giofranchi

You and original mungerville might think this is strange, but my idea is that today an investment in VRX is much safer than it was when VRX stock price was around $120… Why? Because now we have the evidence the market still likes VRX’s deal making very much, despite all the attacks VRX business model went through in 2014, and despite renowned investors like Grant and Chanos having publicly shorted the stock. This evidence is important to me: never before in its history VRX business model had been put to the test like it was in 2014, and now we have at least some evidence VRX has passed that very demanding test with flying colors! So, let’s put it this way: first I doubled my money in VRX, then I watched from the sidelines when I thought the picture was too hard for me to judge, now that, despite all the doubts raised, VRX seems able to proceed undisturbed, I have decided to invest again. With caution, because its debt is very high indeed, but I want to be again a VRX’s shareholder. Gio

One last thing about the difference between debt and float, and then I will leave it at that: if we have a shock in the market, and the financial system gets into trouble, like it tends to happen with some regularity, banks in dire straits could change their requirements to extend credit... And usually they change requirements for the worse... Transfering the pressure on the debtors! This is something float is immune from... On the contrary, a solid underwriter could take advantage of a dislocation in the market and get better terms for new contracts or the renewal of old ones... Imo, a big difference! ;) Gio

You cannot compare creams and contact lenses with hurricanes and floods, because imo it is conceptually wrong. The predictability of creams and contact lenses should be compared to the predictability of FFH’s investments in its portfolio (bonds and stocks), while the predictability of what Valeant has to pay on its debt (a sure thing) should be compared to the predictability of what FFH has to pay on its float (here instead we have the possibility it doesn’t have to pay anything!). Last time I checked MKL’s stock portfolio was a larger percentage of their equity than FFH’s… But now I will check again! ;) Gio

I don’t agree. Float is a completely different beast. That’s why, as long as you underwrite profitably, Buffett says float is even more valuable than equity. They must be good enough underwriters, of course! And that is the business judgement you have to make. But to compare the predictability of creams and contact lenses with the predictability of hurricanes and floods imo doesn’t make any sense at all… The hedging thing is also a myth imo: a big shock could have a similar impact on MKL’s equity, and yet they don’t hedge… ;) Gio

Anyway, this is what I am going to do: each month my company gives me some cash, little more than 1% its capital of today, and I will start buying VRX again with that cash. I will gradually build a position that won’t be too large, in case a very low probability bad event happens, but which could have nonetheless a meaningful beneficial impact on my company’s portfolio of investments, if VRX actually manages to increase Cash EPS at 20-25% annual from here until 2022. Cheers, Gio

I am not comfortable at all! That’s why, though I would have preferred a rights offering rather than selling shares to new shareholders, I like the fact they have chosen not to raise their debt level. If you don’t owe anything to anyone, your business results may go up and down without feeling the pain too much. To owe lots of money might make business sense, like you have so clearly explained, but you better be sure business results go up and stay up… This is what makes me uncomfortable… Gio

Well, Salix went from $30 in 2010 to $170 in September 2014. Then in November 2014 it gets accused of stuffing its inventory, making its sales growth appear artificial. And the stock goes down 50%. The CEO and CFO resign, lawsuits ensue, etc. Then rumors of a sale begin, and the stock recovers. Pearson now accepts to buy at $158 per share, quite near its all-time high. I am sure Pearson knows what he is doing now, but it doesn’t seem a deal without risks to me… What if he is wrong on a deal that doubles VRX’s debt level? I understand he is giving away something which costs him 6% to get an asset that might earn 20%... But the 6% is sure, the 20%, though very probable, might not be that sure… Listen, in my experience business is difficult… I don’t know what might go wrong… But I usually have a very hard time thinking that nothing could ever go wrong! And the idea of having put myself in the situation of paying 6% over $30 billion no matter what happens to my business makes me somewhat nervous… Though for something as good as VRX, I am trying hard to control this feeling of discomfort! ;) Gio

Thank you, Liberty! Your view on VRX’s debt is very helpful. :) Cheers, Gio

If debt were lower and more easily manageable, I wouldn’t worry at all! I wouldn’t worry even if Pearson might finally commit a major blunder… It is debt that makes me nervous… Because I think debt dangerously shrinks any room left for error… Anyway, thank you! Gio

During the last 3 years VRX has made 22 acquisitions… And not a single mistake? At the same pace from here until 2022 VRX will have purchased 59 more businesses… And not a single mistake? No business that turns out to be a money loser? Even consumer products are durable just as long as consumers’ preferences don’t change, or better products are devised and brought to the market… Is it possible Pearson might truly understand and rightly predict the future for all the products VRX acquires? If this actually happens, I think Pearson will leave Buffett’s investing track record in the dust… Gio

Is it possible to never lose money in the investment world? This is the doubt I have… Really messed up… and make a positive return nonetheless?! Wow! It just seems strange to me… Even difficult to accept as the worst case scenario… I mean, even Buffett made some mistakes in investing that have cost Berkshire serious money throughout the years, both in insurance, and in operating businesses, and in the stock market… Is it possible the worst case scenario for VRX is a large investment on which the IRR is 0-5%? I don’t know… I am asking, because I am trying to get a clearer picture. Gio

Thank you Tom1234! :) Those who are not worried about debt reason along the same lines of thought? Gio

Don't we all! By the way Pete, small shareholders without cash could always sell their rights in the market and receive a sort of special dividend… It is true they get diluted, but is also true they somehow get compensated for that. Cheers, Gio

Liberty, original mungerville, I ask this, because I really like VRX and greatly admire Pearson, and I truly would like to be “convinced” that even with all that debt there is still some room for error… I would feel much better about investing in VRX, if I believed that a large acquisition which doesn’t turn out to be as profitable as expected could get managed without too much distress… But in such a case wouldn’t all that debt become too burdensome? If you are not worried about it, why? Thank you! Gio

With $30 billion of debt, what might happen if Pearson is wrong about the next major acquisition? Pearson is just great, fantastic!… But even he is not a Marvel superhero… He can make mistakes. Where is protection from the downside, when $30 billion of debt are justifiable only as long as Pearson keeps performing like a Marvel superhero? Gio

Original mungerville, Let me ask you a question: we are entering the 7th year of a bull market in stocks, with a macro background we all know very well and basically agree about. Question: do you feel more comfortable owning leveraged companies or businesses which don’t make use of debt? Sincerely, I don’t understand: first you seem to be very cautious going foreword, you hold lots of cash and protections, but then you say an investment in VRX is “obvious” and you quote Munger about errors of omission… Well, I might be the only one to think $30 billion of debt is a lot… but assuming $5 billion of owner earnings in 2016, it takes 6 years of owner earnings to repay that debt… Unless, of course, you go on increasing owner earnings 25-30% annually… What seems amazing to me is that in point n.8 you use two times the word “conservative” to arrive at the prediction of owner earnings growth in between 25% and 30% annually from 2016 to 2022… What are then aggressive projections??! I don’t know of any other company in which I am confident to say owner earnings might grow 25%-30% from here until 2022… Therefore, this is what I think: VRX is a wonderful business, and you as a shareholder will do incredibly well… But don’t tell me VRX is an “obvious” investment… Because VRX is doing something no one else is able to do… And to justify $30 billion of debt it must go on doing something no one else is able to do… Certainly not my definition of an “obvious” investment! No, I don’t think I see it, but don’t act on it… The problem here for me is I cannot see clearly enough. Gio

I have no investment in GLRE, and a small one in Lancashire, which will grow as my company gives me free cash. I also have a large investment in PSH. I still like both LMCA and VRX very much! I have not changed that much! :) Under the present circumstances, though, I simply prefer the wait and see approach. If everything goes fine and we go on experiencing a so called “good deleveraging”, my companies probably will create some value, but less than LMCA and VRX. If, on the other hand, something goes wrong, I believe the vice versa might be true. Gio

Not anymore. LMCA is not quite leveraged right now, but I think Sirius is and it is too much tied to the auto industry, which I don’t like going forward… I have greatly trimmed my investment in LMCA. Another thing I might come to regret… But, whenever I cannot get comfortable with the downside, I’d better be safe than sorry… Gio

Exactly. He used and continues to use leverage in form of insurance float, tax deferring etc. Getting to his 15% BV growth without these leverages in a 8-9% cost of capital environment is pretty tough even for him. This completely misses my point! Gio

Well, this is another possible view… As you say companies which make extensive use of debt might never run into trouble and might even prosper more than companies which don’t… A judgment outside my circle of competence! ;) Gio

Well, I think my reasoning is quite simple after all. Buffett never used debt, and grew shareholder capital intelligently deploying free cash flow. Though in a less levered overall environment I would feel comfortable also with a more aggressive business model, in the present environment I prefer to stick to Buffett’s model. Gio

But it is not like I am not doing business… I am just looking for what I judge to be a more conservative kind of businesses… Businesses I am more comfortable with in this environment… I know VRX might be wonderful, and might be among the best performers out there… I have always said I think shareholders might continue doing very well!... But I am positive I will do well enough concentrating on businesses that better fit what I am looking for today… So I don’t really feel the need to do something I am not comfortable with. Cheers, Gio

Liberty, I don’t argue with what you have just said, because I agree 100%. But right now I am looking for companies which have positioned themselves to grow earnings and BV during a possible market dislocation caused by widespread debt defaults, not after. If during a market dislocation VRX’s stock price gets halved, I will then probably start buying aggressively, because I agree 100% they will behave opportunistically and make some wonderful investments! And I would invest aggressively using as a currency the stocks of those businesses that might perform better during a market dislocation, those businesses I am looking for now. Think about LMCA in 2008: its stock price got badly clobbered… But Malone made the Sirius investment that later paid-off in spades! To have a hard currency to invest in LMCA in 2008 would have been very useful! Right? Gio

Yes, unfortunately I guess you are right… I think in the present environment I might never get comfortable because of debt… Anyway, I think shareholders will go on doing very fine! :) Gio

I don’t really the environment we find ourselves investing in: I see both high debts and high asset prices… Therefore, I look for the exact opposite: companies with very little or no debt, and the performance of which is as uncorrelated to what the stock market does as possible. Unfortunately, I simply cannot get convinced that VRX qualifies. Gio