps calledcafepharma.com. One day in the summer of2015, he found some posts from repsmentioning a company called Philidor—thesame company Hempton was hearing about.

But when Boyd spoke to analysts and even somemanagers at Valeant, “no one had ever heard ofPhilidor.” Intrigued, Boyd began putting in 12-hour days trying to figure out what Philidor was,collecting documents and making freedom-of-information requests. He soon realized Philidor

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was enormously important to Valeant.

Boyd’s big break came when he heard about alawsuit launched by Russell Reitz, a pharmacistin sleepy Camarillo, California, a small city 80kilometres northwest of Los Angeles. Reitz hadfounded a pharmacy called R&O in 2012, sellingit two years later to a Delaware-registeredcompany called Isolani. By then, R&O hadlicences in 34 states to distribute drugs. “[Reitz]was very quiet, very methodical,” says Boyd.

Soon after he sold R&O, Reitz, who stayed on tomanage the pharmacy, became suspicious of thehuge volume of prescription drug sales goingthrough his store. He began seeing sales instates where R&O had no registration tooperate, for drugs his pharmacy had neverbefore supplied. In March, 2015, Reitz receivedan audit from one of his pharmacy benefitmanagers that turned up mysteriousprescriptions with Reitz’s name on them, beingdispensed to patients he had never heard of.

Reitz and his lawyer began researching Isolaniand found it was affiliated with Philidor, aspecialty pharmacy company based in Hatboro,Pennsylvania. Reitz also discovered thatPhilidor had been prevented from selling drugsin California. He began to worry R&O was beingused as a front to commit fraud, so he started

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stashing away reimbursement cheques frominsurance companies as they arrived at thepharmacy, rather than forwarding them to hiscompany’s new owners.

Events came to a head in September, 2015,when Reitz received a letter from Robert Chai-Onn, Valeant’s general counsel, claiming thatValeant was owed $69 million (U.S.) by R&O for“outstanding invoices.” In short, Valeantwanted the cheques Reitz had been puttingaside. Yet according to Reitz, R&O had neverreceived a single invoice or demand for paymentfrom Valeant prior to getting this letter. Reitzdecided to sue Valeant, claiming that either heand Valeant were victims of fraud, or “Valeant isconspiring with other persons or entities toperpetuate a massive fraud against R&O andothers.” (He eventually settled out of court, andValeant did not admit to any wrongdoing.)

Boyd now had evidence linking Valeant toPhilidor, and he reached out to Hempton afterreading his blogs that summer. They agreed topublish their findings about Philidor in October,2015. Little did they anticipate the storm thatdecision would trigger.

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The Philidor ManoeuvreAs Hempton learned more about Philidor andits ties to Valeant, he became convinced it was ascam designed to bilk the U.S. private healthinsurance system. More and more, it looked likePhilidor had been established because Pearson’sbusiness strategy ran smack into a wall.

For one thing, the CEO’s acquisition strategybegan to fail. “It’s flawed in that long term, itbecomes harder and harder to acquirecompanies,” says Khmelnitsky. “This model canwork for the very short term when you’re smallin size. As you buy bigger companies, whathappens is that you create this whole mergersand acquisitions wave in the industry—there arecopycats, and they start buying too.” With morecompetition, finding reasonably priced targetsgets tougher, and indeed, Pearson’s attempt tobuy Allergan in 2014 was rebuffed when thecompany found a buyer in another globalpharmaceutical company called Actavis.

In early 2015, Pearson instead bought SalixPharmaceuticals Ltd. for $15.8 billion (U.S.),including debt. But last year, Valeant tried tounload Salix for $10 billion (U.S.)—less thantwo-thirds of the value of the original deal—andfound no takers. As one company source says:“Pearson overpaid for Salix by something like

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six or seven billion dollars.”

Moreover, because the R&D budget had beenslashed, few promising new drugs were in thepipeline. For a while, Pearson drove sales byjacking up drug prices. For example, the retailprice of a tube of Targretin gel, a topicaltreatment for cutaneous T-cell lymphoma, roseto $30,320 (U.S.)—18 times what it was sellingfor in 2009. Last year, one U.S. Senator said shehad a list of 20 Valeant drugs whose prices hadrisen by more than 200% in just a few years.

But Valeant’s sky-high fees were starting to getblowback from customers. The creation ofPhilidor sidestepped this problem and became amethod for generating sales.

In the U.S., unless a doctor writes a prescriptionspecifying no substitutions, pharmacists areobliged by insurance companies to give patientsthe cheapest drugs on the market. This meantValeant’s expensive products were facing fallingdemand. Pearson’s strategy of buying pharmacompanies and increasing prices had a fatal flaw—those drugs would eventually face competitionfrom cheaper generics.

According to an indictment issued lastNovember by the Southern District of New YorkU.S. Attorney’s Office, Philidor was created inearly 2013 with help from Valeant. Two people

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were critical to its operation: Gary Tanner, aformer manager with a company Valeant hadacquired, and Andrew Davenport, who becamePhilidor’s CEO.

Tanner was an expert in the use of patientassistance programs (PAPs) and alternativefulfillment strategies. These plans are used bydrug companies as carrots to encourage patientsto buy their medicines directly from them. Afterpatients received a prescription from a doctor,they could take it to Philidor, which wouldenroll the patient in Valeant’s PAP, a subsidyprogram that covered most (if not all) of thecost of an expensive Valeant product. Philidorthen submitted a claim to the patient’sinsurance company directly on the patient’sbehalf. The idea was to make Valeant’s drugsmore accessible to patients by covering the costup front.

Valeant’s spending on patient assistanceprograms increased more than tenfold from2012 to 2015, from $53 million (U.S.) to $600million (U.S.), with expectations it would reachover $1 billion (U.S.) by last year.

Tanner oversaw this whole operation,apparently having an office on both Valeant’sand Philidor’s premises. He had access toValeant’s top executives, including Pearson. In

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fact, according to the indictment, in the fall of2014 Tanner e-mailed Pearson a 20-pagepresentation describing Philidor’sfuture prospects.

There was a bit of an art to getting insurancecompanies to remit the funds for Valeant’shigher-priced drugs. Sometimes the insurerwould just refuse to pay. “If the insurancecompany chose not to pay, Valeant just wore it,”says Hempton, meaning the company wrote offthe cost. But Hempton says the profitsgenerated when the insurance company did paymade up for when they did not.

Over time, insurance companies began to balkmore at paying for Valeant drugs. “So whathappens is Philidor decides it needs to diversifythe number of pharmacies it uses, so it startsbuying suburban pharmacies—especially thosewith mail-order licences,” says Hempton.Indeed, Hempton managed to compile a list of76 so-called phantom pharmacies.

Incredibly, if an insurance company wouldn’tpay Philidor for the expensive drugs, thepharmacy instructed its staff to try again usingthe identification number of a partnerpharmacy to secure payment, according toshareholders’ lawsuits. Philidor even had atraining manual for its employees that said: “We

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have a couple of different ‘back-door’approaches to receive payment from theinsurance company.” If the insurer asked adoctor to explain why the patient needed acostlier Valeant drug rather than a less-expensive alternative, Philidor employees wouldsometimes fill out the paperwork for the doctor.Workers were told to change codes onprescriptions in some cases so it would appearthat physicians required, or patients desired,Valeant’s brand-name drugs.

Philidor and its network of pharmacies allowedValeant to jack up drug prices. For example,according to a shareholder lawsuit, WellbutrinXL, an off-patent antidepressant Valeant soldthrough Philidor and its pharmacy network, sawits price increase from less than $6,000 (U.S.)to $17,000 (U.S.) for a year’s supply of the drug,compared to $360 (U.S.) for a year’s supply of ageneric equivalent. This allowed Valeant todouble the revenue generated by Wellbutrin XL.

In total, Philidor contributed roughly 10% ofValeant’s sales—and 50% of its organic growth.Valeant’s board and top executives appeared tobe well aware of Philidor’s operation, too: Theyvisited the company’s premises on at least twooccasions, according to the indictment.

Meanwhile, the indictment further alleges that

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Tanner and Davenport got rich by skimmingprofits from Philidor. Davenport received $40million (U.S.) ($50,000 of which he is accusedof spending on a wine cellar), and funnelled $10million (U.S.) to Tanner. Tanner was fired byValeant in the summer of 2015 and went towork directly for Philidor, before it was shutdown in January of last year. Both men wereindicted last fall for a host of charges, includingmoney laundering conspiracy and honestservices wire fraud. None of these allegationshave been proven in court.

‘Valeant has become toxic’By the time Boyd and Hempton published theresults of their investigations into Philidor inOctober, 2015, Valeant was already in hot water,attracting attention from Senate andcongressional committees over its high drugprices. Los Angeles–based short seller AndrewLeft had been issuing critical reports on thecompany, soon dubbing it a “PharmaceuticalEnron.” The stock was already falling, havingpeaked that summer.

But the Philidor revelation changed everything,attracting a whole new level of scrutiny from

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regulators and the mainstream business press,with one New York Times columnist labellingValeant “a sleazy company.” The Times, TheWall Street Journal, Bloomberg, Vanity Fairand other media outlets began unearthing a raftof damaging news.

Behind the scenes at Valeant, internal e-mailsreveal how the crisis was affecting the company.Bill Ackman, the controversial Wall Streethedge fund manager and CEO of PershingSquare Capital Management, which had sunkmore than $3.3 billion (U.S.) into Valeant’sstock, was among those panicking. Ackmanbegan sending Pearson a steady stream of notesreprimanding and cajoling him. “I don’t thinkyou are handling this [crisis] correctly and thecompany is at risk of getting into a death spiralas a result,” he wrote. In an other e-mail toPearson, Ackman wrote: “Valeant has becometoxic” and, “You have previously made themistake of waiting while Rome was burning.There is now a conflagration.”

Soon Pearson’s health began to deteriorate: OnChristmas Eve of 2015, he checked into ahospital suffering from a severe case ofpneumonia. By the time he emerged, he waswalking with a cane. Pearson would stay awayfor a total of two months.

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And then, just as he announced he wasreturning to his post, Valeant said it wouldn’t beable to file the previous year’s financial reportdue to accounting problems with Philidor.Valeant also disclosed that it was beinginvestigated by the SEC, and its inability to filecould cause it to breach the terms governingsome of its $31 billion (U.S.) in debt. The stockclosed down more than 50%. For DimitryKhmelnitsky, this was a moment of vindication.“Pearson finally admitted that his businessstrategy was completely unsustainable.”

The company cleaned house, ushering outPearson. Layers of management and directorsstreamed out the door. As the stock sankthrough 2016, most of the Wall Streetinvestment firms that had invested heavily inValeant found themselves knee deep in red ink.Pershing Square alone is estimated to have lostat least $3 billion (U.S.)—making the drugcompany Ackman’s worst ever investment.Despite insisting for months that Valeant had agood chance of turning itself around, in mid-March Ackman announced he would cash outhis remaining stock and step down from theboard, suggesting that even he had givenup hope.

With Pearson now gone, Valeant hired JosephPapa as its new CEO. Papa has 35-plus years

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working in the pharmaceutical sector, withprevious stops at companies such as Watsonand Novartis. Yet Papa had left his former firm,a pharmaceutical company called Perrigo Co.plc, in poor shape. He now faces a Herculeantask, wrestling with Valeant’s massive debt load,as well as potential fines and lawsuits, ongoinginvestigations and a bevy ofunderperforming assets.

Papa’s prime focus is on reducing debt. Thispast January, the company sold $2.1 billion(U.S.) in assets via two big deals. It may try tosell $8 billion (U.S.) more. In late February,Valeant announced its 2016 results, and thenews was not good: Each of the company’s threeunits saw flat or declining sales. It’s nowpredicted that generic competitors will pummelrevenue and profits this year and into 2018. “Itstill doesn’t appear that management has arealistic outlook on its organic growth,” IrinaKoffler, of Mizuho Securities, told her clientswhile cutting her price target on the shares to$9 (U.S.).

The larger problem, says Khmelnitsky, is thatValeant’s business model is now broken. “Youcan no longer do acquisitions—and theirbusiness model revolved around makingacquisitions, firing people, cutting R&D andmoving intangibles offshore,” he says. “So that

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leaves them essentially going back to the modelthey’d said was stupid—where they have togrow internally.”

Meantime, the victims of the company’scollapse continue to multiply. Canadianinvestors lost tens of billions of dollars. By lastsummer, T. Rowe Price Funds, a Baltimore-based mutual fund giant (which at one pointheld a 6.4% stake in Valeant), along withinstitutional investors Alleghany Corp., TIAA-CREF and CalPERS, filed lawsuits againstValeant, accusing the company of securitiesfraud for failing to disclose the use of Philidor.

And then there are the small investors, likeBrian Firestone, an unemployed accountant inhis 50s who lives in Atlanta. Firestone investedthe bulk of his savings in Valeant’s stock inOctober, 2015, when it was at $109 (U.S.). (“Iam not a diversified investor,” he explains.)Since then, Firestone saw the value of hisholdings fall by more than 70%, wiping out hisbrokerage account and causing him no end ofrestless nights. “I wish I never got involved inthe pharmaceutical industry,” he says.

Firestone still has a lot of money tied up inoptions on Valeant, hoping the company will berevived. In the meantime, he’s had to downsizehis lifestyle dramatically. “The mortgage of my

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house is getting paid for by the government, Ieat less and don’t go out,” he says. “I have lostsome weight. If things don’t turn around, I amtruly cooked.”

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