Valeant Pharmaceuticals Intl Inc (VRX) Answers the Short-Seller Casting Call

The Valeant Pharmaceuticals Intl Inc (NYSE:VRX) saga is just another in a long line of short-seller stories

Nov 5, 2015 at 9:38 AM
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We've all seen the short-seller movie before. The plot is always the same: Short Seller makes claims about his public target. Media picks up the story. Shares tank. Target company defends itself by attacking the short seller without addressing much about the claims themselves. Media takes the bait and starts questioning the short seller.

This script has played out hundreds (thousands?) of times since I've been in the business. The only variation is the ending sometimes changes. A couple years back, Herbalife Ltd. (NYSE:HLF) was the "it" short. But it ended up having a happy ending for the longs. That's probably the rarity, though. There's almost always more smoke where there's fire.

The current "it" name is Valeant Pharmaceuticals Intl Inc (NYSE:VRX). It fits right in. A prominent short seller cast all sorts of doubts. The company has been forced to admit much of what Citron said is true, but has basically resorted to defending itself by attacking the accuser.

Michael Hiltzik of the Los Angeles Times has a great synopsis of the story here, as well as a good defense of short selling in general.

The main point is that shorts serve a valuable function in the marketplace. They ferret out the overhyped and the fraudulent.

They are, of course, not always right. And they can make unsubstantiated claims. Every hyped company smackdown isn't necessarily correct. Far from it. Short sellers can also be irresponsible and attempt to simply manipulate their targets down.

But let's face it, longs do a lot of this too. The Financial TV day is filled with guests talking about their books, be it long-side investors, traders trying to shill for their services, CEOs getting softball questions, et al. Why are they all automatically on the up and up and the shorts manipulative opportunists?

They're not, of course. Facts ultimately win out in the long term. But in the short term, noise can prevail. It's tough to separate the wheat from the chaff. Companies aren't obligated to respond to every accusation. Sometimes the noise gets too great to ignore though, as in this case with VRX. A good clue that there's actually fire behind that smoke is in the nature of the company's defense. And in this case, the VRX defense is basically, "Yeah, maybe he's right ... but short sellers are still evil." The stock hasn't exactly given them a vote of confidence: it's lost about two-thirds of its value since early August.

But hey, there's a plus side. It's now a noteworthy option name! Implied volatility was 32ish before the implosion, now it's about 100. And that even underprices the stock itself! Ten-day realized vol peaked at 155 last week. Unfortunately, the quotes are wide enough to drive a fake mail-order pharmacy through, so you best be a market maker if you want to trade it actively.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research


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