Despite all that has been written about Valeant Pharmaceuticals in the past few weeks – and there has been quite a lot – there's something particularly jarring: the repeated references to "the Canadian company."
On its face, the description fits. Valeant is incorporated in British Columbia. It has designated Laval, Que., as its principal executive offices, and importantly, has its primary stock listing on the TSX.
There are differences, though, between Valeant and two previous Canadian stock-market champions, Nortel Networks and Research In Motion, that flew, then crashed, like Icarus. You can say what you will about some of their financial practices – Nortel executives were ultimately charged with fraud (and subsequently exonerated), and RIM got caught up in the stock-option backdating scandal of a decade ago. But Nortel and RIM represented, at their peaks, the idea that Canadians could be world leaders in technology.
Valeant has represented something less – a lot less. The company has been proud of its business model that eschewed research and development, preferring instead to write big cheques with borrowed money for other companies' best drug ideas. Its chief innovation is amped-up financial engineering.
Which is why, perhaps, the other key difference with Valeant is not such a bad thing: Outside of the addresses on the corporate papers, Valeant is far more a U.S. company than a Canadian one. Its executives work from Bridgewater, N.J., not Laval. It has about 1,100 Canadian employees, but more than 15,000 elsewhere. In 2014, it got 54 per cent of its sales from the United States, with just 5 per cent coming from Canada. It traces its TSX listing back to its acquisition of the old Biovail in 2010.
The problem, however, is that it's the average Canadian who's now losing, as the collapse in Valeant's shares is eroding this country's portfolios.
You may I ask why I didn't complain about Canadian exposure to the stock when the situation was reversed, during Valeant's meteoric rise. (Its market capitalization roughly tripled from 2014 to early August, when it briefly exceeded Royal Bank of Canada as this country's most valuable company.) And the answer, as I've detailed before, is that I have continued to argue investors should stay away from Valeant for two reasons: an emphasis on earnings metrics that don't follow generally accepted accounting principles; and a business model that avoided research and development in favour of ever-larger acquisitions.
Those arguments looked silly as Valeant shares soared, and Canadian investors benefited. The company grew to become such a large component of the S&P/TSX composite index that, by one Canadian money manager's calculation, Valeant's gain of nearly 80 per cent from Jan. 1 to May 29 contributed 85 per cent of the index's gain.
Whether a mutual fund manager is explicitly tracking the S&P/TSX composite or TSX 60, or merely using them as a benchmark to measure their active management, that kind of performance by Valeant meant that the fund needed to own the company's shares.
According to Morningstar, there were 73 Canadian mutual funds that had at least 4 per cent of their assets in Valeant shares as of their most recent reports to shareholders. They owned a total of $2.15-billion of Valeant stock, or 3.2 per cent of the company. (The numbers are imperfect, because the reporting dates range from June 30, when Valeant was still on the rise, to Sept. 30, when it was in decline.)
It will take some months before we can figure out which funds got out, when – although, any manager that's supposed to be tracking the TSX indexes should still be holding the stock, as long as Standard & Poor's keeps it there. And, as long as Valeant meets the financial requirements, it should, because there's little precedent for taking a good, hard look at a company and deciding it's simply not Canadian enough.
Standard & Poor's says that for index purposes, a Canadian company needs "a substantial presence" in Canada, but that can simply mean the location of its head office. S&P's David Blitzer, the chairman of the firm's index committee, says only in rare circumstances would S&P say a head office wasn't enough, such as a South American mining company that tried to claim one lawyer in a Toronto office was a headquarters. (Mr. Blitzer declined to speak directly to the Valeant situation.)
But after years of following this company, here's my take: I'd argue that Valeant simply doesn't have the "substantial presence" that justifies its continued inclusion in Canadian indexes – and is creating substantial losses for Canadian investors.
David Milstead