Will Valeant Become Fairfax Financial Redux?

“What has been will be again, what has been done will be done again; there is nothing new under the sun.” --Ecclesiastes 1:9 (New International Version)

Back in the stone ages of financial history, or to be more exact, a little over a decade ago, a group of hedge funds, journalists and one securities analyst allegedly executed a highly sophisticated--and highly successful, at least temporarily--bear raid on a Canadian company called Fairfax Financial Holdings. Interestingly, upon review and analysis of the court filings and other documents that have come to light since then in the litigation initiated by Fairfax against the various players in this bear raid, one can discern quite a few similarities between it and the recent "short attack" perpetuated against Valeant Pharmaceuticals (or VRX). More specifically, one finds that the tactics, arguments and even the dramatis personae in both cases are strikingly similar, and in many instances identical. Even more interesting, however, is the denouement to the Fairfax story, which may hold clues for investors regarding who the bear raid on Valeant may ultimately end up benefiting (spoiler alert: it's the longs).

This article will be divided into three main sections. First, I examine the many similarities between the "short attacks" on Fairfax Financial and Valeant. Second, I discuss the aftermath of the Fairfax Financial bear raid and what it means for current and prospective Valeant investors. Finally, I scrutinize the most recent Valeant bear arguments, which seem to me to be increasingly unfounded and desperate, suggesting that the bear raid has largely run its course.

Part 1 - Similarities Between the Two Short Attacks

A. John Hempton, James Chanos and Citron Research Were Instrumental In Propagating Each Short Thesis

John Hempton of Bronte Capital Was "Present At The Creation" of Both Bear Raids

According to this link, Australian hedge fund manager John Hempton has posted on Yahoo! Finance message boards under the pseudonym "brolgaboy1", as well as "jamiewoodford1", "scudzy_short" and "zipperdydoodah". Back in July 2000, we find "brolgaboy1" posting the following (note that one needs to click "View More Messages" at the bottom of the link to get to the applicable post) regarding Watsa and Fairfax:

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We first note the use of "shonk", a seemingly unfamiliar term to American eyes and ears. According to this, "shonk" is Australian slang (remember, Hempton is Australian), meaning something similar to "fraud" or "shyster".

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Second, a "brolga" is a type of Australian bird. Thus, it seems fairly clear that the poster "brolgaboy1" is of Australian origin. Lastly, we note that Hempton has stated that he began his career as an analyst of insurance companies and banks, which would logically dovetail with him examining Fairfax (an insurance company) as a possible investment:

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Assuming that "brolgaboy1" is indeed Hempton, from the above message board posting it appears that he was confident that Fairfax was a good short by mid-2000. Further, there is an  interesting  trove  of  documents  online regarding Mr. Hempton and other short sellers. This appears to derive from the subsequent "Fairfax Financial versus The Hedge Funds" litigation, by early December 2002 Hempton, who was working at a hedge fund called Platinum Asset Management, was even more certain that Fairfax was a compelling short opportunity. By then he had "convinced [his] boss [at Platinum] to have a bit of a go at [i.e., short] Fairfax Financial", as he explained to a fellow hedge funder at Rocker Partners, with whom he was discussing the short thesis:

! Later that same month we find Hempton practically begging noted value investing firm Longleaf Partners to explain their long position in Fairfax to him (he describes Fairfax as a "ponzi pure and simple"):

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The key part of Hempton's message to Longleaf was that it was inevitable that their Fairfax Financial investment would "end in tears" and essentially "go bust" (i.e., go to zero):

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Similarly, we find that Mr. Hempton was likewise short at the inception of the Valeant bear raid. He began posting about Valeant �  6

on his Bronte Capital blog in June of 2014, when VRX was trading around $130/share. He has continued posting iterations of his bear thesis ever since (including his sleuthing out of the Philidor-Valeant relationship), with the most recent VRX blog entry made just a few days ago.

Much like Fairfax, Hempton was and is also convinced that Valeant "is a zero" and will end in "Chapter 11" (bankruptcy), as is clear from his following recent Twitter posts:

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James Chanos of Kynikos Associates Was A Key Short Detractor of Both Companies

It appears that either directly or indirectly Hempton's research succeeded in also interesting famed short seller James Chanos in the Fairfax Financial short thesis. By August of 2002, two years after "brolgaboy1" initially revealed the short thesis, we find confirmation that Chanos had also bought in:

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Indeed, in 2002 Chanos declared to Dan Loeb of hedge fund Third Point that he believed that Fairfax's shares were "going to zero" (echoing Hempton's prior call).

More recently, Chanos has openly attacked the Valeant business model. In May 2014 on a CNBC appearance, he revealed that he was shorting VRX stock:

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Once again it seems that Chanos and Hempton are strangely vibing with one another, as Chanos's CNBC remarks were made just a few weeks prior to Hempton's initial negative blog posts on Valeant.

Citron Research (fka Stocklemon) Published Ill-Informed "Smoking Gun" Exposees Regarding Both Companies, Comparing Each To Enron

Finally, it is remarkable how similar a role Andrew Left at Citron Research played in both the Fairfax and Valeant bear raids. In both instances he was somewhat late to the short party, however he attempted to make up for that by spouting the most incendiary allegations possible (the proverbial "shouting fire in a crowded theater"). Back in October 2005, Left (then publishing under the "Stocklemon" moniker) let loose with the following broadside against Fairfax, incorrectly claiming "the final fatal blow" to Fairfax may have just occurred:

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A few months later Left published another piece on Fairfax in which he stated that the company was likely the next Enron:

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"The next Enron"!!! "Where There's Smoke, There's Fire"!!! "Smoking Gun Revealed"!!!!!! Does any of this sound--to paraphrase Left's words--"eerily similar" to anything more recent? Amazingly, ten years to the very day after Left published his initial Fairfax piece, he published his so-called "smoking gun" Valeant piece:

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And much as with his erroneous Fairfax hit job, which ultimately proved entirely baseless, Left has now begun backtracking on his nonsensical Valeant / Enron thesis. Even his fellow shorts have gone on the record to state that Citron's "channel stuffing" thesis was complete nonsense:

! History indeed rhymes.

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B. Reporters and Columnists Allegedly "Fed" Critical Stories About Fairfax and Valeant By the Shorts

The above-excerpted email from Eavis to Chanos in August 2002 regarding Fairfax indeed foreshadowed the success of the shorts in getting financial reporters to critically cover Fairfax Financial. By early 2003 Eavis was penning the likes of the following about Fairfax:

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Similarly, it appears that journalist Roddy Boyd, now of SIRF (or the Southern Investigative Reporting Foundation) and previously with the New York Post, has also played a key role as a "mouthpiece for the shorts" in the bear raids against Fairfax and Valeant. Back in 2006, for example, while the hedge funds were still scrambling to take down Fairfax, we discover from the above New York Post link that he penned at least four pieces that were highly critical of Fairfax, echoing the arguments of the short sellers:

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Boyd's "hits" (against Fairfax) kept coming when he transferred to Fortune, as witnessed by the following from a 2008 piece:

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Boyd, now at SIRF, has played an instrumental role in the Valeant bear raid as well. He broke the Philidor story, for example:

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And he has published several follow-up pieces that are sharply critical of Valeant (see here and here).

If anyone doubts that Hempton was Boyd's (and possibly Citron's) prime source for breaking the Philidor story, or that somehow the three parties were coordinating their actions, simply look at the following sequence of events and tell me what it suggests:

On October 15th, Hempton mysteriously teases the following regarding "Philidor" in a blog post:

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On October 19th, just four days later, Boyd reveals the Valeant / Philidor connection publicly for the first time.

On October 21st, just two days after that, Citron goes public with its Valeant / Enron "smoking gun" piece. If it walks like a duck...

Finally, it should be noted that Gretchen Morgenson of the New York Times has also been sharply critical of both Fairfax and Valeant. For examples, see here and here (for Fairfax) and here and here (for Valeant). Morgenson's May 2008 Fairfax article so outraged noted short seller (ironically) Whitney Tilson that he publicly called it a "smear and a hatchet job":

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Call me crazy, but I wouldn't be exactly floored if it were one day revealed that Morgenson's prime sources for the above-referenced articles were short seller(s) with a financial interest in seeing Fairfax and/or Valeant publicly criticized. If fact, given the clearly slanted nature of the articles, I would be floored if it were the opposite. Of course, reporters can always claim that their sources are subject to a journalist's 1st Amendment privilege, so we will likely never find out the truth on this point.

C. The Stock Prices of Both Companies Collapsed in the Wake of the Bear Raids

So, what was the result of the foregoing? Each bear raid (at least initially) accomplished what it set out to--tank the applicable company's stock price. In the wake of the Fairfax bear raid (just around the time Peter Eavis was publishing his negative articles), the company's stock price plummeted from $90/share in December 2002 to a low of $46.71/share just 3 months later, a total drop of nearly 50%.

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In like fashion, Valeant's stock price cratered from $178 to $110 (or down 38%) in just four trading days following the initial

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SIRF story regarding Philidor, and continued to fall thereafter to as low as $69.33:

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Part 2 - Denouement of the Fairfax Financial Bear Raid and Lessons Learned Therefrom

So we have seen above that both Fairfax Financial and Valeant appear to have been the subject of extremely well-coordinated and well-executed bear raids, which in each case successfully tanked their respective stock prices. But why should this similarity matter to Valeant investors today?

Certainly, Valeant longs should be worried if the bearish warnings of the shorts from 2002 and onwards had ultimately proven correct and Fairfax had indeed "gone to zero" as the shorts so vociferously predicted. But did it? As they say, a picture is worth 1000 words:

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As can be clearly seen from the above chart, the "short attack" on Fairfax ultimately proved to be toothless, as the endlessly repeated short seller predictions of Fairfax's impending demise never came to pass. The stock is now up a massive 1000% since the depths reached in early 2003, when the Fairfax bear raid reached its point of peak effectiveness. While certainly annoying to CEO Prem Watsa, the company and its shareholders, the raid had no measurable long-term negative effect on Fairfax.

In light of the fact that Hempton, Chanos and Citron were wrong about Fairfax, why should investors listen to them about Valeant? Is it because Fairfax was just an anomaly, the exception that proves the rule of their collective brilliance? I would beg to differ. Let's examine the track record of Mr. Hempton, for example. Here we note that his two most recent publicly-announced long stock picks, SunEdison and Rolls Royce (see Bronte Capital analyses here and here, respectively), have gone horribly wrong for the man thus far.

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Even Hempton himself cannot deny his recent stock-picking boners:

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Well, what about Mr. Chanos, isn't he the guy that uncovered the Enron fraud? Surely he couldn't be wrong about both Fairfax and Valeant, right? Well, here is his record predicting the imminent collapse of China's economy, which still hasn't happened:

2008: "Chanos was excited that afternoon. He had just read a report that China's electric consumption had dropped 4 percent, despite official government statistics that the Chinese economy was growing at 8 percent. He relished the implications. "I think they're making up the numbers!" he said. As Wall Street picks up the pieces of the broken financial system, Chanos is already one step ahead. He sees China as the next domino to fall in the global meltdown."

2010: "James S. Chanos built one of the largest fortunes on Wall Street by foreseeing the collapse of Enron and other highflying companies whose stories were too good to be true. Now Mr. Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc."

2012: "China's economy continues to deteriorate despite the government's efforts to paper over the troubles, making the country's stocks ripe for short-selling, hedge fund titan Jim Chanos told CNBC."

2014: "Hedge fund manager Jim Chanos, who has a long-running bet against China, said that the country's credit bubble was starting to cause capital outflows to accelerate and may ultimately lead to weakness in the nation's currency."

2015: "Longtime China bear Jim Chanos said Wednesday Beijing is running out of room to borrow, which at some point will lead to a "credit event.""

You can't say Chanos isn't consistent! Meanwhile, China continues to irritatingly grow its GDP at 7% per annum. The following is what gazillionaire Carl Icahn had to say about Chanos back in 2013: “Look, I've known Chanos for years. I respect him, but I've been on the other side of him many times [on trades], and I've made fortunes being against him. I don't say this in any derogatory way, but I don't see Chanos on the Forbes 400 list.”

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Ouch. So maybe Mr. Hempton and Mr. Chanos are perhaps not all they are cracked up to be in the press and in stock chatrooms. But how could anyone bet against Citron? Oh wait, I forgot, as shown above Citron has already been completely discredited on the Valeant issue with their 100% false channel-stuffing allegations, which were easily refuted by the company and even dismissed by fellow Valeant short Hempton. Nevermind.

Part 3 - Valeant Short Arguments Becoming Increasingly Desperate and Illogical

While the shorts succeeded in uncovering the Philidor / Valeant relationship, which completely decimated Valeant's stock price (at least in the short term), I believe they have recently provided investors with a "tell"--to borrow a poker term--suggesting that the Valeant bear raid may be petering out. This tell has come in the form of what appear to me to be increasingly desperate and illogical short arguments.

First, as noted above, Citron has put its proverbial tail between its legs and run away, publishing its "Last Word on Valeant" on November 2nd. Accordingly, Citron has not been heard from since. Second, Hempton's most recent blog posts on the company seem to reek of desperation. On November 19th he boldly announced "Channel stuffing by Valeant in Europe confirmed". But when one actually reads the post, it confirms nothing of the sort. Instead, it links to an article by a Slovenian "business website" (i.e., blog) that states that the author received "a yet unconfirmed and unofficial information" that "could indicate" possible channel stuffing in Europe. So much for "confirmed"! More like "100% totally unconfirmed speculation" (note that one website even claims that Hempton was instrumental in fabricating the entire story). Valeant quickly refutted the alleged European channel-stuffing as total nonsense:

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Hempton then lobbed another desperate grenade Valeant's way on November 25th, this one about "Valeant affiliates still setting up and operating bogus pharmacies". This attempt was yet again fairly easily batted away by the company:

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In sum, it appears that Hempton and Citron have each run out of ammunition and are now relegated to deserting the field of battle (in the case of Citron) or grasping at straws in trying to discredit the company (in the case of Hempton). This, in my opinion, does not bode well for Valeant shorts.

Conclusion

A close examination of the bear raids on Fairfax Financial and Valeant reveals many eerie similarities, from the respective participants, to the tactics employed, indeed right down to the very arguments used by the shorts against each company. Their playbook seems to be the same in each case. In the fullness of time it became apparent that the Fairfax bear raid was based on false arguments and empty predictions, none of which held any water. I believe that the examination of the Fairfax "short attack" and its aftermath provides quite a few important clues to investors as to how the Valeant bear raid may ultimately play out, namely, in favor of the longs. Indeed, in my view the shorts appear to be increasingly desperate and illogical in their arguments against Valeant. While the future is always uncertain, history indeed rhymes--"there is nothing new under the sun".

Disclosure: Long Valeant (obviously).

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