Just before Valeant imploded as its iffy accounting procedures and business practices – buying drug makers or the rights to drugs protected by monopolistic structures then jacking up the price of these drugs – broke the surface, there were the Wall Street analysts.
They’re following the company. They’re experts on the company. They’re rating it and putting lofty price targets on its shares. It’s a quarterly routine. The Q&A portion of the earnings call on April 29, 2015 – before all heck broke loose and before the stock crashed 90% – depicts to what extent analysts are in bed with the company (transcript via Seeking Alpha):
Analyst with Canaccord Genuity:
“I’ve noticed that you’ve taken two 9% price increases in Q1. Does that mean that you’re feeling pretty good about where you stand with managed care…?”
Analyst with Guggenheim:
“Just on the gross margin reaching 80% by the end of 2015, could you give more color on what is going to be driving that?”
Analyst with BMO Capital Markets:
“Howard, congratulations on a strong track record with Valeant. You sounded very committed to the company last year, and we were under the impression that you were staying on for another two years. If you don’t mind us asking, what changed since mid-last year?”
“Howard” is Howard Schiller, CFO from 2011 until he resigned in 2015. Before that gig, he was COO of Goldman Sachs’ investment banking division. Valeant awarded him about $65 million in stock and securities. Then on January 6, 2016, when CEO Mike Pearson disappeared for health reasons, Schiller came back as interim CEO, with a salary of $400,000 a month! Investors weren’t so lucky.
Analyst with Barclays:
“And then in terms of the gross margins for Dendreon which you expect to get to 60% by year-end, is that sort of how we should think about that for 2016? Or as some of the other initiatives … take hold, could you start to inch up from that level or move up from that level? I think when you announced the acquisition you sort of indicated that you thought you could get considerably above that 60% level.”
Analyst with Piper Jaffray:
“So just on your comments on the expansion of the hospital sales organization and then greater promotion into the pain specialist market, should we take that to mean that you are now more open to acquisition activity in the hospital space or in the pain management space?”
Analyst with Susquehanna Financial Group:
“Could you talk a little bit about pricing on some of the products where it is a driver? I think it’s certainly a contributor in the neurology and generics segment. Does that continue to be a year-on-year driver through this year?”
Analyst with Morgan Stanley:
“Mike [CEO Mike Pearson], could you just update us on opportunities ahead to use stock for a large transaction and whether there might be any opportunities to buy large assets out of big pharma?”
“And then, Howard… what do you think investors on Wall Street most underappreciate about Valeant?”
Yup, he did ask that, hilariously, on the eve of Valeant’s implosion!
You get the drift. Rather than poking around to figure out what was really going on at Valeant, analysts, in between glorifying management, were just looking for decoration with which to hype the stock to their clients.
But last Wednesday, the day after Valeant shares had plunged 51% and were down nearly 90% from their peak last year, ten analysts finally cut their ratings or price targets.
According to Bloomberg, “only about 5% of the ratings on 1,778 US companies worth at least $1 billion are ‘sells’ or the equivalent.” For pharma stocks, it’s 2.5%.
Analysts’ median price targets for pharmaceutical companies are an average of about 53% higher than the actual stock prices even though shares of those companies have dropped almost a quarter since July 20. Only biotech stock-pickers had rosier outlooks, with consensus targets 68% above current prices.
But why “the stubborn persistence of optimism?” As Bloomberg put it, “Two things: saving face and access.”
After bamboozling clients into buying a stock, analysts have trouble telling these same clients that it was all based on hype, and that now it was time to unload this crap at a loss. They also have trouble downgrading the company because it could further eat into their clients’ portfolios. So price targets get moved higher, even at the end of the seven-year bull market, and even for companies like Valeant, weighed down by a mountain of debt, a dubious business model, and problematic accounting.
What analysts want, among other things, is access. Bloomberg:
Upbeat guidance can mean golf and soirees with company executives, hosting them at investor conferences and being picked first to ask a question on quarterly conference calls.
Then there’s the flip side. A neutral or negative recommendation can get an angry phone call from the C-suite, said Kennen MacKay, a biotech analyst at Credit Suisse Securities in New York.
“If you have a positive rating and wrong assumption, you might not hear about it from management,” MacKay said. “If you have an underperform, the management will attack every assumption you have.”
And then there are the investment-banking divisions of the firms where the analysts work. Investment bankers want these companies as clients, and they pressure analysts to butter up corporate executives – or at least not screw up the relationship. These folks want to be in on the next bond issue, merger, acquisition, or spin-off to extract their fees and fatten up their bonuses.
Officially, inflating ratings and price targets to the detriment of investors in order to get profit opportunities from those companies violates securities law. But hey, a slap on the wrist every now and then is well worth the extra billions in fees and millions in bonuses over time. And investors who believed those analysts and took their recommendations and price targets seriously and lost their shirts, well, to heck with them.
Now we’re getting reports that prices of the most expensive homes in the Hamptons, where Wall Street’s richest hobnob over the summer, are getting crushed. What’s getting blamed? Read… Super-Luxury Homes Hit by Reversing “Wealth Effect”