The King’s Gambit: Valeant’s Big Secret

If the name Valeant Pharmaceuticals International doesn’t ring a bell, its business practices should. The Quebec-based drug manufacturer’s policy of implementing regular price increases that often run north of 100% has generated plenty of anger, a congressional investigation, constant press coverage and a subpoena from the U.S. Attorneys offices in both the Southern District of New York and the District of Massachusetts.

But as strange as it may seem, a slim legal filing in California federal court is poised to make Valeant’s world rockier still.

The story starts 50 miles northwest of Los Angeles in Camarillo, Ca. with R&O Pharmacy, a modestly-sized operation co-owned by veteran compounding pharmacists Russell Reitz and Robert Osbakken.

According to a lawsuit filed by R&O, Russell Reitz got a letter from Robert Chai-Onn, Valeant’s general counsel and director of business development, requesting repayment of $69.8 million for “invoiced amounts.” This apparently struck Reitz as odd since R&O had done no business, at least in any direct fashion, with Valeant. Moreover, he had never received a single invoice from Valeant or its subsidiaries.

Reitz forwarded the letter to Gary Jay Kaufman, his lawyer down in Los Angeles, who sent a letter to Chai-Onn on September 8 noting that the lack of invoices from Valeant indicated to him one of two things was happening: Valeant and R&O were being jointly defrauded by someone, or Valeant was defrauding R&O. He suggested they talk it over by phone.

Chai-Onn never responded and on October 6, Kaufman filed suit, seeking a determination from the court that R&O owes Valeant nothing.

There is, however, a hook and as these things go, it’s a big one: the Southern Investigative Reporting Foundation has confirmed that Reitz was indeed doing business of some sort through a company called Philidor Rx Services and a man named Andrew Davenport.

Which makes Valeant’s demand letter very interesting.

To understand why, it’s important to understand what Philidor is. To the public, it describes itself as a “pharmacy administrator” and, according to a call service operator last Thursday, Valeant is its only client. Located in Hatboro about 30 miles outside Philadelphia, its corporate filings indicate both companies are independent of the other.

Pharmacy administrator appears to be, in Philidor’s case, a term of art.

A better description is a “specialty pharmacy,” filling, shipping and getting insurance approval for prescriptions of the more complex drugs Valeant makes. In its third quarter conference call last year, the only instance where Philidor has been publicly mentioned by an analyst, Valeant chief executive Mike Pearson said that perhaps 40% of its business flows through specialty pharmacies. In July, he reiterated the company’s guidance for up to $11.1 billion in 2015 revenue, implying that as much as $4.4 billion in product could move through this channel.

(Note that specialty pharmacies are exempt from reporting the drugs they sell to IMS Health, the tracking service used by companies and analysts to monitor drug sales and inventory channels.)

Like many private companies, Philidor’s financials are hard to come by but it is unmistakably an operation of some mass, with around 900 employees and its own legal unit. A Pennsylvania State Senator posted an April 6 interview with company CEO Andy Davenport where he stated the company was on track to process between 12,000 and 15,000 prescriptions daily by December. With prescription costs regularly running into the hundreds and even thousands of dollars, the company could potentially handle upwards of $1.5 billion in product this year.

A key cog in Valeant’s “patient access” program, patients referred to Philidor often receive coupons for reduced or waived co-pay requirements–given to the prescriber by Valeant’s sales representatives–and in turn, Philidor would appear to attempt to recoup the cost of the drug from private insurers or Medicare. Theoretically, this makes price increases less risky for Valeant given that a sizable population of a drug’s users frequently won’t observe them. Still, the patient access program is central to the company’s distribution program, and one of the issues the U.S. Attorney subpeonas specifically sought information on.

Philidor’s business practices have generated mixed reviews (at best) on consumer message boards — including numerous instances of alleged unwanted refills and an allegation of the improper removal of HSA funds. Another message board account alleges that to get reimbursement approvals, prescriptions already denied at larger insurers were “pushed through” their sister pharmacies. (To be sure, comments on these sites can be gamed, both by consumers and the company, and the Southern Investigative Reporting Foundation was unable to verify these accounts.)

Several questions remain unanswered: On the assumption that there is $69.8 million due someone, why wouldn’t Philidor’s two in-house attorneys have issued a demand letter to R&O? Similarly, why wouldn’t Valeant’s high-profile general counsel, when challenged, not provide support for his demand and avoid the risk and expense of litigation? Additionally, if Valeant does have some sort of claim to that nearly $70 million, what then is their real relationship to Philidor?

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The Southern Investigative Reporting Foundation was able to uncover Valeant’s financial connection to Philidor–one that it hasn’t disclosed to investors–as laid out below.

The first task was to establish who owns Philidor. What we discovered was indeed revealing, albeit probably not in the way its owners intended.

Put bluntly, Philidor has gone to great lengths to conceal its ownership. Start with a man named Matthew Davenport, the listed principal on most of Philidor’s state registrations; additionally, several states list David Wing, John Carne and Gregory Blaszczynski as officers, and a few more have an End Game Partnership LLP listed as an assistant treasurer.

Given Andy Davenport’s video above, his role as Philidor’s chief executive is clear. Plugging the address of End Game Partnership LLP (which in turn is owned by End Game LLC, a Las Vegas-based entity) from its filings into a search engine turns up a match to a house Andy Davenport owns in Horsham.

A Southern Investigative Reporting Foundation phone call to Philidor’s administration revealed that there is no Matthew Davenport, David Wing, (Edward) John Carne or Gregory Blaszczynski working at Philidor. On the other hand, all four work at BQ6 Media, a pharmaceutical marketing company located about 2.5 miles from the company. At one point, prior to Philidor, Andy Davenport was its CEO. Both BQ6 and Philidor share the same domain registrar, Perfect Privacy LLC. The company’s LinkedIn profile lists 28 employees but the majority are consultants or contract workers, with several listing time spent at Philidor.

The Philidor state registration in North Carolina was particularly helpful in that it listed a broader array of owners than other states.

David Cowen is a former hedge fund manager and Elizabeth Kardos is general counsel for restructuring consultants Zolfo Cooper who are married and own Four Beads LLC; they did not return a message left at their house or reply to an email sent to Ms. Kardos. Nick Spuhler is a BQ6 alum who could not be reached, David Ostrow is a Physical Therapist and golf swing coach who did not return multiple calls to his house and residence, Jeffrey Gottesman is an insurance agent who has a sideline as a competitive poker player; reached on his mobile phone, he declined comment. The address listed for Gina Miller tracked to a code inspection business with no apparent connection to Philidor. Alternatively, a Gina Milner works at BQ6, but it couldn’t be determined if she is involved. Fabien Forrester-Charles of Hatboro, Pa. and Francis Jennings of Naples, Fla. could not be reached, and Michael Ostrow of Bala Cynwyd, Pa. did not return a voice message left at his house. Paula Schuler of Old Greenwich, Ct., listed as an owner along with her husband Timothy, said she couldn’t talk at that moment; she never returned two follow-up calls.

It is not readily apparent if there are any specific relationships among group members, beyond the general ties to Matthew and Andy Davenport (according to an online database they appear to be brothers), BQ6 and Philadelphia. One that does jump out is David Cowen and Andy Davenport’s tenure together at hedge fund Quasar Financial between 2004 and 2008; Davenport also donated to the Museum of American Finance, where Cowen is the president.

Not every state looked kindly upon the way Philidor went about securing out-of-state pharmacy operation privileges. California took exception to Matthew Davenport’s attempt to register as Philidor’s principal and rejected the company’s application for a Non-Residency Pharmacy Permit in May 2014. The state’s Department of Consumer Affairs Board of Pharmacy cited a series of disclosure-related problems, specifically his swearing to what was termed “false statement of facts” on the application, several of which involved the failure to disclose Philidor’s ownership group, as well as Andrew’s 27% ownership stake.

(A brief aside: Francois-Andre Philidor was an 18th century French Chess master, writing a book about it, The Analysis of Chess. BQ6 Media is named after the chess shorthand for Bobby Fisher’s legendary move against Russian chess master Boris Spassky in 1972. Another popular chess move is the King’s Gambit Accepted, or as it’s often referred to in chess notation, KGA.)

Establishing the economic connection between Valeant and Philidor was less time-consuming.

As it happens, Valeant has a wholly-owned unit named KGA Fulfillment Services Inc., that was formed in Delaware in November, 2014. Its only mention in any Valeant filings is that sole line in last year’s annual report. An exhaustive search didn’t turn up any references to it in trade publications, nor state and federal databases. (What the initials stand for, apart from the similarity to the chess strategy, is unknown.)

The Southern Investigative Reporting Foundation found KGA Fulfillment Services listed  as the “secured party” on UCC-1 liens placed this January and February against the members of Philidor’s ownership group. These liens are the public notice that a lending entity may have an interest in the debtor’s personal property. In this case, Valeant/KGA lent money to Philidor’s ownership group and per the rules, is announcing that their equity stakes in Philidor are potentially collateral.

The UCC-1 financing statements for the group are: David Cowen and Elizabeth Kardos, Timothy and Paula Schuler, Nick Spuhler, Andrew Davenport Trust, David Ostrow, David Wing, John Carne, Matthew Davenport, Fabien Forrester-Charles, End Game Partnership LLP, End Game LP and Michael Ostrow.

That an important financial relationship exists between Philidor and Valeant’s KGA unit is inarguable; why it exists is much less clear. From the standpoint of rational self-interest, the owner of a rapidly growing business would almost never want to borrow against their equity stake, let alone from the newly launched subsidiary of the enterprise’s sole customer.

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Over several days, since coming across the California lawsuit, the Southern Investigative Reporting Foundation made repeated phone calls to every person or company discussed above. With the exception of Jeffrey Gottesman from the Philidor ownership group and R&O Pharmacy’s lawyer, Gary Jay Kaufman–both of whom declined comment–every other person did not return our calls.

Robert Chai-Onn did not reply to a call to his office; a call to a mobile phone registered to his name was answered by his wife, who said she was on the West Coast and was unsure where her husband was at that moment.

Meghan Gavigan of Sard Verbinnen & Co., an outside spokeswoman for Valeant Pharmaceuticals, was unable to secure a response from the company.

 

14 thoughts on “The King’s Gambit: Valeant’s Big Secret

  1. If they sell inventory to this group and lent them money to get started, that seems very suspicious. Do they disclose how much inventory this group has? Could this just serve as a way to “record sales” for Valeant? Sell inventory to this group?

    • It seems according to reports, Philidor is consolidated into Valeant’s financials so inventory remains Valeant’s inventory either way. Also revenue is only recognized when patient prescriptions are filled so cannot really stuff the channel through specialty pharmacies if revenue only recorded when scripts are filled.

      • “Revenue is recognized when patient prescriptions are filled.”
        That’s great, but there is NO REVENUE. Just accounts receivable that will never be collected, which is why VRX sued R&O. So VRX books phantom revenue, that they will have to write off some day.

  2. Based on the transcript cited, Mr. Pearson cited 40% of revenues were processed through alternative fulfillment channels in response to a question about Jublia. So this 40% is only as a % of Jublia not the overall revenues. On recent call, Mr. Pearson indicated it is roughly 10 – 15% of US revenue ($700mm – $1bn) and not quite the $4.4 billion suggested. I am not sure that it makes any difference in your work but did want to point that out.

    Question-David Steinberg: Thanks very much. I had some questions on Jublia. The first thing is, it looks like in the prescription graph that you added up the Walters data and the specialty pharmacy data. I was just curious, what’s the rough breakout between the prescription audit information and that now you get through your specialty pharmacy Philidor?

    And, secondly, is sampling still a significant part of your program? And if so, perhaps how much would it understate TruScripts by? And then could you give us an update on how managed care discussions are going on that product? Thanks.

    Answer-J. Michael Pearson: Sure. Thanks, David. In terms of the breakdown, the specialty pharmacy channels are multiple specialty pharmacies throughout the United States. But the rough script breakdown is about 40% of the volumes going through specialty pharma and 60% is going through traditional pharmacies.

  3. Not an expert on drugs but I have extensive experience with electronic components. Apparently, in both fields, it is common for manufacturers to `consign`inventory to distributors. Let us assume something has a manufacturing cost of $5 and sells to distributors for $12.50. The manufacturer carries the item it inventory at $5 and, when they ship it to the distributor, there is not accounting transaction – under consignment the manufacturer retains ownership and has simply changed the inventory location from its plant to the destributor`s warehouse. When the distributor has a demand for the item from an end customer it `pulls`the item from the consigned inventory – title has then passed under the consignment agreement. At that point the manufacturer records a sale and receivable of $12.50 and records a cost of sales and inventory reduction of S5. The distributor may then sell the item to the end customer for $15 and record a sale and receivable for that amount and record a cost of sales and inventory reduction of $12.50. When Valeant says it consolidates Philidor they are referring to the first set of transactions. Unless Valent has direct ownership of Philidor then it would not record the sales at the distributoréend custyomer level. This is typically how consignment agreements work.

  4. Wow, interesting research – I’m a (very small) shareholder in Valeant from a while back. My father introduced me to them after they purchased the company that he worked for and he was “retired” (he was Head of R&D so no surprise there!). I bought when the shares were about $130 and on the rise.

    What do you make of the Philidor “network?” When R&O’s lawyer confirmed that R&O’s website was http://r-opharmacy.com, I initially thought that someone (maybe at Philidor since they’re hosting) had set up all of these network pharmacy websites a few months ago as part of a Valeant smear / short selling scheme – particularly in connection with the R&O claim. I thought it would be odd for Philidor to create new websites with altered logos simply as part of their “back-end services” to these pharmacies. And I couldn’t find any mention online by these pharmacies of their presence in the network. But then Philidor confirmed that they have a “right to acquire” the pharmacies, including R&O. I suppose the websites are part of the eventual consolidation plan? Like a Valeant mirror on the pharmacy side?

    Right now, I’m just hoping that enough of Valeant’s revenue is legit/sustainable for it to change out management and start afresh on a realistic, transparent valuation.

  5. You say the GC “never responded” but the R&O complaint only says that there was no “substantive written response.” Like you, I think it is a big deal if the GC never responded, but “never responded” is very different from no “substantive written response,” especially given that the R&O counsel asked for a phone call.

    Why do you think that VRX GC never responded?

  6. Stacy – I’m guessing but the “network” may be regulatory related. I believe pharmacies have to have licenses to ship to other states. If that is true then Philidor may not be licensed to ship to all states. Hence, let us say they are not licensed in Alaska, they find someone who can be licensed in Alaska and set them up as a pharmacy there. To get it up and running they would “mirror” the Philidor computer systems. website etc. At some future date, when regulatory hurdles are surmounted, Philidor would buy the AlaskaNewco and presumably collapse it into its core operation. I imagine it is all technically legal but they would presumably be reticent about going into too many details for both competitive reasons and to avoid upsetting regulators (for example the Alaskan regulators might deem unlicensed Philidor to have too many ties, effectively controlling, the licensed AlaskaNewco). It is not clear whether Philidor sold the inventory to R&O or whether it re-consigned the Valeant owned inventory to R&O. Under the latter scenario Valeant would be sending letters to R&O demanding payment when the goods R&O sold the goods to an end customer.

  7. Does anyone else notice the “end game” aspect, and the alternate explanation? What if all the related private entities are not (merely) ways to book revenue, but are actual places to park net worth? The “if the stock crashes and the game ends” insurance policy being to shift financial resources to the shadow penumbra of Vegas LLCs and such, before the bondholders can demand and attach them. Valeant has a tangible book of negative $40 odd billion. Somehow I doubt everyone in its loose orbit has negative tangible book value, themselves.

    • Endgame … these guys are dual citizens with israel and will run with billions. Israel won’t extradite with that mucho $$$ parked in tel aviv. Watch CNBCs “Greed … most wanted’ in the future. LOL

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