Editors Note:

The market decline continued with the Dow barely clinging to the 17,500 level, which was prior support. The Friday rebound saw the Dow lose 50 points from its intraday high and futures are severely negative on Sunday night.

We are still waiting for the normal May decline into the summer doldrums before adding a bunch of new plays to the watch list. We do not want to be buying a bunch of stocks with the market in decline. There is a buying opportunity in our future.

New Watch List Entry:

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Stocks Dropped from Watch List:

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Active Watch List Play Descriptions:

VRX - Valeant Pharmaceuticals Company Profile


Valeant continued to trade erratically as hedge funds filed SEC notices of new positions and closed positions. The creditors filed another notice of default forcing them to accelerate reporting deadlines. The company now has 60 days to file its 10Q and they said they plan to file on or before June 10th. The default notice was just another way to force Valeant to file the required forms on time. The company also said senior VP Bran Stolz had resigned effective May 30th to pursue another opportunity. A Wells Fargo analyst also complained about "retention bonuses" paid to some senior executives. The $1 million bonuses and special equity awards were called "brazen" by Wells Fargo. However, if I worked at Valeant I would probably be looking for another job as well and they needed to do something to keep these key employees.

Original Trade Description: May 8th.

The Yahoo profile for Valeant says, "Valeant develops, manufacturers and markets pharmaceuticals, over-the-counter products and medical devices worldwide." They have dozens of name brand products and earn billions of dollars a year.

They were a serial acquirer and went on a buying spree that astonished the sector. CEO Michael Pearson was credited with making dozens of timely decisions that turned into a basket of golden eggs for the company.

Last year they ran into trouble when they were found to have likely acted improperly with a specialty mail-order pharmacy company named Philidor. Papers show that Valeant was the only customer for Philidor and they had purchased an option to acquire Philidor and consolidated Philidor's results into Valeant's own financial results. The entire thing appeared to be suspect to short seller Citron Research. They blasted out a short sell paper asking a lot of uneasy questions and making a lot of unsubstantiated claims as they always do when they attack a company.

Also suspect was a practice of sending out millions of dollars of product to specialty pharmacies and then claiming the profits from those drugs before they are actually sold. They also claimed the unsold inventories at those pharmacies as still on Valeant inventory lists. One specialty pharmacy was R&O, which was 100% owned by Philidor, which was secretly owned by Valeant. Citron believes this was a scam to deceive the auditors and claim sales of drugs that were not really sold. Citron dug up links to other "captive" pharmacies owned by Philidor, including West Wilshire Pharma, SaferX Pharma, Rando Pharmacy and Orbit Pharmacy. All were supposedly online drug stores and all their domain names were registered on the same day by the same person.

Since the Citron report went public Valeant ended its relationship with Philidor and the stock declined from $263 to $25. Some are trying to say that Valeant did not know about the captive pharmacies and Philidor was trying to scam Valeant. This would be hard to believe given the hundreds of millions of dollars in drugs flowing to Philidor.

Fast forward to the present. Bill Ackman and several other activist fund people have been named to the board. CEO Michael Pearson has been fired and Perigo CEO Joe Papa has been hired to replace him and started on May 1st. Ackman appears to be running the board. His firm has lost more than $1 billion in Valeant stock so he is a man on a mission.

Creditors extended the deadline for filing the annual report from April 29th to May 31st but Valeant filed it as promised on April 29th. The 10K spelled out the minor restatement in the financials where some sales were moved from 2014 into 2015. It also listed numerous probes, inquiries and suits currently in progress.

Valeant is a solvent company. They said they were "comfortable with its current liquidity position and cash flow generation for the rest of the year and remains well positioned to meet obligations."

Ackman said he could restore value to Valeant relatively quickly. Filing the 10K and hiring the new CEO were the first steps.

Secondly, Ackman said they were going to install a new management team within a "matter of weeks, not months" and that would reassure investors as well. Ackman said he was confident he would recover all his money in the Valeant investment. He bought VRX shares at $161 and again somewhat lower than that.

Ackman said Valeant was willing to sell off noncore assets to raise cash and pay down debt to improve the financial picture. Valeant only has a market cap of $11 billion today compared to nearly $100 billion back in August of 2015. This drop is entirely due to the confusion over Philidor and possible impropriety. The board now claims there was no additional problems other than the $58 million restatement of earnings.

The last time Valeant issued guidance they were projecting $12.6 billion in revenues for 2016. Adjusted EPS of $13.50 a share. Double digit sales growth and $2.25 billion in debt reduction. A company that can produce $13.50 in earnings at a relatively mild PE of 10 would be worth $135 per share.

They have plenty of assets they can sell to raise cash if needed. According to analysts their Bausch & Lomb division is worth as much as $20 billion by itself or twice the current market cap of the entire company.

I believe Ackman will get the ship righted again. His reputation depends on it plus the $1 billion he has lost. The potential for Valeant shares to decline significantly has been greatly reduced with the resolution of the accounting probe and termination of Pearson and Schiller. I am sure the company made some mistakes. However, the sum of the parts is worth more than $118 a share according to a BMO analyst.

The stock has been crushed. The odds of a significant additional decline from here have been significantly reduced. The odds of a dramatic rebound have greatly increased.

In the LEAPS portfolio, we want stocks with the potential for significant appreciation. Once positive announcements become commonplace with Valeant the shares should rebound appreciably. Just filing the updated financials was a major step forward.

Valeant shares have been extremely volatile. They dropped 13% intraday on two different days in the first week of May. We need this volatility to subside before we enter into a new position on Valeant. There are analysts who claim Valeant could trade down to $20. Others believe it could hit $75 by the end of the year.

I am recommending we buy the Jan $45 call and sell a $25 put to offset the cost of the call. Premiums are expensive on Valeant because of the potential for a huge rebound. The stock was $263 a year ago and I do not expect that again but we could easily see the current price double or triple given the strong earnings potential.

The recent high was $38.50. If the stock moves over that level we want to enter the position. I would rather not play in the current volatility range that knocked us out of the last position.

With a VRX trade at $30.50

Buy Jan $40 LEAP Call, currently $4.25, no initial stop loss.


Short Jan $25 LEAP Put, currently $6.35, no initial stop loss.