Apr 13, 2016 @ 08:30
Pharmaceuticals' Prescription For Disaster
This story appears in the May 10, 2016 issue of
By Nathan Vardi and Antoine Gara
When you are speeding toward billionaire status,
nothing says “I’ve arrived” more loudly than a big donation to one’s
alma mater. In June 2014
Duke University announced that
J. Michael Pearson, the CEO of
Valeant Pharmaceuticals, one of the fastest-growing companies in
America, and his wife, Christine, would be making a $30 million gift
to its engineering school, on top of $23 million in earlier gifts that
had resulted in renaming Duke’s nursing school building after her.
“We’re grateful the Pearsons share our vision,” Laurie
Patton, former dean of Duke’s
Trinity College of Arts &
Sciences, said in a release that recognized the husband and wife as
some of the school’s most prominent alums, as well as the
fourth-largest contributors to its capital campaign.
J. Michael Pearson, CEO of Valeant
Pharmaceuticals. Benjamin Lowy/Contour by Getty Image
Less than two years later it’s hard to view this
announcement as anything more than a mirage. The Pearsons, it turns
out, weren’t actually a couple–New Jersey court records show that
Christine had sued her husband for divorce in 2013. In fact, a Florida
magazine had featured him and another woman several years before as “a
couple” who were in the midst of decorating their three-bedroom
apartment–which documents show they purchased together–in a luxury
high-rise in Miami Beach.
They also didn’t actually have the cash available to
make the donation.
On paper, Michael Pearson, now 56, was a billionaire,
but his wealth was locked up in Valeant stock, earned by meeting
seemingly impossible shareholder-return goals. He was barred from
selling his shares for years and even prohibited from borrowing
Valeant’s board waived its policy in order to allow
Pearson to borrow $100 million from Goldman Sachs against his stock to
fund the Duke contributions, build a community swimming pool and
finance his own tax obligations. But even this well-intended gesture
turned south–by this past November, the aggressive moves that Pearson
had used to juice Valeant’s stock were backfiring, its price was
tumbling and Goldman had issued a margin call, resulting in the
liquidation of 1.3 million of the CEO’s shares, a forced sale which
spooked the market and sent the stock plummeting even more.
All told, Valeant’s market cap has fallen 87% since
August–some $80 billion in shareholder value has vanished. The company
has come under intense congressional scrutiny for its drug-pricing
policies, lumping it in with the firestorm surrounding the new poster
boy for corporate greed, Martin Shkreli. Next were revelations about
an undisclosed mail-order pharmacy called Philidor Rx that Valeant
essentially controlled, which was accused of using controversial
methods to get patients, doctors and insurers to use expensive Valeant
drugs instead of cheaper alternatives.
In March Valeant slashed its earnings and revenue
projections and said its continuing inability to file its annual
financial report could lead it to default on its $30 billion of debt
because of covenants it has with its lenders. The company also
announced that Pearson would leave Valeant as soon as a replacement
CEO is chosen. (Pearson did not respond to numerous interview requests
It would be easy to blame Valeant’s Icarus-like plummet
on a CEO whose life is seemingly falling apart. Or on an unsustainable
business model that was destined to catch up with itself. Or on the
kind of financial-statement gymnastics–and an accompanying
announcement from the company that blamed these ills on the “tone at
the top of the organization”–that bear too much resemblance to those
of Enron, Tyco and WorldCom for comfort.
And there’s some truth to all of those things. But the
ultimate culprit here is something for which until recently Valeant
was lauded far and wide as a role model for other corporations: its
executive compensation plan.
Valeant’s plan was praised for years by everyone from
activist hedge fund billionaire Bill Ackman to top executive-pay
experts at the University of Chicago and Harvard Law School for its
unique incentive model. Pearson and other top executives would receive
relatively little in the way of cash compensation but massive amounts
of incentive stock and options. And that stock would be tied up for
extremely long periods (an extended vesting period–then for Pearson
another three years). In short, Pearson and his team would be paid
handsomely if they could create long-term value, in lockstep with
their shareholders. There would be no easy cash-out.
On paper it worked brilliantly, and Pearson went on a
tear that created tens of billions in value and continued for several
years. Ackman, who invested $4 billion in the company, compared him to
Warren Buffett. But the plan also put an inordinate amount of pressure
on Pearson to sustain the growth, and the stock price, by whatever
means he could. Valeant was built to become a pressure cooker. And
eventually the lid exploded, taking the chef out with it.
For most of his career Michael Pearson was a
consultant, and a very successful one at that. During his 23 years at
McKinsey & Co., he became one of the firm’s most talented and
hardworking partners, running its pharma practice as consigliere to
CEOs like Johnson & Johnson’s William Weldon and Schering-Plough’s
Then he began to advise a moneylosing California drug
company that had been around since 1960 and focused on neurology drugs
and generics. When Valeant sought a new CEO in 2008, San Francisco’s
ValueAct Capital, a hedge fund run by Jeffrey Ubben and Mason Morfit,
recruited Pearson and designed his compensation plan. Pearson
simultaneously brought outsider and insider credibility.
“We think he is ideally suited to run a business that
is at heart a value investor in pharmaceutical products,” wrote Robert
Goldfarb and David Poppe early in Pearson’s tenure, explaining to
investors why their Sequoia mutual fund was on its way to making
Valeant its biggest position, replacing Berkshire Hathaway.
He brought a mission: to prove that the “buy and cut”
growth strategy he had long been preaching from McKinsey’s ivory tower
was more than expensive hot air. In the first year of Pearson’s watch,
Valeant, which then had revenues of about $800 million, made three
acquisitions, including buying acne remedy specialist Dow
Pharmaceutical Sciences for $285 million. And then he increased the
pace: By last year he had swallowed more than 50 companies.
This debt-fueled acquisition strategy created rich fees
for investment banks and sold investors on a low-cost pharmaceutical
company model that emphasized boosting drug prices, gutting research
and development budgets, firing employees and lowering taxes through a
merger that moved Valeant’s tax address to Canada.
Instead of creating new drugs, Pearson bought and
squeezed profits out of old remedies like Wellbutrin XL, an
antidepressant; Isuprel, an off-patent heart drug; and Provenge, a
prostate medicine whose maker had filed for bankruptcy. Pearson’s
drug-price increases became legendary, and there were no U.S. laws on
the books to stop him.
For example, Valeant boosted the price of its diabetes
drug Glumetza by about 800% in 2015, the year Valeant bought it. The
company acquired Carac cream in 2011, and the price for the treatment
of cancerous skin conditions rose by 1,700% in six years, mostly on
Valeant’s watch. Pearson defended his prices, claiming that just about
anyone who needed Valeant’s drugs would receive them because patients
were protected by insurance and financial assistance programs.
Pearson acquired some of the drugs and products in big
deals for companies like Medicis (antiwrinkle medicines), Bausch &
Lomb (contact lenses) and Salix (gastrointestinal treatment). Along
the way more than 4,000 pharma employees in the U.S. alone fell victim
to Pearson’s axe–as much as half of the workforces of companies he
acquired. The result was a company, Valeant, headquartered in Canada
and employing 18,000 but with executives in New Jersey, that spent 3%
of its revenues on drug research and development while selling
products in areas ranging from dermatology and eye care to
gastrointestinal neurology and over-the-counter remedies.
Wall Street analysts, whose investment banking
colleagues thirsted for Valeant’s fees, issued bullish reports, and
big hedge funds rushed into the stock. Valeant’s shares soared by
2,450% in seven years, affording it a market cap of nearly $90 billion
by 2015. Investment banks like Goldman Sachs and Deutsche Bank made
$750 million in fees. ValueAct realized $1.15 billion in gains–and
still retained a 4.4% stake in the company. Everybody got rich–at
least on paper–board members, executives and, most of all, Pearson.
Pearson’s original employment agreement with Valeant,
struck in February 2008, put him on track to become one of the richest
executives in the pharmaceutical industry within three years, based on
large amounts of stock and option awards. But the lockups were long,
and the awards came with both hurdles (he needed to deliver a minimum
15% return annually) and incentives (his allotment tripled if the
company produced a 45% annual return). In 2011 he renewed his
employment contract–extending both the lockup (2017) and the bonus
potential (maximum-return hurdles at 60%). His most recent deal,
struck when Valeant’s stock changed hands for $141, included up to
2.25 million in performance share grants if Valeant’s stock hit $1,068
Yes, Pearson was incentivized. Perhaps fatally so.
“They would cloak it in shareholder equity, as if there’s a bunch of
widows and orphans [invested]–but it was just all about money,” says a
former Valeant executive. “That was all that mattered.”
An early warning sign for Valeant came late on Sept.
30, 2009, as Pearson returned from his Madison, N.J. office to his New
Vernon estate. Without signaling, Pearson made a fast right in his
gray BMW and was almost immediately apprehended by Madison police.
When Pearson lowered his window, the patrolman noticed a waft of
alcohol coming from the vehicle.
Police records show that Pearson slurred his speech and
was unable to touch the tips of his fingers together or recite the
alphabet from the letter “D” to the letter “W.” After the officer had
Pearson spit out his chewing tobacco, his breath test indicated that
the chief executive had a blood alcohol level of 0.13%. Pearson
ultimately pleaded guilty to driving under the influence and lost his
driver’s license for three months.
DUIs are commonplace, even in executive suites, but
Pearson’s 2009 drunken driving arrest fed concerns about Pearson’s
behavior that were spread by both short-sellers targeting Valeant’s
once lofty stock and employees in the corridors of the company’s
Like many top executives, Pearson was a workaholic. He
overate, and he traveled all the time. Even though Valeant was
decentralized, with operating units run by their business leaders,
Pearson micromanaged things he deemed important. His dedication to
drive Valeant and its stock forward was fierce.
Pearson led grueling weekly calls with dozens of
Valeant’s top business managers and made it clear they had to deliver
their numbers on a weekly basis–or else. Though Valeant was ostensibly
a science company, scientists were seen as unnecessary costs to be
cut, unless the product they were working on looked almost certain to
succeed. And as Pearson made acquisitions, those cuts came quickly:
The company once handed out envelopes to Valeant’s new employees–if
you got a black envelope, it meant you were fired, the Wall Street
Management turnover was high–more than half of
Valeant’s top 15 executives have left the company since 2011–and those
who stayed took their lead from the CEO. The culture was
hard-charging, everyone kept late hours, and the distinctions between
work and play became blurred. One former executive says Pearson was a
heavy drinker who favored double bourbons and that he sometimes saw
Pearson gulp down six to eight drinks before business dinners. Another
former executive saw Pearson get inebriated at an important function
during the negotiation of a major business acquisition.
Others who worked with Pearson told FORBES that his
alcohol consumption never impeded his working ability. But at least
one sizeable investor in Valeant’s stock was worried enough to raise
an alarm to a board member, who shared the information with another
board member. (Valeant’s response: “The company is not going to
discuss or comment on topics related to Mr. Pearson’s personal life or
family. Valeant announced on March 21 that it has initiated a search
for a new CEO and that Mike Pearson will be leaving the company upon
the appointment of his successor.”)
Senior management, for its part, was filled with
Pearson diehards. He liked to hire cronies like his former McKinsey
partner Robert Rosiello, who is now Valeant’s chief financial officer.
Pearson hired his brother-in-law, who was paid $299,000 a year as
director of corporate procurement/real estate. Ryan Weldon, head of
Valeant’s U.S. dermatology operation, had been a summer associate at
McKinsey and was the son of former J&J CEO Bill Weldon.
“Mike wanted to win at all costs and surrounded himself
with people who would basically do whatever he told them to do,” said
a former Valeant executive, who says he left because he was
uncomfortable with positions that Pearson asked him to take.
As for the board, which, like management, was paid
generously in restricted shares, there was no incentive to question
the Pearson money machine. Indeed, by the beginning of 2015, eight of
Valeant’s independent directors held $108 million of equity between
them. Their stock, like the CEO’s, was also extremely restricted,
incentivizing them to keep Pearson’s streak going a bit longer.
Ultimately, that proved impossible. “Their business
model was: Borrow money, buy companies and boost prices,” says Erik
Gordon, who studies the pharmaceutical industry at the University of
Michigan’s Ross School of Business. “That’s a lousy business model,
and it’s a business model which you know obviously comes to an abrupt
Valeant’s golden run began to unravel starting last
September after it came under attack for its drug-pricing policies and
the tactics of its captive pharmacy, Philidor Rx. Philidor denied the
accusations, but that didn’t stop a congressional subpoena and
increased scrutiny that placed into question Valeant’s accounting and
Pearson wrote a letter to his employees, saying it was
nonsense to suggest that Valeant’s business model was dependent on
drug-price increases or that there should be concerns around Valeant’s
exposure to U.S. government drug-price reimbursement. It assured
investors that Valeant’s sales to Philidor were recorded only when the
product was dispensed to patients and then terminated its relationship
with the pharmacy, which had been linked to 7% of its sales.
ValueAct’s Morfit rejoined the company’s board, which also hired a
former U.S. deputy attorney general to help on issues related to
Philidor. To help replace Philidor, Pearson struck a deal with
Walgreens to distribute Valeant products.
Then in December, Valeant announced that Pearson had
been hospitalized after contracting a severe case of pneumonia and
would be going on medical leave. The news further rattled investors.
Press reports at the time indicated Pearson had been working around
the clock to get the Walgreens deal done.
After about two months of convalescing, Pearson finally
returned to the helm of Valeant at the end of February. Pearson told
employees he was learning to walk again and that he had lost 30
pounds, Bloomberg reported. Within a month, he was on his way out.
Valeant has been trying to make former chief financial
officer Howard Schiller the fall guy for the company’s current
accounting woes. In March, when Valeant admitted that $58 million in
revenue should not have been recognized in 2014 when its drugs were
delivered to Philidor’s mail-order pharmacy, its statement used the
phrase “tone at the top,” implying that the “improper conduct” was
driven by Schiller.
The former CFO is accused of providing false
information to the company’s auditor, PwC, in an effort to get it to
sign off on Valeant’s 2015 10-K, critical to avoiding debt covenant
default. Schiller, who refuses to leave the board despite being asked
to, denies any wrongdoing.
Not a single person FORBES spoke with who was familiar
with Valeant believes that Schiller was the company mastermind. It was
always the Michael Pearson show at the Madison executive offices,
which was converted from a YMCA building and still has a basketball
court, emblazoned with Duke’s Blue Devil insignia.
Class action lawsuits have been filed, the SEC is
investigating and the Senate Special Committee on Aging threatened to
begin contempt proceedings against Pearson. Bill Ackman, who
infamously compared Pearson to Buffett, was forced to join Valeant’s
board in an effort to shore up billions of dollars that his Pershing
Square has so far lost on its investment. Valeant is under attack by
politicians for its drug-price gouging, and it recently said that it
would need to restate previous financial results.
Effectively fired from the company he built but still
technically its chief executive, Pearson has yet to fulfill his most
important obligation, signing Valeant’s long overdue 10-K annual
report. Valeant has some valuable assets, like Bausch & Lomb, but it’s
also saddled with some $30 billion in debt associated with Pearson’s
acquisition strategy. Without new deals or the ability to raise
prices, it’s unclear where Valeant’s growth will come from.
Additional reporting By Matthew Herper.