All signs point to Bill Ackman setting up the oldest trick in the book (VRX)

Reuters

Build it up and break it down. It's one of the oldest tricks in the corporate playbook — financial engineering to create value where there is little to none.

It looks like Bill Ackman is gearing up to pull this off with Valeant Pharmaceuticals.

Ackman spoke about his infamous investment on Tuesday at the Harbor Investment event in New York. He said that the company should consider selling part of its consumer eye-care business, Bausch & Lomb, which it bought for $8.7 billion in 2013.

"Bausch & Lomb is a very valuable standalone business and some day — if Valeant chose to — they could sell a piece of that to pay down their debt," Ackman said, according to Bloomberg.

Of course, with a 6% stake in the company — and several board seats now under his thumb – Ackman most certainly has a say in whether it'll make that move.

And then he made it clear that what he says goes

"Either management will restore confidence in the reputation of the company with the public and the investment community or they won't," Ackman said. "If they can't then one of two things will happen — new management will be brought in or the business will be sold."

This coming from the man who helped Valeant attempt what would have been its biggest acquisition of all time, its 2014 hostile bid for Allergan Pharmaceuticals. Ackman supported Valeant in its ambition to become gargantuan, and now that that model is over, it's time to consider breaking up the platform.

The question is, will the market give him time?

Valeant's stock, once the pride of Wall Street, started cratering in October after accusations of malfeasance from a short seller combined with government scrutiny over its business model.

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The model that had been championed up until that point had a few parts to it: (1) growth through debt-fueled acquisitions, (2) slashing of research and development spending to an industry-wide low of 3%, and (3) huge price hikes for the drugs that Valeant acquired.

That last part caught the ire of legislators and Democratic presidential candidate Hillary Clinton.

According to the company, though, that's all over now. It said that in 2016 it would make no acquisition and focus on paying down its $30 billion in debt. Plus, instead of selling Valeant's specialty pharmaceutical drugs at elevated prices through its now-defunct private pharmacy, Philidor, it will now sell lower-price drugs through Walgreens at a higher volume. At least, that's the plan.

Stick with the classics

The question is, will it work? Analysts at Japanese investment bank Mizuho think not. They came to this conclusion after seeing Valeant's presentation at the American Academy of Dermatology Meeting last weekend.

According to the plan, commercially insured patients will be able to get Valeant drugs at Walgreens for free on site, even if their insurers normally require them to get approval for the drug or don't approve it down the line. Commercially insured patients with poor coverage will have the same deal with some free refills kicked in — 12 free refills for Jublia, a drug CVS won't sell to patients until they've tried and failed with a generic, even if the patients' plans don't cover the drug.

"While this may be a good way to assure that patient volumes remain relatively high after the closure of Philidor, we believe that the program could be giving away too much free product and struggle to understand how this agreement will generate longer term revenue growth for Valeant," Mizuho analysts wrote.

They lowered their price target for Valeant from $112 to $70, and expect guidance — which will be announced on Tuesday — to be lowered from $11.7 billion from the consensus projection of $12.5 billion.

If the rest of Wall Street is just as confused, Valeant may not have a lot of time before price targets are lowered and the stock sees another sell-off.

ReutersTo Ackman, another brutal sell-off would likely be an example of Valeant management being unable to "restore confidence."

What would? Raising cash and paying down debt by selling off assets — a total reversal.

The Bausch & Lomb product line is perfect for this. It's full of reliable, no-prescription-necessary consumer products. The kind of products that never generated the eye-popping double-digit revenue that Valeant's specialty dermatological drugs — which were pushed by Philidor — did, but they're steady products.

And there's an argument to be made that businesses like this one, once removed from under the cloud that hangs over Valeant, could be worth a lot more than investors are giving it credit for today. That's a classic underpinning for a breakup, which is bread and butter for activists like Ackman.

Squad goals

Now, if Ackman wants to make moves, some signs point to him putting those ducks in a row already. On Tuesday, Valeant added three new independent board members. One is Stephen Fraidin, an M&A lawyer and vice chairman at Ackman's hedge fund, Pershing Square Management.

Another is Dr. Fred Eshelman, whom Ackman tried to get on Allergan's board in 2014. He also served on the University of North Carolina's board of governors, including its Audit Committee.

While Eshelman was at UNC, he overlapped with the third new board member, Thomas Ross Sr., who is president emeritus of the UNC system, having served as president from 2011 to 2016. He also once served on the board of trustees for Blue Cross Blue Shield of North Carolina.

Note that Robert Ingram, who was recently appointed chairman of Valeant's board when the roles of CEO and chairman were split at the end of last month, also serves on the UNC Advisory Committee on Strategic Directions.

In other words, at least four members of Valeant's board are connected, and two of them to Ackman directly. Not that Valeant is trumpeting this. It's just apparently a happy coincidence that a second new board member has been nominated by Ackman for other roles at other companies.

Pershing Square declined to comment on this story, and Valeant didn't return calls for comment on the board structure.

We cool?

That still leaves the question of what Ackman can expect of Valeant's recently reinstated CEO, Mike Pearson.

According to The Wall Street Journal, during Valeant's most tumultuous times over the fall of last year, Ackman told Ingram: "If Mike hides in his bunker on this, he can't be CEO."

Pearson came back from a medical leave from the company at the end of last month. Wall Street was mixed on his return. Some considered it a boon — he's the guy who grew Valeant under the old model, after all.

Others, like Wells Fargo analyst David Maris, saw his return as a problem, writing: "We are concerned by Pearson's return, as during his leadership at Valeant, issues such as serial acquisitions, the extreme pricing strategy, the Philidor arrangement, the Sprout deal and others arose.

"As of this writing, Valeant has lost more market value than it has created. Just six days ago the company scheduled a conference call to discuss preliminary results, and now, Valeant is withdrawing its guidance and cancelling the call."

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Ackman and Pearson have seemed at odds before. At the end of last year, when Valeant changed its business model, Pearson told CNBC that he never described Valeant as Ackman had and does to this very day — as a platform company.

"Look, I love Bill, but I've never talked about a platform company," Pearson said on CNBC. "I've talked about a company that grows organically."

He then described his relationship with Ackman as "pretty cordial."

Ackman, on the other hand, said in his 2015 letter to investors that he still believed in the platform model, but that the market was pricing them all wrong.

He wrote:

We believe that "platform value" is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than pharmaceutical products, operating businesses, real estate, or other assets as it depends on access to low-cost capital, uniquely talented members of management, and the pricing environment for transactions.

Breaking up pieces of Valeant could bring some of the magic for building a platform — like low cost of capital — back again. We've seen this play before. It's classic. Build it up, break it down — then who knows, maybe build it back up again.

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