Corporate inscrutability may be the best reason to shun Valeant

There are plenty of reasons investors should be wary of Canadian drug giant Valeant Pharmaceuticals International Inc.

The deluge of bad news includes U.S. criminal and civil probes, class-action lawsuits, congressional ire over its tax and drug pricing policies, and swarming short-sellers.

A now-infamous report this month by short-seller Citron Research suggested that Valeant may be a "pharmaceutical Enron" with murky accounting practices and "phantom" revenues – allegations the company has vigorously denied. The stock continues to plummet.

But there is a much more fundamental reason why the fast-growing pharmaceutical company is a potential minefield for investors.

And it isn't what you might think.

The Laval, Que.-based company is a growth-by-acquisition monster, whose true value has become virtually impossible to decipher.

According to its website, Valeant is a "diverse and decentralized pharmaceutical company" that sells prescription brands, generics and over-the-counter consumer products in every major region of the world.

A dizzying acquisition spree in the past few years has created more of a company that is a moving target. Valeant is different today than it was a year ago, or even six months ago, with evolving products and pricing strategies.

Valeant may have something more basic in common with Enron, which collapsed in an accounting scandal in 2001. Like Enron, Valeant is a product of growth by acquisition – the so-called acquisition "roll-up" model.

Since 2010, it has made roughly 100 acquisitions worth a total of $30-billion (U.S.), typically financed with junk-rated bonds. Like Enron, it's been a favourite of Wall Street and Bay corporate finance types because of the lucrative underwriting and M&A fees all this activity has generated.

Investors apparently loved the strategy. Before the recent spate of bad news, the stock had risen 800 per cent since 2010. Since the summer, the stock has come back down to earth, plummeting from almost $350 (Canadian) to around $122.

Valeant is no longer just a pharmaceutical company. Thanks to its acquisitions of companies such as Paragon Vision Sciences this year and Bausch & Lomb in 2013, Valeant is also a dominant player in the making of a key component in rigid contact lenses and other medical devices.

The Paragon acquisition is now the focus of an investigation into whether Valeant has sought to illegally corner that part of the market for contact lenses.

The company is facing a separate criminal probe by the U.S. Justice Department into possible violations of federal health care laws by Bausch & Lomb.

Is Valeant a cohesive company, with a common purpose and a profitable structure? Or is it a fragile company made up of fragmented and disjointed pieces?

Right now, many analysts aren't sure of the answer. And yet inexplicably, just one of 25 Valeant analysts tracked by Bloomberg has a "sell" rating on the stock. Most still rate the company a buy.

The company says its core values – a commitment to "key stakeholders" and delivering consistently high performance – are the glue that holds it together. Those values "provide the overall direction for our company, and provide us with the tools necessary to rise to any challenge by leveraging our collective hard work and effort along with our unwavering competitive spirit," according to its corporate mission statement.

That's all bafflegab, of course. In practice, Valeant's secret sauce has been to buy up companies, slash their staffs and research budgets, find clever ways to jack up prices and tap into the parent company's rock-bottom corporate tax rate structure.

That strategy looks to be in tatters. The company is facing uncomfortable questions about its lucrative and previously undisclosed distribution relationship with specialty pharmacy Philidor RX Services. On Friday, the company severed all ties to Philidor, raising many new questions about its once lucrative connection to the company.

Warnings about Valeant's convoluted profit picture have been around for at least two years. But few were listening.

Companies that leave you scratching your head probably aren't worth betting your retirement on.

Here's a good rule-of-thumb: If you can't figure out what a company does – or more precisely, how it makes its money – run for cover.