The Collapse of Theranos


Background: Theranos is a medical diagnostic company that promised consumers and medical practitioners affordable, painless, and less invasive blood tests to aid in the diagnosis of a variety of different medical conditions and illnesses with only drawing a drop of blood. The company was founded by Elizabeth Holmes, a first year Stanford dropout in 2003. The company had the ambition of replacing needles with the prick of a finger and threatens to uproot the global multi-billion dollar lab diagnostic industry. The company reached $9 billion USD valuation with half of the company owned by Holmes making her the youngest female self-made billionaire.



Accusation: In October of 2015, the WSJ accused the company of using traditional diagnostic machines to run the majority of its blood tests while only using its Edison diagnostic machine for fifteen of the blood tests. The FDA has only approved one of the tests run on Edison due to inaccurate diagnostic results from blood dilution and from the Edison machine. This revelation threatened the business model for Theranos as its main product does not work and should not have reached unicorn multi-billion dollar valuation. Information or testimonies provided by past employees showed that the company had repeatedly violated diagnostic lab standards and failed to fix these violations.



Result: In mid April of 2016, the US securities commission is looking into criminal charges against Theranos and investigating whether or not it had deceived investors. Federal health regulators are looking into issuing Elizabeth Holmes a two year minimum ban from being an officer within the diagnostic industry.



Early days: Elizabeth Holmes’ father Christian Holmes IV was Global Water Coordinator for USAID with deep rich connections within wealthy circles. Her early investors included Timothy Draper, a childhood neighbor, and Don Lucas who was a college friend of her father. While this has made early funding easier, Elizabeth Holmes still mastered the art of persuasion to convince investors to invest millions into her company.




Building a medical company that involves the FDA such as developing a new drug, creating a new medical device or even working on novel breakthrough research is very different than building a traditional business. When one works in a traditional business and does activities such as writing a report or working on constructing a building project, there is a sense of accomplishment daily because one can see progress and can roughly estimate when their project or report will be finished. If the company hired the right talent, there is a good chance that the project will turn out well and be deliverable favorably to the client or the consumer.



Contrasting the step by step completion projects we just discussed with developing a new drug, creating a new medical device, or doing novel research. These activities require the work of some of the top talent within their niche scientific fields. Every day, the scientists spend hours in the lab unsure if today will be the day of a major breakthrough they are looking for. Weeks or even months can go by with no signs of progress which can be disheartening as one is unable to see the fruits of their labor. The scientists hope and dream that tomorrow is the day that the breakthrough happens and they are able to see the progress of their labor.



Relating this back to Theranos, one might conclude that the company needed luck or a breakthrough which it was not lucky enough to get. When their valuation was driven into the billions, there was no other company with a successful product similar to the Edison machine that Theranos could acquire and use the acquired company’s proprietary technology to save itself. A material part of Thomas Edison’s wealth was derived from the efforts of Nicolas Tesla. Theranos could not attract the Nicolas Tesla equivalent for their Edison machine. Moreover, technology has not evolved quickly enough for Theranos to adopt current existing technology and build on current innovations.



Within the drone industry, the global development of video technology, GPS and other technological advances has allowed the rapid development of collision avoidance technology with a much lower cost and a lot less time compared to five years ago. Theranos had to create multiple breakthrough technologies in order for their Edison machine to work. For example, the creation of graphene sensors has allowed pollution levels to be measured in ppb (parts per billion). If an equivalent sensor was developed for blood tests, then Theranos would not have needed to dilute blood samples which further added to the inaccuracy of the blood tests and even impacting the accuracy of the older traditional diagnostic machines.

How Holmes likely raised funding:


When Elizabeth Holmes founded Theranos, it was built more similar to Silicon Valley technology companies than a medical company. When money was invested into Theranos, it was assumed that the scientists and engineers will eventually make the technology work. Thus, large funding rounds to commercialize the technology, and secure deals worth hundreds of millions with major retailers to open blood diagnostic centers within grocery stores including Safeway and Walgreens were signed. The mastery of public relations on various media outlets further added to the company’s hype. At the same time or later, the Edison machine was submitted for regulatory approval even though there was not enough credible data for regulatory approval. During the later stage investment rounds, one speculates that Theranos was vague in the use of the Edison machine in running diagnostic tests. Its progress in seeking regulatory approval with a just do it and seek regulatory approval later attitude similar to the operation of Uber in taxi licensed cities did not help its cause.

What Holmes should have done:



When one builds a company that can affect the life or death of a patient, strong regulatory approval cannot be avoided or negotiated later. When Holmes had built Theranos, she should have developed a technology that would have passed regulatory approval or acquired a company that had passed regulatory approval. Only then should Theranos have pursued commercialization. Unlike normal technology, one cannot release a minimum viable product into the market in the medical devices space and risk harming human lives.


The business concept and message behind her company was simple with a huge impact on health and huge profit potential and attracted many prominent investors because the main idea behind the company could be understood easily by non-scientists. However, the business aspect of the business such as the ability to seek funding, to attract business partners, to grow the list of potential clients and to gain patients has greatly outpaced the scientific advancement aspect of Theranos. The overpromise to these retail partners, investors, patients and clients compared to the challenges of developing a new blood diagnostic technology led to cover-ups which snowballed into bigger problems. The eventual discovery of this scandal by Wall Street Journal led to greater scrutiny of Theranos by regulators and the general public.


Takeaway: Theranos has shown that in order to build a successful company and change the world, one need to develop the scientific aspect of the business in addition to marketing and business technology. To build a medical company without sound science will soon lead to its inevitable collapse.


Currently, the career path for scientists is not considered lucrative with many underemployed or choosing different career paths including accounting. However, I believe that science will make a comeback especially with the need to innovate in the scientific field and act as the driving force behind many of the future technological innovations and advancement including blood diagnostics, and lithium batteries, We need to train more talented scientists who can overcome these challenges and develop new innovation to better the world while compensating them enough to attract the best into the field.


Demystifying Crude Oil Investing



I have traded crude oil since grade nine in high school when my mom mentored me on this subject and I helped her to do market research and to execute actual crude oil trades. Over the next few years, I would start out on my own and develop my own ideas, thesis, and investing models involving knowledge across a variety of different disciplines. Throughout my ten years of crude oil trading experience, I have experienced gains and losses as well. To understand crude oil price movement, one must learn short term technical analysis. To build a general understanding of crude oil over time, subjects such as economics and politics must be learned and daily news must be read as crude oil is influenced by global supply and demand and political regulations and policies including sanctions and free trade as well as unpredictable daily events. I will layout the macroeconomic perspective followed by some of my personal findings and things I look for when investing in crude oil. In general, only invest when the upside is much greater than the downside otherwise the losses will outweigh the gains much like playing a hand of poker when you only take a chance  when you have great cards with a good chance of winning.

The economic theory of storage arbitrage, crude oil futures and non-renewable crude oil depletion will be discussed. Moreover, the factors that affect crude oil prices including political, economic, supply and demand as well as geopolitical risk will be touched on.

Supply Side

OPEC controls the crude oil prices through production output changes. OPEC or the organization of the petroleum exporting nations control more than ¾ of the world’s oil reserves.1 They include twelve members consisting of Venezuela, United Arab Emirates, Saudi Arabia, Qatar, Nigeria, Libya, Kuwait, Iraq, Iran, Ecuador, Angola, and Algeria and produce about 40% of the world’s oil to meet demands.2 Historically, OPEC dictated the global crude oil prices through production level changes with oil production cuts when crude oil prices are low (approx $80USD/barrel) or increased production when crude oil prices when above $100USD/barrel. Thus crude oil historical over the past decade tends to stay within $80-100USD/barrel range.3


The oil shale or kerogen shale boom in the US has decreased foreign oil dependency and increased global crude oil market share for the US. In the long term, US global market share of crude oil would have continued to increase had crude oil prices remained at $100 USD/barrel due to the leveraging effects of debt that many oil companies used to finance their acquisitions and expansion of operations n order to increase profit. OPEC would have lost the effectiveness of its oil market price control ability through increases and cuts in crude oil output as it slowly lost global crude oil market share. The greatest threat to OPEC’s market share is mega projects with start up costs in the billions which can bring excess supply to the market with a production life in excess of 20-30+ years and would not be shutdown once it is operational due to positive cash flow that stems from the project. The rapid decrease in crude oil prices from $100+ in June 2014 to under $40/barrel in December 2015 meant that the risk profile of these capital intensive mega projects were negatively impacted. These executives in these large corporations will not start up the project again for decades once it is shutdown as in the case with Shell’s abandonment of Arctic exploration which no longer made economic sense given the potential crude oil price uncertainty and increased volatility.3


The reduction in geopolitical risk. As geopolitical risk increases in crude oil rich countries, the uncertainty of crude oil supply shortages increases due to the disruption in the crude oil supply chain. This has a positive effect on the increase in crude oil prices. In the first half of 2011, the civil war in Libya disrupted the crude oil supply and decreased global supply and when supply is low, the economics of supply and demand meant that prices will increase. In 2014, port blockage of crude oil transport in Libya created uncertainty by decreasing crude oil output out of Libya. Geopolitical risk, however, is short lived and causes temporary rapid changes in crude oil prices. Once the issue or problem resolves itself, crude oil prices will revert back to normal levels.

Fighting flares in Benghazi

Increasing volatility caused by price speculation.  Traders and speculators place bets on the underlying direction of crude oil price movement. This speculation on price exaggerates price swings.  For example, if actual crude oil prices is projected to go up to only $90USD/barrel without a futures market, the price swing exaggeration might bring prices up to $105+USD/barrel with the existence of a futures market as speculators rent crude oil storage facilities to store crude oil inventory to sell later as supply tightens. This removes inventory from the market which further worsens the supply shortage causing prices to increase. Conversely, when prices are low, speculators dump crude oil futures onto the market which further dampening or decreasing the price and the price decline accelerates. Once crude oil reaches variable cost of crude oil extraction, speculators will start to store excess crude oil on tankers and crude oil storage facilities which should slow down price declines. If crude oil storage facilities reach storage capacity, and there is no new facility to store crude oil, then prices will rapidly decline as the newly extracted crude oil is sold on the open market for what the buyers are willing to pay.


Demand Side

The state of the Chinese economy affects global crude oil prices. China overtook the US as the largest economy in 2014. Being the largest economy meant that a large percentage of global demand for commodities comes from China. If the Chinese economy improves, the demand for these commodities including crude oil increases which increases global prices. In 2015, the Chinese economy has faltered due to a slowing economic growth with demand for these commodities decreasing which dampens global prices of commodities including crude oil.

Pedestrians on Nanjing Road

Pedestrians on Nanjing Road

Seasonality – refineries

Refinery seasonality affects crude oil prices. Crude oil trades in short term and long term cycles. Annually, the crude oil price cycle is dependent on refinery demand. In January and February, crude oil prices are fairly steady as people use less of the crude oil derivatives such as gasoline for driving. This is  balanced by full capacity production from refineries which use up the crude oil to make derivative products. In March and April, refineries shutdown to switch to a summer blend which causes crude oil inventory to build up and prices decrease. From May through August, the refineries are near full capacity to meet the demand for the summer driving season.  This reduces the crude oil supply as refineries turn the crude oil into its derivative products and price of crude oil increases. From September to October, the refineries are shutdown and refitted with a winter blend. Crude oil prices decrease due to the increase in inventory. From November to December, crude oil prices increase as use of heating oil in homes due to winter increases due to the positive relationship of crude oil and heating oil. Heating oil is a derivative of crude oil. As heating oil is used, refineries convert more crude oil to its derivatives further decreasing the supply and causing the price to increase.


Future outlook:

We look and learn from the past to understand the future. The crude oil market has seen a rapid price decline from over $100+ USD/barrel in 2014 to a low of under $27 USD/barrel in early 2016. This rapid decline in crude oil prices is due to an increasing global crude oil production output coupled by a slowing down of the global economy led by China which dampened crude oil future demand outlook. Prices in crude oil were in free fall in 2015 and looks to stabilize in 2016 around $40-50 /barrel range. Speculatively, we can expect prices to slowly increase to $65-$70 in 2017 once crude oil production cuts are finalized with the various OPEC nations and Russia. In 2018, crude oil prices may once again touch above $80 / barrel. In 2020 to 2025, due to recent decreases in capital expenditure in bringing online new crude oil projects, crude oil prices may once again reach $100-$110 USD/barrel due to supply shortage from new supply. Once crude oil prices reach this level, many small and large oil companies will once again increase crude oil production to full capacity to capture this excess profit. It is within 1-2 years of this point, that crude oil prices may once again free fall and provide a trigger to reset the market for the cycle to begin again.






Simplifying Language: Connecting the World’s Knowledge to Every Individual


A scientist is awarded the Nobel Prize in Chemistry for the mechanistic study of DNA repair is encouraged to interact with the general public about his groundbreaking research and to inspire the next generation of young scientists to advance humanity’s pursuit of scientific knowledge. How will he communicate his message in order to inspire and to invoke curiosity so that young adults can understand the significance of scientific advancement of humanity and want to become future scientists?



A medical student crammed for an examination on the topic of cardiovascular and learned about the anatomy, diseases and symptoms of the heart, and the mechanisms of the drugs involved in the treatment. Years later, he became a certified doctor and a patient sits in his office with a serious heart condition the patient is unaware of. How will the doctor communicate with the patient in such a way that the patient can understand and involve the patient in the treatment regime to increase patient awareness, treatment compliance and come up with the best possible method of treatment?


On the left, an optical image from the Digitized Sky Survey shows Cygnus X-1, outlined in a red box. Cygnus X-1 is located near large active regions of star formation in the Milky Way, as seen in this image that spans some 700 light years across. An artist's illustration on the right depicts what astronomers think is happening within the Cygnus X-1 system. Cygnus X-1 is a so-called stellar-mass black hole, a class of black holes that comes from the collapse of a massive star. New studies with data from Chandra and several other telescopes have determined the black hole's spin, mass, and distance with unprecedented accuracy.

A renowned physicist gained new insight on physical matter being swallowed up by a black hole. He theorized that materials may not have all been swallowed up by the black hole and instead traces exist on the event horizon. How will he communicate this significant abstract concept with the general public without losing their attention in a way that they can understand within their reality and expand their perspective of experiencing the wonders of the universe?



What do all of these scenarios have in common? It involves a specialist or someone with an uncommon body of knowledge who has spent years perfecting their craft interacting with someone who may have never studied the field before or know the subject’s set of terminologies. What steps could they take to simplify the communication of their technical knowledge into something more understandable for the general public as well as young people with limited experiences and exposure to the subject while still retaining the core message?


The importance of writing at a lower grade level:  increasing commercial popularity, increasing social shareability, and increasing content understandably.



Some of the best works of best-selling authors are written at a lower writing level than one would expect. A lower writing level positively correlates with commercial popularity as a greater number of the population are able to understand the text. Yet, as we get older and progress through the education system and become accustomed to writing at a higher grade level with complex vocabulary, and subject specific jargons about difficult concepts, we are given the illusion that we have matured and have become better writers and communicators. When we finally reached the pinnacle of our career and became one of the top experts in our field, it is as if only 50 people in the world could understand our work.



Within the past few decades, massive growth in scientific knowledge has driven the knowledge frontier into unknown territory creating sub-fields within disciplines yet the knowledge discovered is not trickled down to the general public who are the taxpayers that fund these projects through government grants. If the general public can understand and appreciate the significance of such groundbreaking research, then politicians would publicly fund these research projects in order to gain voter support and strengthen their national economy through innovation in the long term.


How do we find the balance between talking in exact scientific language filled with jargon that the general public does not understand and the abstract political ‘change’ Obama speech during the US elections which seems to appeal to almost every one of Barack Obama’s supporter’s imagination, life circumstances and reality in order to maximum the benefit of our work for humanity?

(A thought experiment) Imagine yourself designing a game and choosing how difficult to make each game level. If only 50 people in the world can complete the game, and you wish for commercial success, the chances of this occurring are low, as most people will have given up due to the game being too difficult to play and unplayable.


How to Increase Global Collaboration across Different Disciplines:


The world is moving towards a more collaborative model where the boundaries across different disciplines vanish and new fields emerge from a combination of two or more fields and people of different backgrounds from science to business to design work together across countries, oceans and continents. How do we eliminate the misunderstandings between different groups who may not share the same language and/or method of communicating? How do we debate on common issues with different interest groups when the experts specialize in their own domain without understanding of other alternative perspectives outside of the accepted views within their industry? How do we form a common basis of communication to facilitate greater understanding and knowledge exchange?



Now back to the example of a black hole mentioned in the opening third example.  In 2015, Stephen Hawking, a renowned Nobel Prize winning physicist had a new theory that says information from a black hole is not stored inside the black hole but on its boundaries or the event horizon? How does one explain such an abstract concept to a younger audience or the general public without losing a majority of its meaning or becoming too complicated to understand?

Using everyday examples, analogies, and thought experiments:

Using analogies:


I have two friends named Jack and Jill and they both love eating junk food. I could predict what they had eaten based on what they previously ate and the junk food packaging. Jill eats the junk food while leaving the packaging in a neat pile for me to examine. Jack, on the other hand, eats everything so I am not able to tell what he has eaten. However, I noticed even though Jack eats everything including the food packaging, he is also quite a messy eater. I could tell what food he has eaten by examining traces and bits of food around the corner of his mouth.

Relating back to Hawking’s black hole theory, the black hole (Jack) might not have left traces of information (food) but one can look at the event horizon of a black hole (the corner of Jack’s mouth), to find traces of information (food) to examine about what has been absorbed (eaten).

Using thought experiments:


Albert Einstein, one of the greatest and most well known Nobel Prize winning scientists in modern day history idolized for his uncombed silky white hair and his insight into the macro and microscopic universe with one of his most widely known theories being the theory of special relativity.  While the average physicist might explain the complex concepts with higher level mathematics, cryptic formulas and physics, Einstein explained relativity as a thought experiments that even a 5 year old can comprehend about the concept of time dilation. He imagined two sisters one of which remained on earth and the other who left Earth’s reference frame and traveled at the speed of light on a spaceship. While 30 years has passed on Earth and the Earth twin has aged 30 years, the time traveler twin would have only experienced two Earth years pass when the twin returned from space.

Using everyday examples:


The Panama Papers was a leak of 11.5 million confidential documents from the Panama law firm Mossack Fonseca spanning 214,000 offshore companies where very wealthy individuals from celebrities, politicians, businessmen, and arms dealers hide their wealth from the eyes of the public, tax authority and even their spouses ranging from legitimate privacy reasons to illegitimate reasons ranging from tax evasion, hidden assets from divorce court to shady business dealings. How does one explain such a sophisticated concepts to a younger audience or the general public?


Imagine yourself back in your childhood elementary school. Every one of the kids owned a piggy bank that they put their allowance, birthday money, lunch money, and money earned from chores into. The mom of each kid managed the piggy bank by checking each week the amount of money in their kid’s piggy bank. Thomas’ parent does not go into his room and since he has a big room, he decides that he would help other kids by safekeeping the other kids’ piggy banks. Some kids at school started to have two piggy banks. One found at home which their mothers kept an eye on and one with Thomas. One day, Thomas’ mom entered his room and found that he has many piggy banks. She asked Thomas why he has many piggy banks and he confessed that he was safekeeping them for his classmates. The parents of the children were called to Thomas’ home to reclaim the piggy banks. While some piggy banks were kept for legitimate reasons such as Cindy saving money for a present for her mother’s birthday, other kids did not have such innocent motives. Jeff used his piggyback to keep money away from the eyes of his mother so that he could buy candy that his mother forbids him to eat. John used his piggy bank to keep stolen money from his mother’s purse. Andy bullied other kids and kept their lunch money.


When we simplify the language used to communicate with the general public or a younger audience, we remove the barriers of understanding across different disciplines. When people can understand something they can make more informed decisions, rally in your cause, and develop a greater appreciation of what the world has to offer.

To further enhance our way of communicating to people outside of our domain, we should combine different methods of communication with the use of diagrams, drawings, and graphs in addition to simplifying language and increasing readability.



The head office and logo of Valeant Pharmaceutical are pictured in Montreal on Monday May 27, 2013. Valeant announced an agreement Monday to buy Bausch + Lomb Holdings for US$8.7-billion in cash in a deal that will boost the Canadian drug maker's presence in the eye-care sector. THE CANADIAN PRESS/Ryan Remiorz

Recently, there has been a lot of news about Valeant Pharmaceuticals. To understand the uncertainty surrounding the future outlook of the company, one must look into its history, and examine its business strategy in order to understand the possible future outcomes of the company which would indirectly affect the future of the pharmaceutical landscape.

History and background:


Valeant Pharmaceuticals was formed through a name change in 2003 from the assets of ICN Pharmaceuticals Inc. The company struggled in 2007 due to declining revenue and Michael Pearson, a consultant working for McKinsey was hired and helped to sell off some of Valeant’s non-core business assets to raise cash. The board was so impressed with his strategic work that they hired him as the new CEO. Pearson transformed the company through mergers and acquisitions of other drug companies including a merger with a Canadian pharmaceutical company named Biovail which moved the corporate headquarters to Canada due to Canada’s favorable corporate tax rate. Its market capitalization increased from a low of $15-20 in 2010 or approx five billion in shareholder value to over $100 billion in the summer of 2015 when share prices increased to over $250 USD. In mid 2015, the company became the largest publicly traded company on the Toronto stock exchange surpassing Royal Bank of Canada in market capitalization. At the end of 2015, the company struggled with a rapidly declining stock price due to allegations of channel stuffing through its undisclosed subsidiary Philidor1. Near the end of 2015, various accounting issues emerged from the timing of revenue recognition due to a competitive sales target based career promotion and bonus based on performance work environment as well as double counting of revenue due to the failure of integrating Philidor’s existing inventory which was previously counted as sales to Valeant.

Corporate strategy:


Valeant purchased patented pharmaceutical drugs by acquiring pharmaceutical companies, off patent pharmaceutical drugs by acquiring generic drug manufacturers as well as recently FDA approved pharmaceutical drugs from biotech and small pharma companies at a large premium to publicly traded share price which would not earn a positive investment return based on the current drug price. The distribution channel for the pharmaceutical drug especially in the orphan drug category became more tightly controlled. Drug prices for the acquired drugs were raised many times over the next few years for multiple times the original price of the drug (price increases of 200-800% are common) leading to price increases in excess of 10x the original price. The justification for the price increases was that the pharmaceutical drug was underpriced and increasing the price will slowly re-price the drug price to the true value of the life saving medication. The revenue for the drugs increased every year even though the sales volume of each drug decreased. This was due to the new formula of high drug unit price x low unit volume sales = higher revenue compared to the old formula of low drug unit price x medium unit volume sales= low revenue. The increase in drug prices greatly outpaced the decreases in sales volume which led to continuous trending stock prices increases as the growth is praised by Wall Street investors. Newly acquired business R&D departments were laid off to reduce costs. However, as patents neared expiration for more popular drugs, the sales volume declined rapidly. Valeant had to continuously acquire new businesses to prevent any fall in revenue which would be an ominous sign to investors.

Why did this strategy work for so long?


Valeant acted more similar to a pharmaceutical hedge fund than a pharmaceutical drug development company that develops and markets new drugs. It borrowed at a low interest rate via bank loans, line of credit and corporate bond offerings, and acquired pharmaceutical businesses and products which earned a greater return than the cost of the loan and increased with each subsequent drug price increase compared to their cost of borrowing. This is known as a carry trade in Forex currency trading where you arbitrage and pocket the difference between the amounts you earn in the business minus the cost of borrowing. Their non-step acquisitions are further fueled by a rapidly rising stock price which became a cheaper form of financing by issuing new shares instead of cash payments for acquisitions by borrowing money. Everything worked fine as long as they continued to buy companies and the stock price continued to rise and their rate of return from their acquired companies was less than the cost of borrowing. Moreover, loopholes in mergers and acquisitions accounting allowed the company to write off one time cost items which seems to happen every year and became an annual occurrence. In addition, some orphan drug categories have such low sales volume that it was not profitable for pharmaceutical or generic drug companies to find bio-similar compounds and set up distribution channels for the product.

What went wrong?


The negative side of a carry trade is that the leveraging effect reverses when the rate of borrowing exceeds the rate of return earned in the business, shareholder value is quickly evaporated. According to equation A= L +SE where A = asset, L = liabilities and SE = shareholder equity, as asset value decreases or liability increases, shareholder value goes down. As shareholder value goes down, the debt to equity ratio increases and the chance of default increases which further increases the cost of borrowing.

Revenue: Valeant’s forward revenue guidance will be lowered because existing patent drugs will not have their prices raised as much as before as revenue growth becomes hindered. When the drug patent expires, the existing brand name drug will face stiff competition from generic drug companies which either results in greatly decreased sales volume or forced price cuts to compete with the generic drug companies due to much lower drug prices.

Price increases: The trajectory of future drug price increases will be hindered. US presidential election candidates such as Hillary Clinton have pledged to fight Valeant against higher drug price increases in its portfolio of drugs to win over voters with minimal downside. Normally, politicians have to be careful about making such statements to pharmaceutical companies because their justification for stopping price increases that burden the public healthcare system could potentially hinder future drug development research which can cost billions of dollar to create an FDA approved drug over many years. Valeant, on the other hand, had little R&D spending and even cut entire R&D departments of acquired companies justifying that it was not an efficient use of capital with too much uncertainty and risk in creating an FDA approved drug. This meant that politicians did not have to face any backlash from voters or Valeant and could potentially gain sympathetic voters as the price increases for drugs will not be used in R&D spending and instead used to acquire more companies for Valeant’s drug portfolio.

Sales volume: The pharmaceutical drugs that Valeant acquire continues to lose sales volume each year as hospitals move to generic bio-similar or other viable FDA approved drugs for treatment meaning that the only way to increase sales revenue is by increasing the drug price more than the decrease in sales volume. The large profit seen in the pharmaceutical industry is earned either by charging a small group of patients’ insurance companies lot of money each patient for very expensive drugs or a large group of patients’ insurance companies for moderate amount of money each patient for relatively expensive drugs by controlling the distribution of the drug. The revenue from the drug has to earn a profit, to provide a good return on investment in R&D that justifies the uncertain and risk as well as to provide capital for future R&D expenses. Once the drug comes off patent and generic drug companies develop bio-similar alternatives, doctors usually prescribe the generic cheaper alternative to save the patient money. The brand name drug has a steep fall in sales volume once it comes off patent.

Valeant, on the other hand, owned many off patent and generic pharmaceutical drugs and continues to increase the price. They no longer had patent protection and had no control of the drug or bio-similar drug distribution. However, Valeant owned specialty pharmacies and had relationships with other pharmacies that prescribed its own brand of drugs instead of the cheaper alternative even if the doctors wanted to prescribe the generic alternative to the patient. This created a moat for their business in a similar way to controlling the distribution channel except on the patient end. The collapse of their specialty pharmacy Philidor meant that their own brand name drugs are no longer being exclusively prescribed and instead has to compete with the same compound or bio-similar molecules with much cheaper prices on the market which collapsed the demand for their drugs due to price competition. Note that this does not include the orphan drug market which doesn’t have competition.

Future outlook:


Valeant has a very volatile stock price that could move in either direction 10% a day with a market capitalization of 10-15 billion, $1.4 billion of cash or equivalent and over $30 billion of debt. If Valeant does not submit the financial statements by end of April, it could be in danger of breaching debt covalent which would mean that creditors could call their loan. If Valeant does not have the cash to pay off the loans, then there could be a going concern issue.

Valeant’s future is uncertain in that the stock price for common shareholders could range from zero if creditors call on the loan for breaching debt covenants and Valeant is forced to sell core and non-core businesses at fire sale prices and money raised from the fire sale is unlikely to pay off all creditors to $80-100 a share if Valeant comes to an agreement with creditors and slowly sell off non-core businesses at market value or a slight premium.

Each participant related to Valeant has a role and face dilemmas whether it be the creditors, the shareholders or the auditor PwC. For the auditor PwC, the firm’s auditors only look at past financial performance except in the case when they have to look at the going concern of the business where the future outlook on the financial health of the company is examined. If PwC issues a going concern worry or even a qualified audit, then the debt covenant is breached. PwC might not be found liable or has greatly reduced its future liability lawsuit from shareholders for audit negligence but has “nailed in the coffin” the client’s fate. A going concern issue would cause creditors to call in the loan which would force Valeant to sell its assets quickly. New creditors would not lend Valeant the money to pay off existing credits due to potential risk of bankruptcy. Potential acquirers know the company needs money now and will only pay fire sale prices for its assets. If asset sales do not cover the amount owed to creditors, then the shareholders could walk away with nothing.

If PwC issues an unqualified audit that nothing is wrong, then no debt covenants are breached. Valeant would be given enough time to sell its non-core assets for market price or at a slight premium which is enough to pay off due loans and interest payments. With the company having enough cash for operations, the rate of borrowing goes down as the risk of default decreases. Share price could rise to over $80 per share as its core business is still quite valuable. However, if this plan goes wrong, then existing shareholders could sue PwC for negligence in court and likely win.

For the shareholders especially the hedge funds, Valeant could launch or break their hedge funds and their careers. It could either launch careers or force early retirement and liquidation of funds. There are players making bids both in the company success to turn around the business as well as on its failure. Since Valeant was once the largest Canadian company for a short duration of time, the fall in the stock price has affected Canadian pensions, mutual funds and small investors has it composed a sizable portion of large cap index funds in a basket of stocks where the majority of publicly traded companies are Canadian financial, resources based, and utilities and shows a lack of diversification.

For the creditors, if the company goes bust, then they are only going to get a portion of their money back. They have a high interest is in keeping the business alive so that the creditors could get their money back but they would definitely want to extract as much cessations from the company as possible in exchange for reducing the debt covalent.

1 Philidor was a specialty pharmacy which Valeant paid $100 million for the option to acquire the business for $0 and used the pharmacy to sell its various brands of pharmaceutical drugs.

Testing the limits of economic theories

A friend recently posted an article on Facebook located at called How economists rode maths to become our era’s astrologers. Here is my comment to his article share.

This is my comment to the article. There are a few things we might consider. One is to push the boundaries of economics towards a more mathematical and quantifiable discipline but presented in such a way that the common person can understand. Nate Silver from quantified election predictions based on different weighs on the results of public opinion polls when in the past, news commentators just guessed who might win an election with nothing to back it up other than a gut feeling. Another is to expand the disciplines required to be studied by new economists to fields including statistics, and politics because with government monetary intervention, every major economic policy or event has a political component. The introduction of negative interest rates, the creation of a credit market many times the value of an economy, and the advancement in automation of technology has skewed the effectiveness of an economic theory to explain the current phenomenon. For example, the automation of manufacturing technology means that less physical labor is required in the face of increasing demand for the manufactured product. Since there is less demand for physical labor, according to the laws of supply and demand, employers will pay less for their current labor. Technology efficiency also means that less raw materials are required because there is less waste in manufacturing which leads to decreases in commodity prices as less raw materials are needed to produce the same goods. The lower commodity prices further increases cost savings. The cost savings of their produced product is passed onto consumers in the form of lower prices which shows up in the form of lower inflation. The economic theory becomes less effective in using inflation rate as an indicator of economic growth. Another way of saying this is that we are currently testing the limits of these economic theories. Whether current economic theory holds, theorists have to add another factor to the economic theory mathematically to account for these new phenomenon (e.g. in Chemistry, the Van Der Waals equation explains the behavior of gasses in ideal conditions. To account for real gas behavior, a factor is added to the equation to explain the deviation from the ideal gas law), or we have to create a new set of equations remains to be seen.

What we cannot do, however, is to make the mistake of trying to use the economic phenomenon to explain the economic theory instead of asking whether the economic model is still viable in explaining the current economic landscape.