Valeant's future hangs on a single word

On Wednesday embattled drug maker Valeant will present its guidance for 2016 in a four-hour Investor Day conference call that starts at 8:00 am EST.

It will have a lot of explaining to do, and most of it will have to do with one word - volume.

Valeant has seen its share price cut in half since October.

That's when questions about its drug price practices and organic growth collided with the revelation that its specialty pharmacy - a distributor called Philidor - was allegedly engaged in some shady practices in order to sell Valeant drugs.

An investigation in to Philidor is ongoing, as are investigations into Valeant's drug pricing practices on the state and federal levels. Valeant has tried to move on, and severed ties with Philidor at the end of October.

On Tuesday, Valeant announced that it would be partnering with Walgreens to distribute its products, easing some of the fears around how Valeant would replace the sales it lost when it cut ties with Philidor. The company's stock price shot up 15% on the news.

However, there's a catch here. To work with Walgreens, Valeant had to give the pharmacy products on consignment - products which will have their prices slashed.

The deal

At Walgreens, Valeant's branded prescription-based products will be cut by 10% with co-pays as low as $0. Walgreens will also distribute Valeant's branded products which compete with generic alternatives at discounts of between 5% and 95%, with a weighted average price decrease of 50%.

If you're thinking - 'hey, how are they going to make up for that lost revenue,' you're not alone.

In an interview with CNBC on Tuesday, CEO Mike Pearson said that some of that lost revenue would be made back by cutting out the middle men who usually stand between drug companies and pharmacies.

The rest of the loss will have to come from selling a lot of drugs - a lot more than it used to.

"We've always had strong growth and volume growth, but the skeptics have said that it's all price," Pearson said on CNBC. "This will turn it all into volume."

According to Valeant this deal will result in $600 million in savings "to the healthcare system" but they disclose that that $600 million is derived exclusively from price decreases:

Valeant expects the price decreases across both programs, when fully implemented, will provide up to $600 million in annual savings to the healthcare system. This number is derived from calculating the 10 percent reduction in average selling price (ASP) of Valeant's dermatology and ophthalmology brands, multiplied by the actual 2015 volume, plus the estimated 50 percent price reduction in ASP of Valeant's branded products to the current reimbursed generic equivalent at 2015 volumes.

So while this deal may be saving the system $600 million, it's costing Valeant $600 million in revenue.

To the skeptics

The skeptics have said that Valeant is a company that depends on aggressive acquisition accounting and price increases to show that it's growing. Neither of those strategies will be available to Valeant in 2016 - at least not based on what we know.

Valeant has said that it will not do acquisitions in 2016 and instead focus all of its cash on paying down its $34 billion debt pile. To get board approval for its last acquisition, it agreed to a mandatory draw down of at least $560 million in 2016.

"The lion's share of cash flow generated next year will go to debt repayment," Pearson said on a call last month.

Also on the company's November call, one analyst estimated that Valeant could be forced to pay down $3 billion in debt next year.

In other words the company still needs cash. It will also need to prove to investors that this new volume-based model, which is not the model that made it a Wall Street darling, actually works.

So investors will want to know: What happens if Walgreens can't sell the volume of drugs Valeant needs it to? Will it seek other partnerships? Is it in talks with other distributors? Will it have the option to raise prices at any point?

One more thing: In the past, Valeant's third-largest shareholder, hedge fund billionaire Bill Ackman, of Pershing Square, was a big presence during Valeant's conference calls and Investor Days. It's unclear whether or not he'll like this new Valeant, as he was a huge proponent of Valeant as a "platform company" that grows through acquisition.

On Tuesday, Pearson walked away from that description of his company.

"Look I love Bill but I've never talked about a platform company," Pearson said on CNBC. "I've talked about a company that grows organically."

He then described his relationship with Ackman as "pretty cordial."