The Street Is Underestimating Valeant's Potential Downside From Legal Woes

Wells Fargo reiterated its Underperform rating on Valeant Pharmaceuticals Intl Inc (NYSE: VRX) as it believes the Street is underestimating the potential downside from the company's legal woes.

Senior analyst David Maris specifically pointed out an insider trading suit filed against Valeant and Pershing Square related to their failed joint takeover attempt of Allergan plc Ordinary Shares (NYSE: AGN). Recently, the plaintiffs won what is considered to be a key motion. Pershing Square owns 21.6 million shares of Valeant.

"[T]his is a major positive for the plaintiffs as the "advice of counsel" defense (that is, we trusted our lawyers) could allow a far greater amount of discovery as when claiming it as part of a defense, some client-attorney work product may no longer be privileged," Maris wrote in a note.

The analyst expects investors to be more concerned about the potential negative outcome of this trial as they enter 2017.

"We would expect investor concern to eventually focus on potential selling pressure given a negative outcome as well as what might happen to Valeant's balance sheet if they lose," Maris highlighted.

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There are also lawsuits from T. Rowe Price Group Inc (NASDAQ: TROW) and a separate class action suit with TIAA-CREF as the lead plaintiff, as well as investigations from the SEC, Southern District Court of NY, and IRS, among others.

Maris warned stakes of the lawsuits "might not be in the tens of millions, but much larger" as Wall Street Journal said T. Rowe Price's stake was alone worth more than $4.5 billion at its peak. Importantly, Valeant hasn't taken any reserves for Allergan or Philidor-related litigation.

"We believe Valeant shares currently carry too much risk for us to be comfortable recommending them as an investment," Maris added.

Maris's concerns include accounting issues, balance sheet risks, unanswered questions related to business practices, and skepticism over benefits of the Walgreens deal to Valeant.

The analyst has a valuation range of $17 to $22.