Why Valeant Pharmaceuticals Plummeted Today

What: Valeant Pharmaceuticals was down almost 40% at one point today after Citron Research published a report claiming that the drugmaker could be "creating invoices to deceive the auditors and book revenue."

A company mid-day response helped relieve some of the bloodletting, but shares are still down 17% as I'm writing this.

So what: When Citron speaks, people hit the sell button. Throw in a scintillating title, "Valeant: Could this be the Pharmaceutical Enron?" and they move a little quicker.

That's exactly what Citron wants investors to do because presumably the firm is short the stock and makes money when it goes down. Citron has no evidence that Valeant is actually making fake sales. It's an assumption based on the fact that Philidor RX Services, a specialty pharmacy that Valeant Pharmaceuticals has an option to buy, has the same phone number and patient privacy disclosure as quite a few other pharmacies.

"It is apparent to Citron that Valeant has created a network of "pharmacies" as clones of Philidor. Why do these exist? Citron believes it is merely for the purpose of phantom sales or stuff the channel, and avoid scrutiny from the auditors."

Valeant Pharmaceuticals has a simple explanation for why the pharmacies Citron found look so similar: Philidor Rx Services provides "back-end services, including call center, claims adjudication, IT and logistics support, as well as compliance/HIPPA regulation guidance, to other pharmacies." They all have the same phone number for patients to call because the other pharmacies pay Philidor to answer the phone.

Most importantly, when Valeant Pharmaceuticals ships drug to Philidor or its network pharmacies, the drugmaker doesn't book them as sales. The drugs stay in inventory on the financial results and only get booked as sales when the pharmacy ships them to patients.

Booking sales when a patient gets the drug is pretty common for drugmakers. Almost all small drugmakers use this more conservative method initially when the drug is launched because they don't know how much drug is going to get returned.

Companies that book sales when they ship product to middlemen -- wholesalers and pharmacies -- can get in trouble when the inventories at the middlemen get higher than expected. Until it's realized, revenue will outpace the actual demand. But with Valeant Pharmaceuticals' accounting practice, that can never happen because sales matches demand exactly with a slight delay in booking sales until the pharmacy tells them the product is sold.

Now what: If Valeant Pharmaceuticals is telling the truth, it really shouldn't be worth any less today than it was yesterday. Normally this would be a good time to break out the Buffett saying about buying when others are fearful, but sometimes they're fearful for a reason. Besides the Citron issue, Valeant has other concerns, including government investigations into its drug pricing practice and an uncertain future if it doesn't continue raising drug prices. Of course, Valeant Pharmaceuticals is down about 50% over the last three months, so much of that risk is already priced into the stock.

The article Why Valeant Pharmaceuticals Plummeted Today originally appeared on Fool.com.

Brian Orelli has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.