A major Philidor strategy is very much alive and well at Valeant

Philidor is dead, long live Philidor.

Last year the discovery of a secret pharmacy inside Valeant Pharmaceuticals called Philidor contributed to the company's near-death stock dive.

At 2015's peak Valeant's stock reached $257, only to fall to where it now sits at around $14.25. Amid the turmoil, which included a federal investigation into alleged insurance fraud at the pharmacy, Valeant shut Philidor down completely at the beginning of 2016.

But that doesn't mean the company has done away with the Philidor playbook entirely.

According to an internal Valeant document obtained by Business Insider, one major strategy Valeant used to get managed healthcare companies - like pharmacy benefit managers and insurers - to cover drugs sold from Philidor was to simply pay them really fat rebates. The more competition the drug had, or the more expensive it was, the fatter the rebate.

And according to Valeant's third quarter earnings call, this strategy is still central to the company's success. Paying up on rebates is still a big way the company ensures that its drugs are covered by insurers.

"Yes there are some higher rebates ... Xiafaxan is a good example," said CEO Joe Papa referencing the company's leading irritable bowel syndrome drug, which has considerable competition. "Coming into the year we wanted to get better access ... we did have to give incremental rebates."

What's more, Valeant executives said those rebates are set to increase even more in the fourth quarter, likely contributing to the company's lowered guidance. That lowered guidance combined with an earnings miss decimated Valeant's stock after the announcement. It fell as much as 25%.

Philidor style

The document Business Insider viewed was a presentation called 'Solodyn and Jublia Economic Analysis and Factbase.' It's dated August 9, 2015, when Valeant's stock was riding high.

In it, the company outlines a strategy for getting more payers to cover two of Valeant's top dermatology drugs, acne drug Solodyn and toe fungus drug Jublia.

After Philidor started selling the drugs in 2015, Jublia's and Solodyn's sales exploded. But that was just gross sales - volume. Valeant was actually netting far less revenue than gross sales suggested because it would mark drugs as sold before payers were actually shelling out cash.

For example, sometimes payers would reject Philidor drugs because the pharmacy would send them too frequently, or because the payer simply preferred a cheaper generic alternative. The payer's mandate, after all, is to keep costs down for consumers.

So when payment was rejected, Valeant would have to eat the cost of those drugs that were already sent out. Those losses accounted for 32% of Solodyn sales and 14% of Jublia sales in Q1 2015 - not an insignificant number.

"Solodyn and Jublia sales grew 56% and 188% overall, but most of Solodyn's growth was subsidized (free) through Philidor," the presentation said.

That's why Valeant created this presentation in the first place - to strategize ways to get payers to accept more Jublia and Solodyn claims.

And the solution was pretty simple actually. Pay higher rebates to the gatekeepers between the drugs and their payments. For Solodyn, which is $1,000 drug with $100 competition, that meant paying rebates as high as 80%.

Here's a rundown of some of the rebate payments in the documents:

• Caremark Performance took a 70% rebate on Solodyn, and a 36% rebate on Jublia.
• Express Scripts National Preferred took a 39.4% rebate for Solodyn, and a 29.4% rebate for Jublia.
• United Healthcare Advantage took an 80.7% rebate for Solodyn and no rebate for Jublia.
• Anthem Blue Cross in California took a 39.4% rebate for Solodyn and a 29.4% rebate for Jublia.
• Optum Rx 3 Tier traditional took a 62.5% Solodyn and no rebate for Jublia.
• Humana Rx4 Traditional took a 66.4% rebate on Solodyn and no rebate for Jublia.
• Aetna Premier Commercial took a 45% rebate on Solodyn and no rebate for Jublia.

This strategy also involved hiking rebates in exchange for relaxed prior authorization restrictions. A prior authorization is when a doctor has to get permission from a payer or its representative before prescribing a drug.

Rebates were also hiked in exchange for a removal of step therapy requirements. Step therapy is when your insurer requires you to try cheaper generic alternatives before you get a more expensive branded medication.

Valeant is still using that strategy, and current CEO Joe Papa discussed it in relation to rising rebate costs on the Q3 earnings call.

"Remove step therapy requirements with higher rebates - we were willing to do that ... and that's what's been driving some of the rebates," he said.

Nice drug you got there, shame if anything should happen to it

After Philidor was shut down, then-Valeant CEO Michael Pearson announced that the company had struck a deal with Walgreens to open up a new distribution channel.

"We've always had strong growth and volume growth but the skeptics have all said it is price. But this will turn it almost all into volume," Pearson said on CNBC following the announcement.

That's true, sales volume is slowly starting to come back for drugs that were distributed through Philidor, but that doesn't mean revenues have.

Solodyn, for example, saw total prescription sales rise to 153 million in Q3 2016, according to data from Symphony Health solutions. That's up from 151 million total prescriptions during the same time a year before.

Solodyn's revenue, however, fell over the same period to $26 million from $66 million a year before.

Philidor, it seems, was better at getting drugs paid for than Walgreens is.

That said, Valeant expects that revenue to improve. In its presentation it said that former Philidor dermatology drugs (like Jublia and Solodyn) now going through Walgreens are seeing improving revenues thanks to "substantial improvement in patient access and prior authorization." Average sales prices for those drugs are also up 40%.

In other words, Valeant has started hiking those rebates too.

Again, Xiafaxan, which Valeant acquired last year and was supposed to be a $1 billion drug in 2016, is getting the same rebate treatment.

According to Valeant's data, Xiafaxan total prescriptions are up 24% from this time last year. Sales revenue, however, comes in below that - at $273 million in Q3 2016 as opposed to $220 million in Q3 2015.

And we should note that on the call analysts sounded worried about higher-than-normal- inventories for Xiafaxan. Inventories are backlogged about a month and a half while Xiafaxan's peers are usually holding around a few weeks.

Valeant executives told analysts not to worry about that. After all, rebates are going up in Q4. That should help.

Zero sum drug game

There are two big issues at play here, even though all of this is quite legal. First, money that Valeant is spending on keeping its old, expensive drugs relevant using rebates could be used to develop new drugs.

Second, these rebates are acting as incentives to keep costs high in the system. Drugs that would normally be rejected because they're too expensive are still getting paid for. That defeats the purpose of even having pharmacy benefit managers (PBMs) as gatekeepers between the drug companies and your insurance plan.

Not that the PBMs are complaining. Just as Valeant was reporting its atrocious earnings, CVS, which has an internal PBM, was reporting a "solid" quarter despite difficulties in the retail pharmacy business.

"We posted a solid third quarter with the PBM exceeding our expectations and retail performing at the lower end of our expectations," said President and Chief Executive Officer Larry Merlo [emphasis ours]. "However, very recent pharmacy network changes in the marketplace are expected to cause some retail prescriptions to begin migrating out of our pharmacies this quarter. In addition, we are currently experiencing slowing prescription growth in the overall market as well as a soft seasonal business. These factors combined are leading us to reduce the mid-point of our guidance for this year by five cents per share. The network changes have more significant implications for our 2017 outlook. While we expect a healthy increase in PBM operating profit growth in 2017, we expect a decrease in retail operating profit growth."

Someone's taking share here, guys. And it's definitely not you.