In 2006, a little known hedge fund out of San Francisco made a big bet on a small California drug company that had been founded by the former Prime Minister of Yugoslavia. Jeff Ubben’s ValueAct Capital hedge fund managed $3.5 billion in 2006 and had more than $200 million of it riding on Valeant Pharmaceuticals.
Ubben’s partner, Mason Morfit, joined Valeants’ board, recruited its CEO, Michael Pearson, in 2008 and helped set the company on a strategic path that would prove both extremely profitable and controversial.
ValueAct’s investment in Valeant is one of the great hedge fund trades. It is also one of the longest, approaching its ten-year anniversary. Over nearly a decade ValueAct has bought and sold Valeant stock several times and had four of the hedge fund’s partners on Valeant’s board at one time or another.
In total, ValueAct’s $650 million investment in Valeant is now worth $4.3 billion, Securities & Exchange Commission filings show. Making the $3.6 billion in profits even more impressive is the fact that ValueAct has cashed-in a portion of them, collecting $1.8 billion through Valeant stock sales and special dividends. In Wall Street speak, the internal rate of return on ValueAct’s investment in Valeant is more than 40%, a person familiar with the investment says.
ValueAct’s Valeant trade has produced the hedge fund’s biggest profits and fueled its returns for years. Today ValueAct manages $19 billion and has seats on the boards of companies like Microsoft, MSCI, and soon, 21St Century Fox.
Valeant Pharmaceuticals is the company that people love to hate. Federal prosecutors are the most recent players to scrutinize the company’s practices—Valeant disclosed on Wednesday that government lawyers in Manhattan and Boston sent it subpoenas seeking documents related to the way the company prices drugs. Democratic lawmakers in September said they wanted to force Valeant to reveal documents related to the company’s “massive price increases” of two heart drugs.
The U.S. Senate earlier this year singled out Valeant’s tax strategies in a report put out by a Republican that highlighted the impact of tax-driven foreign deals on U.S. corporations and jobs. Valeant’s executives are based in New Jersey, but a merger with a Canadian company in 2010 was designed to leave it with a Canadian tax address. Short sellers over the years have argued that Valeant plays aggressive accounting games by buying companies and writing down assets. Other critics have slammed Valeant tactics ranging from its slashing of drug research to its partnership with a hedge fund to stage a hostile takeover of another drug company.
But Valeant, which has argued that the criticisms against it are unfounded, has also been a giant money-making machine for its billionaire CEO, hedge fund investors, executives and directors. It has been a financial success of massive proportions, expanding the fortunes and businesses of the key players who bet on it early and big. Some of those fortunes have diminished a bit in recent weeks as Valeant’s detractors have managed to dent its stock, but the men who made a fortune off the company are still sitting on enormous profits. The stock is still up 18% in 2015 and has returned 585% in the last five years.
Valeant’s CEO, Mike Pearson, is arguably the biggest Valeant winner. Born in London, Ontario, Pearson is the son of a phone installer and spent 23 years working as a consultant at McKinsey, rising to become head of its global pharmaceutical practice in New York. But Pearson quit the security of McKinsey to become CEO of a relatively small and struggling Valeant in 2008. It was a risky move that carried the potential of rich rewards because of an unusual compensation scheme that was put together by ValueAct’s Mason Morfit. Pearson has essentially been paid with large amounts of stock and option awards that he can’t cash-in for years.
In the past, the awards would only be made if the stock produced a minimum 15% return annually and tripled if the company produced amazing 45% annual returns. This arrangement, which these days includes a 10% hurdle, coupled with Valeant’s eye-popping stock run, has made Pearson a billionaire.
But Pearson is not the only Valeant executive who has benefited from Valeant’s compensation practices and stock performance. Howard Schiller spent 24 years at Goldman Sachs, becoming a partner and chief operating officer of its key investment banking division. He ditched Goldman Sachs to become Valeant’s chief financial officer in 2011. Schiller resigned as Valeant’s CFO in the summer of 2015. In four years with the company, Schiller accumulated Valeant stock and securities worth about $65 million. Schiller remains on Valeant’s board of directors.
Robert Goldfarb joined the New York firm now known as Ruane, Cunniff & Goldfarb in 1971. For nearly 20 years, its flagship Sequoia mutual fund counted Berkshire Hathaway as its top holding, reflecting the tight relationship the investment firm’s founders had with Warren Buffett. But in 2010 Goldfarb’s team heard from another fund manager about an extraordinary corporate executive named Mike Pearson. Goldfarb co-manages the Sequoia Fund and he bet big and fast on Valeant starting in 2010 and let the investment ride. Valeant replaced Berkshire Hathaway as Sequoia’s top holding by early 2011. SEC filings show Ruane, Cunniff owned 34 million Valeant shares by September 2010 valued at $850 million. “If we were going to own a pharmaceutical company, especially in size, it would most likely be an unconventional company,” Goldfarb said at his annual investor day in 2011. “Valeant certainly fits that bill.” Valeant remains Sequoia’s top holding today and Ruane Cunniff is Valeant’s biggest shareholder, owning more than 10% of its shares. The investment firm owns 33.9 million shares worth about $5.7 billion. The investment firm has made nearly $5 billion, mostly in paper gains, on its five-year investment in Valeant.
Executives and fund managers are not the only players who have made fortunes off of Valeant. Corporate directors have, too. Operating out of the Boston area, Theodose Melas-Kyriazi is an under the radar guy who used to be the chief financial officer and vice president of corporate strategy for Thermo Electron Corp., where he worked for more than a decade. In recent years he has become a board member and investor in early stage biotech companies like Moderna Therapeutics. But a long time ago, in 2003, he became a board member at Valeant Pharmaceuticals’ predecessor company, known as ICN, and has stuck around on Valeant’s board ever since. Over all those years, Melas-Kyriazi has been paid Valeant securities that were recently worth $36 million. He currently sits on the board’s audit and risk committee, and finance and transactions committee.
Not all the winners of the Valeant juggernaut have been around as long as Melas-Kyriazi. By his own admission, hedge fund billionaire Bill Ackman was late to the party. But his audacious partnership with Valeant to buy Allergan last year fueled Ackman’s career year in the hedge fund business. In a move that Botox-maker Allergan said amounted to insider trading since Ackman knew a takeover offer was coming from Valeant, Ackman’s Pershing Square hedge fund bought a nearly 10% stake in Allergan as part of a partnership with Valeant to try to buy the company last year. Ackman said he was operating fair and square, and the move unleashed an expensive hostile takeover battle that put Allergan in play and caused its stock to soar. In the end, Allergan avoided being swallowed up by Valeant, accepting a $66 billion deal from Actavis. Ackman may have lost the Allergan battle but Pershing Square made some $2.7 billion in profits from the deal, and quickly dumped the stock.
After three ho-hum years, Ackman’s main hedge fund returned 37% net of fees in 2014, trouncing most other hedge funds and the U.S. stock market. The Valeant-Allergan trade made up 19.1% of Pershing Square’s gross returns in 2014 and Ackman personally earned an estimated $1.1 billion from his hedge fund activities last year. Ackman hopped right back on the Valeant train, disclosing a new $3.3 billion bet on the company in March. In 2015, the Valeant trade has not worked for Ackman. The sell-off of Valeant’s stock in the summer helped push down Pershing Square’s main hedge fund by 8.5% for the year as of early October.
Still, the money manager who got to Valeant first was Taymour Tamaddon. He had just finished up an internship at T. Rowe Price and was working as a healthcare analyst in 2005 when he became the first T. Rowe Price analyst to pick up coverage of Valeant. Tamaddon recommended the stock because he thought Valeant’s underlying business was worth more than the stock was trading for and that one of the two key drugs in its pipeline, an epilepsy drug, would be a winner. In early 2005, Brian Berghuis’ big T. Rowe Price Mid-Cap Growth Fund started buying up shares of Valeant in size as did the firm’s Health Sciences Fund. The moves made T. Rowe Price Valeant’s third-biggest shareholder. Tammadon was wrong about the epilepsy drug, which turned out to be a commercial bomb, but he kept believing the underlying value business was not reflected in the stock price. He also eventually started believing in Mike Pearson. When the financial crisis was raging in 2008, T. Rowe Price was Valeant’s biggest shareholder and Valeant was the second-biggest contributor to T. Rowe Price Mid-Cap Growth’s net asset value growth, providing a bit of a cushion to the market crash. Valeant was the fund’s biggest net asset value driver in 2011, even though Valeant wasn’t one of the fund’s top 25 holdings.
Berghuis kept his $25 billion mutual fund’s Valeant position until 2013, but other T. Rowe Price mutual funds added to their holdings and benefited from the rise of Valeant’s stock. Tamaddon became the manager of the $20 billion T. Rowe Price Health Sciences Fund in 2013 and Valeant was the fund’s fifth-biggest holding and top profit engine that year.
It isn’t easy being long Valeant. T. Rowe Price’s money managers have gotten flack about their big Valeant position from short sellers, management teams at other pharmaceutical companies, and healthcare wonks, but T. Rowe Price is still Valeant’s third-biggest shareholder. Tamaddon still covers the stock for T. Rowe Price and his fund remains a big shareholder. The people who have benefited the most from Valeant tend to stick by it.
Written by Nathan Vardi of Forbes