The Ultimate Kick in the Pants: Valeant's Former CEO Is Suing the Company

By Sean Williams Markets Fool.com

Never say never when it comes toValeant Pharmaceuticals (NYSE: VRX), because things can always get worse.According to news reports, the embattled drug developer is now being sued by its former chief executive officer J. Michael Pearson.

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The suit alleges that Pearson was due more than 3 million shares of Valeant stock as part of his exit from the company. This includes 580,676 restricted shares of Valeant stock and 2.46 million performance-based shares. Yes, I did just say "performance-based shares," despite the fact that Valeant's share price has fallen by 95% since the summer of 2015. Based on Monday's closing price, Pearson claims that he's due about $32.8 million in added compensation -- that's on top of the $9 million in pay he received as severance.

Image source: Getty Images.

Valeant's former CEO is a big reason the company is in this mess

Pearson led Valeant through great times. Between his appointment as CEO in Feb. 2008 and the summer of 2015, Valeant shares returned better than 1,800%. However, Pearson was also the architect behind the foundation that eventually crumbled under the company.

Valeant was caught with its hand in the cookie jar last year after Pearson, while testifying before a Senate committee, admitted that he and his team had made a "mistake' in the way the company priced two cardiovascular drugs that it had acquired from Marathon Pharmaceuticals in Feb. 2015, Nitropress and Isuprel. Shortly after acquiring both drugs, Pearson and his team raised the list prices for Nitropress and Isuprel by 525% and 212%, respectively. But neither drug had any formulary or manufacturing changes, meaning the price increase was entirely arbitrary.

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Raising the list price of its mature drugs was a core strategy under Pearson's leadership. But Valeant's pricing power has been severely compromised following Pearson's admission, with regulators keeping a close eye on its list prices. In the fourth quarter, Valeant noted that its pricing power was a detriment, not a benefit, to its overall sales-- and that's particularly troubling with the loss of patent exclusivity expected to cost the company an estimated $785 million this year.

Pearson was also at the reins when Valeant marched forward with its merger-and-acquisition-based growth strategy. For years, Valeant sought to acquire new drugs, developing pipelines, and healthcare products, and financed its acquisitions with debt. Valeant's lenders weren't worried in the least that the company had racked up more than $30 billion in debt because a key measure, Valeant's EBITDA-to-interest coverage ratio was adequately high. In plainer English, the company was generating enough in earnings before interest, taxes, depreciation, and amortization to easily cover the annual cost of servicing its debt (e.g., paying interest).

Image source: Getty Images.

But when Valeant's pricing power fell by the wayside and its public image began to suffer, dragging down the sales from its core operations, the company's EBITDA-to-interest coverage ratio also began to suffer. On multiple occasions, Valeant has been forced to renegotiate its debt covenant terms with its secured lenders, accepting fees and higher interest rates in the process.

All the while, the company has been mostly unsuccessful in its efforts to sell off non-core assets in order to reduce its debt. With the exception of selling its Denderon assets to China's Sanpower for $820 million, and the disposition of three medicated skincare products to L'Oreal for $1.3 billion (both sales occurred well after Pearson's departure), Valeant has hardly made a dent in its debt load.

Blame Valeant's board of directors, too

Put plainly, Pearson made some really bad decisions that ultimately came back to bite the company and its shareholders squarely in the behind. Even smart money managers, such as Bill Ackman of Pershing Square Capital Management, were taken for a ride. Ackman wound up losing upward of $4 billion on Valeant, riding its shares lower for the past year-and-a-half.

But it's not 100% Pearson's fault. Valeant's board and management team have made a number of poor decisions, too. In fact, they can partly be blamed for Pearson's current suit that's attempting to acquire around $33 million worth of Valeant's stock. One needs only to look at the deal they made to land former PerrigoCEO Joseph Papa as evidence of this.

Image source: Getty Images.

When the details of Papa's deal were disclosed in April 2016, they revealed that Papa had an opportunity (albeit a long shot of one) to earn in excess of $500 million from his deal. He was awarded a $1.5 million base salary, with a maximum cash bonus of $3 million, and required to purchase $5 million worth of Valeant shares within his first year as CEO.

Further, he was awarded about 2.25 million in share grants, most of which were dependent on the direction of Valeant's stock price down the road. All in all, it was a performance-based contract -- but getting Papa still came with a premium.

According to The Wall Street Journal last week, Papa wound up making what now seems like a ludicrous $62.7 million in pay in 2016. Mind you, Valeant's share price has declined by roughly two-thirds since he took over, which hardly seems commensurate with such a large sum.

If this is what shareholders have to deal with at the management level, it's no wonder the company's operations and balance sheet are a mess.

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Sean Williams has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool has a disclosure policy.