Valeant has another big problem

For days Wall Street has been watching in horror as one of its former darling stocks, pharmaceutical behemoth Valeant, has gotten utterly destroyed.

But if you're only looking at the company's stock, you're missing the scariest part of the story: its corporate bonds.

Markit points out that Valeant's bonds are telling us that investors have gotten skeptical of the company's health.

Credit default swaps on the company's bonds have blown out, while prices on the company's bonds have dropped sharply.

CDS functions as a type of insurance on corporate or sovereign debt debt. Valeant's CDS spread traded 177bps wider on Wednesday, though Markit noted that the credit default swaps are relatively illiquid. That means the cost of insuring $10 million of Valeant bonds against default got $177,000 more expensive in a single day.

Valeant's bonds, which are liquid, have plummeted. The company's 2021 note, which has a coupon of 5.625%, dropped 8% to 88 cents to the dollar. That means those bonds now yield 6.8% above benchmark US treasuries, up from 3.5% earlier in the summer. Bond yields move inverse to price.

Valeant's has been under intense pressure since Wednesday, when short-selling firm Citron Research released a report accusing it of fraud. The report posited that Valeant may be using opaque "specialty pharmacies" to book revenue for products it never sold.

Since then the stock has fallen over 30%. Naturally, that's getting a lot of attention.

However, the bond market is even more key to the Valeant's survival than its stock price, because Valeant is carrying a ton of debt - a result of the acquisition driven, low R&D spending business model that Wall Street loved and Washington came to hate starting last month.

"Valeant is a relatively leveraged player with $18 billion of long term debt on its balance sheet so the firm will need to placate the bond market in order for the equity portion of its balance sheet to recover," Markit wrote

"Failure to do so could see the firm enter a pattern similar to the one seen in Glencore last month."

So what does that mean? Glencore is a debt-laden commodities giant suffering from low commodity prices. The company's share price and CDS went crazy late last month as rumors swirled about its creditworthiness.

How do you solve a Glencore problem?

Like Glencore, Valeant has a ton of debt to service. To get board approval for its last acquisition, it agreed to a mandatory drawdown of $580 million.

On the profitability side, Valeant's prices aren't under attack, but its business model is.

Glencore eventually decided to suspend its dividend, cut spending and launch a share sale to fund a debt buyback.

CEO Michael Pearson said on the company's Q3 earnings call on Monday that he was also focused on leverage.

"...I do want to re-emphasize that our commitment to reducing our leverage is first and foremost... But that still leaves a lot of cash to either do deals or deploy. I don't think there's any acquisition right now that would earn the return of buying back Valeant shares. So, that will also be part of the consideration."

It has now said it will host another conference call on Monday to address allegations made by Citron.

The participants on the call include CEO Michael Pearson, general counsel Robert Chai-Onn, CFO Rober Rosiello, and a number of board members and risk committee members.

10 Valeant executives will be on the call in total.