As \VC have said in prior letters, our approach 1:0 investing in dtis macro en,•iroon1cnr cc1nains
full stc2m ahc:ad \viltl original prim.ary research and bo[coin~ up stock picking, \vbilc running a slightl)'
mort' cauliOu$ por:tJolio (slightl)' less gross exposure and lo\ver tolerance for fuctor exposures than
11onnal). \Ve are carefully monitoring tail risks. For11:1natel)\ as bot1om-up i;tock pickers, '''e have a
process tbac should allo'v us to drjvc profits independent or most macro outcomes.

\X'e appreciate those partners \\•ho l1ave read our letter chorooghty, as \Ve feel d1e bencr our
partners understilnd our process, cbe better n1:nchcd \VC rcinain fot e:H;:l1 o ther.

\Xie remain, noses down, hard at work on the lnlil of exciting in.... esunenrs.

~ally,

jtlr1'4
Jonathan Auerbach

 
 
 Instead o f questio ning h ow they were achieving these results, ow: skepticism failed, and w e
looked at this as valid ation of theit controv ersial stmtegy. Ow: skepticism didn't merely fail.
It failed U1 a speetacolac way, which we can actw:lly quai1tify. W e have a process that takes
p lace after each team meeting. toughly eveq hvo week s, wltere each memb er of tlte
inv estmet1t team gets to suggest tlu t t1p to tlu ee names U1 the portfolio sho uld b e bigger and
up to tlu:ee oan1es sl1ould be trim.med. While I nuke tlte final si2.ing decisiot1s, I like to hear
where the team bas the highest cot1vietio n , ai1d a back-test o f tllis d ata shows a significant
sigtul wltece mote tlUJ.1 a certain ntlOlber of teammates all line t1p in ou.e directio n . Owing
the fo w: ai1d a half yeus we owned tlte sto ck while it was appreciating. VRX got 72 trim
votes ai1d 3 add votes. Thece was co nsider:a.ble skepticism, tl1o ttgh it lu d to do with si:U-.g;
we dot1't think there was ai1yot1e wl10 tntly d.Jsliked the tume entirely. W 1:We 72 se.en1s lligh,
keep in mind tlu t - 1 S v oters, w ith up to 3 trim and 3 ad d votes, -20x a yeu v oted foe fo w:
and a lulf years. I tet1d to look at the ntio ratltec than the magnitude. The key is befo ce
VRX's peak, the vote count was 72/ 3 trim/ ad d, wl1ereas after \ TR.X's p eak, there were 12
ad d v ote.s and otUy 3 trim votes.

W e feel Otte of the main ceasot1s out skepticism. fu.iled is that we became ltxJ dost to the oan1e
after 11oldit-.g it foe so many yeacs. W e recognized tllis as a risk two yea.cs back ai1d had an
independet1t team o f two H ounds do a " devil's advocate" review by seeking out beat cases
and cliligencing tl1e O\OSt ctedible Ottes. 1his process led US to what we still believe (after
much debate) was the coueet decisiot1 to 11old tlte sto ck dtu:U-.g a sigtUficant beu attack
(AGN ounagemet1t + Cha.no s) , and tlte stock 01oce than doubled However, with the
passage o f time, tho se two How.1d s potet1tially joined the \7R.X aoolysts ai1d myself in the /Qo
,Jost camp. W e also feel tlu t tlte ntlOlbec of ti.mes tlu t VRX fought off voeal, if not
v el1emeot, beus desensitized t1s. As we sat uot1n d tlte tab le d.Jscossiog what had happ en ed,
mai1y u sed the wocd " n un1b" to desctibe out r eaction to tlte latest b eat acgume nt:s.

O ne o f tl1e key takeaways is that lo ng-ten tu ed successful positio n s cai1 cat1se t1s to b e
bebaviocally k)o dost to a name, and we need to guard against tlu t possibility. I r eally would
have liked us to hav e assigned a new team to have d o ne a devil's advocate o n tllis Ogl1t after
Pllilidoc had hit. I can't know that it would have chat-.ged the o u tcome, but it was a b ig aliss
ot1 o u c p art not to have done Otte. L.1 & ct, I 'm emb auassed to say, no Otte even discu ssed the
possibility.

3. A slight derivative of the p oint above is that w e came to /nJJf the management of \7R.X. W e
developed a cebtiot1ship with \ 7aleaot's manageme nt team and Boacd of D iteetocs o ver ow:
owttership p eriod, ai1d we gcew to tn1st tltem . While this level of access is o ften helpful U1
otu motlitocing process, in this case the d ut:a.tiot1 o f tlte celatiot1ship and tlte coa1pan.y's
ot1tstand.Jog pecfocmance gcadually d ulled otu skepticism ai1d led us to p lace too m t\Clt trust
in management ai1d the Boacd .

There ue times wh e n certain elements o f tlte business just can't be ceseucl1ed, ai1d we & ce a
cl1oice to either trust manageo1ent o c be skeptical. W e cho se the fo aner, and tllis tn1st was
misplaced: manageo1ent ultimately misled t1s, and tlte Boacd ultimately failed us. Foe
example, we spet1t tin1e 'Witl1 both management and tlte Boacd d utU-.g the P hilidoc-to-
W algceens transitio n in late 2015 and ultinutely b elieved tlte company's assertio n s cegacding
Pllilidoc's limited impact and W algteet1s's potet1tial to b e a ropetio c charutel. W 1:We we
supplemet1ted these management conversatiot1s 'With a significant amount of independent
diligence, tltese dist:cibutio n paru1ersllips ace tmiquely difficult to diligence from the outside,
so it ultinutely caa1e down to trusting maiugemeot and the Boacd . I t is higlUy w.ilikely tlut
 
 we would have afforded tlte benefit of the d oubt to a team we d.JcL.1't know, but we did witlt
Valeant, which proved to be a mistake.

Other ilia.n to flag this as a clear behavioral mistake to avoid U1 the future, we don't have
mo'e to add on this takeaway.

4. As Valea:nt started to w.uavel U1 tlte sunuiter of 2015, ou.r process repeatedly proved too
i11cr1111mhl. At each crisis poU1t, we went back to out prob ability tree, quantified the impact of
the change (always negative) and assessed tlte updated risk-reward (3lmost always better
given the significant stock price reactions). At each stage, however, we were looking at a
small part of the business, ratlter: than the whole. For ex:unple w e spent consid erable hours
wot.king 0 11 Philidor, which was o nly 6o/o o f sales, of which o nly a portion was ttt1sustaituble,
but didn~t spend enough time revisiting tlte remaining 94o/o. We nlissed the forest fO£ tlte
trees, specifically by failing to reali::e how reflexive the situation would beconte. For
example, Bernie Sander:s's attacks regarding tlte N itropress and Isuprel price increases likely
eattlyudl Hi11uy C linton a11d Congress's attacks 011 Valeant, which in tum likely eattlyud
the PB?t..,[ s to cond uct a category review o f demuto logy 3.fter years of inertia towud and
benefits from pr.ice i11ereases in dem1atology, which ultimately led to significant pr.ice cuts
and associated EBTI'DA reductions at Valeant, wlliclt given Valeant 's levuage introduced
baokroptcy concerm and crushed the @qtlity. Tbis is 011"' of >everal enmpl•s where th•
situation proved reflexive, yet w e failed to gnsp tllis refl~xivity until it was too late.

It 's sinlihtly difficult to U1stitute a process step to guard against U1erementalism., other than
to believe, as we do, that this expecie11ce lus been sufficiently scauing and eye-opening that
we will avoid repeating it.

Out missteps: on \ 7ale-ant have been painful We 'Wish we would have avoided tltem. Since we
didn't, we can only ain1 to learn tlte right lessons and take the appropriate steps to avoid these errors
in the f nture, suclh that ultinutely, this experience will have nude us better steward s of ow: partners'
capital for many y ears to con1e.

 
 
 
a.st./ .cewru:ds such as tltese. We look to net exposute as otu primacy 01etric when d etei:mitting
whethei: we a.ce fully invested. but a.ce cognizant that when g.coss e.xposute exceeds 100°/ o, even to
support hedges. ad ditional risk units ate p.cese.nt.

Best.

JA