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Valeant Fiasco Hits Biggest Holder: Sequoia Suffers Largest Outflow Of The Year, And Why It Could Get Worse

We previously reported that despite his spirited, now weekly and very public defense of his investment in Valeant which has resulted in over $2 billion in losses, so far Bill Ackman's Pershing Square has not been seen notable redemptions. However, the same can not be said about Valeant's top holder, The Sequoia Fund - which was founded by Warren Buffett's friend William Ruane and which had $7.2 billion in AUM as of November 4 - which has likewise defended its massive bet on Valeant, and which according to Bloomberg has seen $98.9 million in redemptions in October, its biggest monthly outflow of the year.

According to Bloomberg, Ruane Cunniff & Goldfarb, the investment firm that runs the Sequoia Fund, was Valeant’s largest shareholder as of June 30, with VRX shares growing to 29% of Sequoia’s portfolio at midyear. The latest outflow is a continuation of previous redemptions: "in the first 10 months of 2015, Sequoia Fund’s outflows totaled about $213 million, Bloomberg data show, after investors withdrew more than $500 million in 2014."

As previously reported, two of the fund’s five independent directors, Vinod Ahooja and Sharon Osberg, quit in October as its top holding plunged and dragged down its long-term record. Shares of Valeant dropped 47 percent last month to $93.77 as of Oct. 30. Sequoia Fund declined about 9 percent in October, compared with a 8.4 percent return for the Standard & Poor’s 500 Index.

Meanwhile, the selling in Valeant has continued while the company's CDS has continued to drift wider, and now suggests a 46% default probability over the next five years.

But what has been a relative trickle in outflows, could accelerate dramatically following a report overnight from the WSJ, according to which "as shares in Valeant Pharmaceuticals International Inc. plunged in recent weeks, representatives from its largest shareholder went to great lengths to check up on its multibillion-dollar investment, including paying hundreds of dollars for information and offering thousands more to not talk with anyone else."

Ruane, Cunniff & Goldfarb Inc., manager of Sequoia Fund Inc., said it reached out to former employees of the Philidor Rx Services LLC mail-order pharmacy that almost exclusively dispensed Valeant drugs and sought to speak with them about the pharmacy’s work.


Staff from Ruane Cunniff paid ex-employees and pledged to keep names of those they spoke to confidential, said David Poppe, the firm’s president. He said the firm paid $1,000 to talk with one former employee for two hours and discussed giving that ex-employee several thousand dollars if the person would keep Ruane Cunniff exclusively apprised “about what was happening at Philidor,” though the firm eventually decided against entering into any further arrangement.

In retrospect the interest in understandable: after all until last month virtually none of the Valeant investors had heard of Philidor:

“At least for us, it’s hard to get great insight into what was going on there. There’s a certain sense of flying blind through this whole thing,” said Michael Waterhouse, a Morningstar analyst who follows Valeant. Mr. Waterhouse said he raised the company’s uncertainty rating to high, up from medium, and is waiting to see what a Valeant board investigation finds.

The problem for Sequoia is how to justify its public statements, which as noted above, rushed to defend Valeant's relationship with Philidor only to see the tie between the two companies officially severed two weeks ago, suggesting at least some impropriety.

Its subsequent backtracking has not helped: as the WSJ adds, "Sequoia has always had a history of buying and selling based on its own research, not on what is popular or unpopular," said Sequoia board Chairman Roger Lowenstein.

Except on this occasion, when the only thing that Valeant had going for itself was a massive debt-funded rollup strategy and, of course, in the process becoming one of the biggest hedge fund hotels, with its popularity becoming its key selling point.

It gets worse: 

“We went into our own due diligence phase, and we reached out to a number of people. Some of them wanted to be paid for their time, and we did pay them for their time,” Mr. Poppe said. He said Ruane Cunniff told every person it spoke with that it “did not want them to violate any nondisclosure agreements they had signed with Philidor.”

Sorry, but the due diligence phase is supposed to take place before not after an investment that accounts for almost a third of your assets. As for whether Sequoia's payments to former Philidor employees constituted "hush money" that will be up to the multi-billions fund's other investors to decide. If the answer is yes, or if the recent stumble in performance has led many to say "enough", expect hundreds of millions or more in redemptions, which will unleash even more selling of Valeant shares, and so on until the fair price of the company finally emerges and true "value investors" can finally step in and buy.