Valeant: Is giving away cheap drugs a good business model?

Valeant has a reputation for significantly increasing the prices of its drugs.  The truth is a little more complex than that.

Through its so-called “specialty pharmacy” channel, Valeant engages in an unusual practice of sending drugs to consumers without a guarantee of receiving insurance reimbursement from private payors.  If the reimbursement claim is ultimately denied, Valeant ends up selling a drug at firesale prices.

Why co-payments exist and how the system can be gamed

Copays exist to deter consumers from choosing drugs that aren’t as cost-effective as generics.  At the same time, copays do provide patients access to expensive drugs at a reasonable price as the payor still covers a portion of the drug’s cost.  Sometimes consumers do need expensive drugs for various reasons.  Perhaps the cheaper drug(s) did not work or has terrible side effects (e.g. allergic reactions to antibiotics).

Valeant, like many other drug manufacturers, has various co-payment coupon programs that serve to circumvent the purpose of copays.

Copay coupons distort the market as the drug manufacturer pays all or a large portion of the copay on behalf of the consumer.  If the drug manufacturer raises the price of a drug high enough, the manufacturer can still make a healthy profit margin despite providing a discount via the copay coupon.  Copay coupons can create a situation where the expensive drug has the lowest out-of-pocket costs for the consumer, creating incentives for consumers to choose expensive drugs over cheaper ones.  Private payors suddenly find themselves covering the costs of expensive drugs rather than cheap generic drugs.  There are various actions that payors (or the PBMs / pharmacy benefits managers acting on their behalf) can take in response:

  1. Raise the cost of health insurance, increasing health care costs.
  2. Raise the copays on the drug in question.  This harms patient access to expensive drugs that they may benefit from.
  3. Deny insurance coverage of the drug in question.
  4. Work with the pharma company to ensure that patients have access to expensive drugs while having financial incentives to try cost-effective drugs first.  The pharma company can offer discounts and rebates on the list price of a drug to the PBM.
  5. Put safeguards in place to curb abuse (e.g. prior authorization).  These safeguards generally result in more paperwork for doctors.  A PBM might require the patient to first try a more cost-effective drug and might require doctors to fill out paperwork to prove that a more cost-effective drug was already tried.

Express Scripts (a PBM) has a webpage that explains their point of view on copay coupons.  The webpage notes that copay coupons are “widely used” and ultimately detrimental to all parties involved.  I believe that the practice of copay coupons is legal when it comes to private payors.  They are illegal if US government programs are involved; the US government has implemented laws to protect itself from getting scammed.

A different copay coupon model

Doctors may dislike recommending copay coupons to their patients if it results in (A) more paperwork and/or (B) patients being denied coverage.  The “solution” to this problem is for the manufacturer to:

  1. Handle paperwork for the doctor.
  2. Guarantee that all insured consumers will have low out-of-pocket costs for the drug, regardless of whether the consumer’s private insurer will cover the drug.  This basically results in giving away lots of cheap drugs.

To the consumer, this may be a little bizarre.  One MetaFilter user reports paying $35 for a tube of Vanos with a retail list price of $1500 even though the insurance company did not cover the drug.

Here’s an example of what Valeant’s pricing structure looks like (PDF):


The chart above shows that some drugs are being given away for free to commercially uncovered patients on the first prescription.

*I did not figure out why the MetaFilter user reported getting a Vanos refill for free.  The Valeant chart above suggests that all refills cost money for commercially uncovered patients, though it does not list the Vanos pricing structure.


One Wall Street Journal article “Valeant and Pharmacy More Intertwined Than Thought” states that “Philidor employees would sometimes fill out the paperwork for the doctor”.

The Bloomberg article “Philidor Said to Modify Prescriptions to Boost Valeant Sales” states:

Workers at the mail-order pharmacy, Philidor RX Services LLC, were given written instructions to change codes on prescriptions in some cases so it would appear that physicians required or patients desired Valeant’s brand-name drugs — not less expensive generic versions — be dispensed, the former employees said. Typically, pharmacists will sell a generic version if not precisely told to do otherwise by a “dispense as written” indication on a script. The more “dispense as written” orders, the more sales for the brand-name drugmaker.

Measuring organic growth

Any business model where you give out product for free (or at firesale prices) will likely generate a lot of organic growth in terms of market share, total number of prescriptions (TRx), volume, etc.  Such metrics can be used to paint an optimistic picture of growth.

Organic sales growth will depend heavily on whether or not the sales numbers are adjusted for discounts and rebates.

Aggressive refills

Some consumers have commented that Philidor seems quite aggressive in mailing out refills.  Such a practice may be harmful for private payors if they are paying for drugs that the consumer does not want and does not intend on using.

Aggressive refills likely inflate the organic growth numbers for a drug.

Is the so-called “specialty pharma” channel a good business model?

I’m not sure.

In my view, this model does not seem sustainable over the long term.  Eventually, the private payors will catch on and take steps to avoid being bilked.  This will lead to a situation where Valeant has overpriced the drug and isn’t maximizing its profits.  Lower prices with higher volumes and higher coverage from private payors would likely increase Valeant’s profits in the long run.

Horizon Pharma

Horizon Pharma has a “Prescriptions Made Easy” program that is somewhat similar to the Valeant/Philidor model.  The New York Times has an excellent article (“Drug Makers Sidestep Barriers on Pricing“) that describes what Horizon does.  Express Scripts, a PBM, has an interesting article that explains how it is protecting its clients from Horizon’s “profiteering”.  The ESRX article begins by quoting a WSJ article:

On Jan. 1, 2014, its first day selling Vimovo, Horizon raised the list price for 60 tablets to $959.04, a 597% increase… Horizon raised the price again on Jan. 1 this year to $1,678.32 for the tablets.

The ESRX article goes on to say:

This year, we have taken the additional action of excluding both Vimovo and Duexis from our 2015 National Preferred Formulary.

As far as profitability goes, Horizon reported operating losses from 2012 to 2014.  (Its cash flow also doesn’t look very good.)  Stated differently: this company seems to have lost money in an industry that normally has very high margins.

Vimovo and Duexis combined accounted for 83% of Horizon’s total net sales in 2014 (see the bottom of page 96 in the HZNP 10-K), so Horizon was close to being a pure play on the “specialty pharmacy” distribution model at the end of 2014.

In reality, life is strange.  Wall Street being Wall Street, Horizon’s share price hit all-time highs at the end of 2014.


One of Valeant’s acquisitions, Medicis, had an “alternative fulfillment” program that is similar to what Valeant and Philidor are doing.  Medicis has enjoyed more financial success than Horizon, though its profitability was declining prior to its acquisition by Valeant.

It’s unclear to me as to how well the specialty pharma distribution channel worked for Medicis.  Towards the end it seemed like Medicis was trying to give out fewer cheap drugs and to roll back unprofitable scripts.  From the Q1 2012 conference call:

David Amsellem – Piper Jaffray & Company: That’s helpful. And then, second question on the second quarter guidance. It looks down from the prior range. Can you give us some more color on what’s driving that and how we should think about the delta?

Mark A. Prygocki, Sr. – President: Sure. David this is Mark Prygocki. So, I think the best way to look at it is really what’s going on in the prescription level. With the initiation of the alternate fulfillment initiatives which happened the week of March 2nd, our prescription volumes in SOLODYN in particular went from about 25,000 scripts a week to where we are today at a little less than 20,000 scripts a week. Parenthetically, as Jonah mentioned during the call, those 5,000 scripts were a vast majority of them were unprofitable scripts, so that increases our ASP over time, but from a wholesale perspective, their volume moving through their channels went down about 15%, so they have to adjust their inventory levels to reflect that reduction in demand, and that’s what they will probably do during the second quarter and that’s what we’ve assumed in our guidance, and that’s why it goes down really from first quarter to second quarter.

The bottom line

Ultimately, I think that Valeant’s “specialty pharmacy” strategy is unsustainable.  The current scrutiny over Valeant has led to CVS and Express Scripts terminating its relationship with Philidor.  Private payors utilizing either of the two PBMs (who are the two biggest PBMs in the US) will not be falling prey to Philidor’s various shenanigans, making the overall business model less viable.  Other PBMs may follow.  Investors should not project historic growth out into the future.

To some degree, the Valeant/Philidor business model is built on many questionable business practices designed to extract money from private payors; I have not addressed such practices in this blog post.  It looks like public scrutiny over Valeant will make it difficult for Valeant/Philidor to continue such practices.

That being said, Valeant does engage in some business strategies that do make sense to me:

  1. Using overpriced stock to buy up valuable assets.
  2. Cutting back on R&D expenses.  Historically, the pharma industry has produced fewer and fewer blockbuster drugs despite similar/higher levels of R&D spending.

Mainly because of #1, I never shorted Valeant.  Instead, I shorted stuff like PVCT (a Dec 2014 post explains my approach to shorting development-stage pharma stocks).  In any case, I think that investors should be careful about Valeant and should try to understand its various business models first before making an investment.

*Disclosure:  No position in Valeant or Horizon.  I am still short PVCT.


Valeant’s Philidor Used `Back Door’ Tactics to Boost Payments

Valeant and Pharmacy More Intertwined Than Thought

Drug Makers Sidestep Barriers on Pricing

Philidor Said to Modify Prescriptions to Boost Valeant Sales


When Buying Pharmacies, Valeant Affiliates Haven’t Disclosed California License Denial

CVS Terminates Philidor, Valeant Partner Pharmacy, From Network

5 thoughts on “Valeant: Is giving away cheap drugs a good business model?

  1. Nice info. What do you think about shorting HZNP? Also I believe VRX has acquired companies using cash, not stock, and took on debt to do so.

    • Haven’t done enough work on HZNP. They did merge with a profitable company though.

      VRX did do a secondary offering and wanted to buy other companies with stock. Though as you point out, they also did use cash for acquisitions.

  2. Pingback: Drug reimbursement shenanigans – Glenn Chan's Random Notes on Investing

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  4. Pingback: A grab bag of shorts (Jan 2019) – Glenn Chan's Random Notes on Investing

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