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Morningstar | RB's Latest Bombshell: DOJ Charges of Fraud at Indivior; Market Assumes the Worst

The extent to which wide-moat RB will be held liable for the charges of fraudulent behavior laid at the door of Indivior  by the U.S. Department of Justice is far from clear. Given limited information, we think the market is pricing in a worst-case scenario. For the time being, we are maintaining our GBX 7,300 fair value estimate on the assumption that existing contingent liabilities made by RB will be sufficient to cover any financial costs. However, we recognize that RB is now more exposed to fat-tail risk, and we may adjust our valuation as more information becomes available.

On April 9, the DOJ indicted Indivior, a former subsidiary of RB until its spin-off in late 2014, of engaging in fraudulent marketing of its opioid addiction treatments and will seek $3 billion in fines. The market valuation of Indivior (not covered) fell 72% on the news, and RB's fell over 5%. It has been public information for some time that the DOJ was investigating Indivior, and RB has held a GBP 400 million provision for the last two years relating to this issue. Still, we did not see this coming, and the size of the fines is a surprise.

We believed that the investigation surrounded anticompetitive practices relating to the release of Suboxone Film in 2007. The indictment appears to be significantly broader than that, including accusations of fraudulent activity in selling and marketing. It is not clear, therefore, if RB’s provision covers the broader charges, and even less clear whether RB has any exposure to those charges.

There are also some mitigating factors to the risk RB faces. The size of the recommended fines seems very steep, given that Indivior generates net sales at a run rate of around $1 billion. It is entirely possible that this figure is the opening public salvo in a process that ultimately will deliver fines at a lower level, although arguably, Indivior should have settled the case by now if the DOJ had been in the mood to compromise.

The timing of the alleged offences could be critical to RB’s liability. The anticompetitive practices issues relate to the mid-2000s, and RB faces exposure to any sanctions related to those activities. The indictment stated that the fraudulent marketing practices began before the spin-off, which would imply some culpability on the part of RB. The unknown pieces of the puzzle are for how long the illegal practices were undertaken under RB’s ownership, and whether they accelerated in terms of severity after the split. In its statement, Indivior insisted that all activities took place before the 2014 spin-off.

The financial implications are much less severe for RB than for Indivior. We estimate a worst-case scenario, in which RB was liable for the entirety of the $3 billion in charges, would lead to a reduction in the equity value of the business of just over 5%, in line with the market reaction. On that basis, we think the market has probably overreacted by assuming the worst, but this is early days in the process, and we have little visibility into how it will play out among the three parties over the coming quarters.

In addition, this is not the first time RB has been reprimanded for its marketing practices, following the fines levied by the Australian Competition and Consumer Commission for the misleading marketing of Nurofen in 2016. We like RB’s strategy of repositioning the business into strong price/mix categories, and we think the consumer health category is one of those, but this is the latest in a long line of apparently unconnected events to disrupt the company. It is understandable if investors are now wondering if RB is making a rod for its own back with a culture of aggressive cost control and marketing practices.