VRX - Valeant Pharmaceuticals International Inc.

[loganc]

Does anyone have a copy of Jim Grant's bear thesis (or any thoughtful bear thesis for that matter)?  The only detail I can find is in the following article:

 

https://businessincanada.com/2014/03/06/jim-grant-bearish-case-on-valeant-pharmaceuticals/

 

If the main points of the bear thesis are highlighted in the above article, then I wish the shorts the very best of luck.

 

[giofranchi]

It seems to me that Valeant's CEO knows that his shares are overvalued and is trying hard to use them to acquire other companies.

 

I think it's the opposite. They've been doing most acquisitions mostly with debt, they could easily have issued more stock, and Ackman wanted VRX to put more equity in this deal but VRX wanted to use more debt (and Ackman has elected to take 100% shares if he can get them, so he also thinks it's quite cheap). The current deal is a compromise.

 

They've bought back a fair amount of stock a few years ago, and the stock price increase since then tracks the operational growth fairly closely (not exactly). If the company can keep executing anywhere close to what they've been doing, and I have no reason to think they can't, the stock isn't overvalued at all.

 

vrx is way undervalued if these two combine. it's undervalued as a standalone.

 

I agree with wellmont on VRX, therefore I invest in VRX.

I agree with ItsAValueTrap on LMCA, therefore I invest in LMCA.

I agree with Dazel on ALS, therefore I invest in ALS.

 

Instead, I don’t agree it should be either VRX, or LMCA, or ALS… Why?! Here we have three undervalued jewels… why should I be satisfied of owning just one jewel, when I can have three?! ::)

 

Gio

 

[giofranchi]

Having said all this ENDP's CEO may be good enough to extract value at the smaller scale he is working at - after all, this is a fundamentally very simple strategy to execute...I don't know, but the Valeant CEO immediately got my attention.

 

Imo the quality of ENDP’s conference calls is on par with VRX’s. Therefore, I am invested in ENDP too. And I would suggest to dig deep (I mean to print its last three conference calls and read them, nothing more!) into ENDP as well. :)

 

Cheers,

 

Gio

 

[giofranchi]

I just made this my largest position.

 

Wow! That’s a huge vote of confidence! :)

 

Fairfax remains my largest investment by far… ;)

 

Gio

 

[original mungerville]

I just made this my largest position.

 

Wow! That’s a huge vote of confidence! :)

 

Fairfax remains my largest investment by far… ;)

 

Gio

 

Well, its a vote of confidence - but time will tell if it is intelligent or not.

 

I understand this has been Sequoia fund's largest position as well for some time (but they were much smarter and bought in quite a few years ago). I just never looked at it closely because I never looked at pharma and figured I could not understand it. But the business model is just so simple - its like the anti-pharma, which I can understand better.

 

I don't like the current debt load (if this deal does not go through, as the deal is a bit of a deleveraging) as it will slow them down to a degree - and I am not exactly paying the cheapest multiple on the current business.

[giofranchi]

Well, its a vote of confidence - but time will tell if it is intelligent or not.

 

I understand this has been Sequoia fund's largest position as well for some time (but they were much smarter and bought in quite a few years ago). I just never looked at it closely because I never looked at pharma and figured I could not understand it. But the business model is just so simple - its like the anti-pharma, which I can understand better.

 

I don't like the current debt load (if this deal does not go through, as the deal is a bit of a deleveraging) as it will slow them down to a degree - and I am not exactly paying the cheapest multiple on the current business.

 

I think it will turn out to be a very satisfactory investment for many years ahead. In between VRX and ENDP I am almost at 10%. But I want to leave some room to average down, as I am doing with ALS too.

I am not worried at all about their debt load. But I am aware of the fact that, if a correction comes, the stock price of indebted companies will decline the most. Just like ALS stock price will decline a lot, if a correction in the price of iron ore comes.

That’s why I am almost at 10% in VRX + ENDP, and a bit more than 10% in ALS, which are not full positions yet.

 

Gio

 

[original mungerville]

What I find interesting is if this Allergan deal does not go through, the debt load is pretty high (and I think they should have issued slightly longer maturities at these low yields because when things go bad they go really bad, but hey, at least they did not fund short-term), and mis-understood acquirers, when their strategy falters (say they make a big acquisition and it turns out badly - like Fairfax 10 years ago), the stock may plummet.  Its a bit like Fairfax's underwriting 10 years ago, everyone thought it was horrible, and it wasn't good but it was far from horrible. It was only horrible if you looked at GAAP. I think if you backed out 2 year restructuring costs of acquirees acquired under book value and put those into the purchase price, you would have seen that the underwriting went from horrible, to not too bad (not Berkshire, but certainly not horrible). And now you see a tremendous change in reported GAAP combined ratios. Anyway, its the same situation at Valeant now. And if they screw up an acquisition, they may go from hero to horribly shorted / bad press in no time. So we need to be prepared for this mentally. And the big risk is some screwed up big acquisition - but I see the risk of that here much lower somehow than when a financial firm acquires.

 

Now, coming back to the big debt load (if Allergan doesn't go through). At a current multiple of around 15x cash earnings, that's an earnings yield of around 7% which is lower than I would like. And you would think it would take time to grow out of that to get the debt/income ratio down. However, 7% is like what? around $6 billion or so? And they shoot for 20% IRR before tax benefits and revenue synergies. They can certainly do a $6 billion acquisition once a year for the next 2-3 years - not incurring more debt. At a 20% IRR, that raises EPS by a similar 20% per $6 billion acquisition, or 50% over 2-3 years bringing the ratio of debt/income down by half in that timeframe - and the stock price up by 50% while deleveraging.

 

This assume no organic growth, and no tax/revenue synergies - and one would expect that revenue synergies would be large to such smaller acquisitions tucked into Valeant's now larger network.

 

Now if Allergan goes through its a bonanza.

 

 

[giofranchi]

Just to be clear: I cannot know if you, or anyone else for that matter!, believe in leaving some room to average down… I guess it is just a way of doing business that fits my personality. Actually, right now the only full position I have in my firm’s portfolio is FFH. Some days ago I had two full positions: FFH and LRE.

Therefore, you see, the fact I have not yet a full position in VRX might mean nothing at all! ;)

 

Gio

 

[txlaw]

Txlaw,

 

ENDP is smaller market cap so easier to do smaller acquisitions and grow.

 

Now that I understand Valeant, I'll take a harder look at ENDP but my instinct is that that CEO is just not going to make me feel as comfortable as the Valeant CEO. I'll see. I mean the Valeant guy, when you look at him, seems like he is falling asleep / about to fall off his chair, but there is an energy in his voice, a determination, I can feel his will to make things happen. And in terms of the content that comes out of his mouth, its bang on.  He seems anchored on the right things for the business.

 

Valeant is very large, and the acquisitions are larger now, and that usually makes things exponentially harder... and that's a big negative...but in this case, the bloody cost savings/integration is just so simple, so simple even at significant scale - and the cost savings are massive. I have never seen anything like this on this scale before. And they are clear about exactly what they are going to do and why. Most $40 billion mergers have huge integration risks, here I see very little - its quite amazing.

 

Having said all this ENDP's CEO may be good enough to extract value at the smaller scale he is working at - after all, this is a fundamentally very simple strategy to execute...I don't know, but the Valeant CEO immediately got my attention.

 

Thanks for the input on ENDP vs. VRX. 

 

I still have a lot of work to do on VRX, but it seems like the quality of VRX's portfolio is superior to ENDP.  B&L is such a great business and truly is a platform for growth. 

[Liberty]

I still have a lot of work to do on VRX, but it seems like the quality of VRX's portfolio is superior to ENDP.  B&L is such a great business and truly is a platform for growth.

 

I also looked at both and ended up going with just VRX because I liked the assets and management better (or at least, I had a higher level of certainty with them). That might change over time as ENDP proves itself.

[bmichaud]

Seems inappropriate to assume a single digit tax rate in perpetuity. No?

 

Say the merger goes through and PF eps is $11 and the tax rate is 5%. Ebt is $11.58 per share - say a 25% tax rate is more appropriate, true economic eps is then $8.69.

 

Given the extremely effective capital allocation practices, a 25x FV PE on this eps number doesn't seem unreasonable.

 

Another way to look at it - a 15% growth rate over the next 6 years gets you to $20 true economic eps in year 6. A 20x terminal PE gets you to $400. Discounted back at 10%, that's a $248 FV today, or roughly 28x the $8.69 eps.

 

Given the growing M&A environment, I worry agn isn't going to go easy, if not be taken away. I wonder if the better play is to take an outsized position in AGN where the estimated VRX shares received equals the approximate desired VRX position. Worst case, AGN gets taken out at a higher price, VRX gets hammered and you roll the agn proceeds into VRX at lower prices.

[original mungerville]

Just to be clear: I cannot know if you, or anyone else for that matter!, believe in leaving some room to average down… I guess it is just a way of doing business that fits my personality. Actually, right now the only full position I have in my firm’s portfolio is FFH. Some days ago I had two full positions: FFH and LRE.

Therefore, you see, the fact I have not yet a full position in VRX might mean nothing at all! ;)

 

Gio

 

Gio,

 

I am 100% hedged. So if the entire market comes down, I can average down as I take the profits from the hedge and plough them back into long ideas - albeit if the market goes up or stays at this level, and my holdings go down, I will not have the luxury of averaging down in my current portfolio. I do have untapped credit lines however if I see something really really stupidly cheap. So all that to say, I do have capacity - I find the market, especially small caps, to be extremely highly valued at this stage.

 

Certainly Gio, your policy should not be to ALWAYS be able to average down. Certainly this makes sense when the opportunities are good or even very good. But if things get so cheap, at some point you will want to be 100% invested - not unlike Monish Pabrai's policy of as he gets to his last 25%, then last 10% - he requires like 50-100% compounded returns on those last amounts of cash. I believe you are saying something similar when you say "always".

[LC]

I still have a lot of work to do on VRX, but it seems like the quality of VRX's portfolio is superior to ENDP.  B&L is such a great business and truly is a platform for growth.

 

I also looked at both and ended up going with just VRX because I liked the assets and management better (or at least, I had a higher level of certainty with them). That might change over time as ENDP proves itself.

 

To link this with the UU thread, do you think by the time ENDP proves itself, the possibility of outsized returns will have gone?

[Liberty]

To link this with the UU thread, do you think by the time ENDP proves itself, the possibility of outsized returns will have gone?

 

If ENDP is like VRX, it's a compounding platform with a huge runway, so there isn't a short time window like with a net-net that closes a valuation gap and then becomes uninteresting. It's a different mental model. And it's not as if ENDP is super cheap either, it's just smaller. I'm not sure how much value I give to being smaller if I don't like the assets and management as much... But I'd say there's no huge hurry.

[loganc]

Seems inappropriate to assume a single digit tax rate in perpetuity. No?

 

Say the merger goes through and PF eps is $11 and the tax rate is 5%. Ebt is $11.58 per share - say a 25% tax rate is more appropriate, true economic eps is then $8.69.

 

Given the extremely effective capital allocation practices, a 25x FV PE on this eps number doesn't seem unreasonable.

 

Another way to look at it - a 15% growth rate over the next 6 years gets you to $20 true economic eps in year 6. A 20x terminal PE gets you to $400. Discounted back at 10%, that's a $248 FV today, or roughly 28x the $8.69 eps.

 

Given the growing M&A environment, I worry agn isn't going to go easy, if not be taken away. I wonder if the better play is to take an outsized position in AGN where the estimated VRX shares received equals the approximate desired VRX position. Worst case, AGN gets taken out at a higher price, VRX gets hammered and you roll the agn proceeds into VRX at lower prices.

 

Interesting thoughts.  I also suspect that AGN is going to put up a fight.  It is going to be interesting to watch this play out.

[EliG]

I also suspect that AGN is going to put up a fight.

 

Allergan board doesn't have the strongest hand, due to some obscure corporate technicalities:

 

http://blogs.wsj.com/moneybeat/2014/04/25/dealpolitik-how-corporate-technicalities-can-influence-takeovers/

[moody202]

 

I agree with wellmont on VRX, therefore I invest in VRX.

I agree with ItsAValueTrap on LMCA, therefore I invest in LMCA.

I agree with Dazel on ALS, therefore I invest in ALS.

 

Instead, I don’t agree it should be either VRX, or LMCA, or ALS… Why?! Here we have three undervalued jewels… why should I be satisfied of owning just one jewel, when I can have three?! ::)

 

Gio

 

Would you add ENDP to the crown jewel list?

[loganc]

I also suspect that AGN is going to put up a fight.

 

Allergan board doesn't have the strongest hand, due to some obscure corporate technicalities:

 

http://blogs.wsj.com/moneybeat/2014/04/25/dealpolitik-how-corporate-technicalities-can-influence-takeovers/

 

Very interesting.  Thanks for posting.

[Liberty]

I also suspect that AGN is going to put up a fight.

 

Allergan board doesn't have the strongest hand, due to some obscure corporate technicalities:

 

http://blogs.wsj.com/moneybeat/2014/04/25/dealpolitik-how-corporate-technicalities-can-influence-takeovers/

 

Very interesting, thanks EliG.

 

I just hope Allergan doesn't start burning the furniture, so to speak, just to avoid a merger. It would be be  sad if, for example, they announced a major acquisition for assets that they know VRX doesn't have interest in.

[moody202]

 

I wish I had really looked hard into the company when I saw that Sequoia had so much money in it.

 

Where can I find Sequoia's current investment portfolio?

[jeffmori7]

 

I wish I had really looked hard into the company when I saw that Sequoia had so much money in it.

 

Where can I find Sequoia's current investment portfolio?

 

http://www.dataroma.com/m/holdings.php?m=SEQUX

[original mungerville]

Seems inappropriate to assume a single digit tax rate in perpetuity. No?

 

Say the merger goes through and PF eps is $11 and the tax rate is 5%. Ebt is $11.58 per share - say a 25% tax rate is more appropriate, true economic eps is then $8.69.

 

Given the extremely effective capital allocation practices, a 25x FV PE on this eps number doesn't seem unreasonable.

 

Another way to look at it - a 15% growth rate over the next 6 years gets you to $20 true economic eps in year 6. A 20x terminal PE gets you to $400. Discounted back at 10%, that's a $248 FV today, or roughly 28x the $8.69 eps.

 

Given the growing M&A environment, I worry agn isn't going to go easy, if not be taken away. I wonder if the better play is to take an outsized position in AGN where the estimated VRX shares received equals the approximate desired VRX position. Worst case, AGN gets taken out at a higher price, VRX gets hammered and you roll the agn proceeds into VRX at lower prices.

 

I don't understand why the tax rate would suddenly jump to 25%. I am no expert but would imagine that an important change in tax law would be required to impact Valeant's current earnings in terms of their taxation. I could see future acquisitions being more likely to be impacted due to tax changes thereby progressively increasing the blended tax burden on a percentage basis for Valeant as it continues to acquire. But I don't see how current AT earnings are suddenly reduced...there are a lot of jurisdictions with 10% tax rates where earnings can be realised in.

[biaggio]

Well this certainly has not developed like I thought it would.

 

Amazing that Mr Ackman is investing 30% of his funds (or ~ $4 B) into this - that's conviction.- to join the other very smart value vectors including Lou Simpson, Sequoia, etc.

 

My biggest issue was they were selling a lot of products that I really not heard of, nor very excited about. Except for the newer acquisitions like contact lenses. This turns out to be their competitive advantage- they make and sell small niche health care products that other companies would not think of competing against or are hard to make. They keep their drug reps + distribution but cut unproductive non ROI costs.--CEO Mr Pearson is quite impressive.

 

As they get bigger I think the product environment will probably more competitive-I am thinking of products like botox-- newer better technologies. I guess they can always license or buy the new technology.

 

Will other pharma companies copy VRX model? I can see private equity companies, hedge funds, etc trying to create the same "platform"- those $6b bolt ons will become more expensive.

 

If allergen merger is completed will they not be a huge company with $28b in debt, with a mkt cap of $100b? Its going to be hard to grow at 15-20% at these levels, no. At 15% growth x 10 years w are looking at a $500b company--does this seem rational?

 

Are we late to the party now?

 

I would love to change my mind on this one and participate in this. I love the idea of cloning others ideas and participating with smart, honest hard working manager with skin in the game.

 

 

 

 

[moody202]

 

And I agree… though, I guess he should get in shape a little bit… Come on, Mr. Pearson, after all you are only 54! ;)

 

Gio

 

I wonder if he uses any of his own skin care/ dermatology products. Maybe Valeant should also invest in weight reduction/ fitness products too....Mike needs it!

[loganc]

Well this certainly has not developed like I thought it would.

 

Amazing that Mr Ackman is investing 30% of his funds (or ~ $4 B) into this - that's conviction.- to join the other very smart value vectors including Lou Simpson, Sequoia, etc.

 

My biggest issue was they were selling a lot of products that I really not heard of, nor very excited about. Except for the newer acquisitions like contact lenses. This turns out to be their competitive advantage- they make and sell small niche health care products that other companies would not think of competing against or are hard to make. They keep their drug reps + distribution but cut unproductive non ROI costs.--CEO Mr Pearson is quite impressive.

 

As they get bigger I think the product environment will probably more competitive-I am thinking of products like botox-- newer better technologies. I guess they can always license or buy the new technology.

 

Will other pharma companies copy VRX model? I can see private equity companies, hedge funds, etc trying to create the same "platform"- those $6b bolt ons will become more expensive.

 

If allergen merger is completed will they not be a huge company with $28b in debt, with a mkt cap of $100b? Its going to be hard to grow at 15-20% at these levels, no. At 15% growth x 10 years w are looking at a $500b company--does this seem rational?

 

Are we late to the party now?

 

I would love to change my mind on this one and participate in this. I love the idea of cloning others ideas and participating with smart, honest hard working manager with skin in the game.

 

First, I don't think there are any laws that would impede VRX from becoming a 500B company.  The question is whether or not that sort of growth in market capitalization would correspond with per share value growth for the current investors.  In other words, Pearson could dilute shareholders by doing bad deals and make a big company.  I think that Pearson's track record demonstrates that such a strategy won't be implemented.

 

Also, I would be careful with a "late to the party" type of mentality.  The business prospects going forward are what matter in terms of making an investment.