Our new leadership elected to sell our position in Valeant Pharmaceuticals, exiting completely by mid-June. Valeant was our largest position to start the year and its 80% decline through June 30 badly penalized our results. – Sequoia Fund Shareholder Letter
Sequoia Fund management’s decision to finally exit their stake in Valeant Pharmaceuticals ends a painful almost year long slide in their biggest position and what was at one time their best performing holding.
Sequoia was an early investor in the Mike Pearson era Valeant. A strong believer in what they saw as a savvy manager who took a value approach to buying healthcare assets and wringing efficiency from them. Sequoia started purchasing Valeant in early 2010, probably at prices in the mid teens, and by the end of the year the position accounted for 10% of the funds assets. At year end they already had a gain of 78%. A fantastic return on investment in less than one year and a big boost to the fund’s performance.
The fund managers continued to build a position over the next five years and were enjoying the outperformance the stock added to the fund’s returns. By 2015 the position reached 20% of the fund’s assets and Sequoia also became Valeant’s single largest shareholder.
Then in August of 2015 the position began to lose money. You can’t fault the fund managers for sitting on the position while the stock declined in August along with the rest of the global markets.
The decline may not have been attributable to the increased scrutiny that the pharma companies were beginning to come under from the practice of acquiring drugs and then immediately raising the prices, sometimes in excess of 500%. It may have just been caught up in the sell-off sparked by a slowdown in the Chinese economy. However, also around that time leading Democratic Presidential Candidate Hillary Clinton made a comment on Twitter saying, “Price gouging like this in the specialty drug market is outrageous. Tomorrow I’ll lay out a plan to take it on. -H” The stock fell 6% that day in reaction to the political risk that pharma companies would now be under.
After the precipitous fall of 30% during the late summer of 2015 the stock still had a big legion of supporters and the downdraft was viewed as temporary. Then in November of 2015 the stock came under fire again, only this time the concerns were around the accounting for acquisitions and its relationship with specialty pharmacy Philidor RX, which it also happened to own after the company purchased an option at $100 million to buy the company for $0. According to Andrew Left of Citron Research, Valeant was using Philidor and other specialty pharmacies as vehicles for fraudulent transactions to inflate its financial results and while the company denied any improper sales through the specialty pharmacy channel, investors bailed at the revelation.
Once the stock had gone from $160 to $108 on questions surrounding its accounting methods, Sequoia Fund managers owed their shareholders a fiduciary duty to re-examine their thesis and apply some risk management to the position.
It’s their lack of risk management that is inexcusable. They are the stewards of other people’s money and the first rule of managing money is, don’t lose. At this point the fund probably still had gains on the position since they had gotten in so early. Yet the managers had no stop loss in place, as of now the shareholders have probably realized a loss rather than a gain that if they had sold in the low $100 range would still have been sizable.
The lesson to be learned here is that no matter what, when making an investment you must have a stop loss. There aren’t many stocks that implode the way Valeant has, but every stock can get caught up in a market sell-off, and having a stop loss allows you to avoid a permanent loss of capital that will keep you from investing again in the future.
There are still other “smart” fund managers that continue to hold Valeant even though their position has lost 80% of its value. One of these investors has even decided that he is the company’s savior and is now taking a seat on the board in order to turnaround the company and restore its former place as a leader in the pharmaceutical industry. – Good Luck – You don’t have to make your money back in the stock you lost it in.
Andrew Left commented on the news that Sequoia had disposed of its Valeant stake:
“I think its obvious its a zero now,” Left said, emphasizing that the announcement of Sequoia Fund’s decision to sell its remaining stake in the drugmaker tells everything. Sequoia was Valeant’s second-largest shareholder, with about 20% of its stock, but announced in a letter to shareholders Tuesday that it is exiting all of its Valeant positions.
“They’ve sat down and they’ve seen and they’ve interviewed and they walked,” Left said, noting that Sequoia has much more of an insider take into the company than the public. “The fact there they’re selling tells everything.”
Meanwhile, it was also revealed Wednesday that Valeant’s former CEO, Michael Pearson, has dropped roughly 5 million shares of Valeant, the value of which is down more than 90% since last summer’s highs.
It’s already a sinking ship,” Left added. “With the Titanic going down you can at least get on a life boat and get out with what you can.”