VRX - Valeant Pharmaceuticals International Inc.

[bmichaud]

The intangibles that VRX adds back would quickly run out in a "steady state" scenario. I believe the useful life is 5 to 7 years. If you take those away, then suddenly there is no tax shield.

 

Page F-98 of the 2013 10k shows the statutory rate is 26.9%. (I was guessing 25%...)....

 

As such, the intangibles that are written off every year and thus shield income should be viewed as a limited life tax shield like an NOL. Once acquisitions stop, those run out.

 

At FYE13 the intangible asset balance was $12.8B. At the statutory rate, that's a gross tax shield of roughly $10 per share undiscounted.

[Liberty]

The intangibles that VRX adds back would quickly run out in a "steady state" scenario. I believe the useful life is 5 to 7 years. If you take those away, then suddenly there is no tax shield.

 

Page F-98 of the 2013 10k shows the statutory rate is 26.9%. (I was guessing 25%...)....

 

As such, the intangibles that are written off every year and thus shield income should be viewed as a limited life tax shield like an NOL. Once acquisitions stop, those run out.

 

At FYE13 the intangible asset balance was $12.8B. At the statutory rate, that's a gross tax shield of roughly $10 per share undiscounted.

 

The CFO has said that the tax rate going forward should be high single digit if the deal goes through. Their low tax rate has to do with the fact that they're a Canadian company and that Canada doesn't tax foreign income the same way the US does afaik, but I'm no tax expert (but I trust that these guys are).

[Liberty]

I've just finished watching the video of the presentation for the second time. Those of you interested in the company who have just looked at the slides, I recommend that you also watch the video. There's more said than what is shown (not tons, but some interesting stuff).

[giofranchi]

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.

 

biaggio,

very nice to see you on this thread again!

 

As wellmont (and me too, I think… but I don’t want to sound too presumptuous here!) has repeatedly said, there are many ways VRX can create shareholders value, besides growing bigger and bigger.

Just look at LMCA!

To me, partnering with Mr. Pearson today is much like having partnered with Mr. Malone 20 years ago… Isn’t this enough? ;)

 

Cheers,

 

Gio

 

[giofranchi]

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".

 

Hi original mungerville,

Have I ever used the word “always”?!

If so, I was clearly mistaken… probably because, while writing, I was actually thinking about something else!! ;D

I believe in opportunistic behavior (only in business, mind you, not at all in personal relationships!), and the word “always” has (almost ;)) no place in my business vocabulary!

 

Gio

 

[jay21]

I am trying to understand the R&D efficiencies.  What makes VRX's model different?  I assumed that their R&D record was better because they don't chase "trophy" drugs and spend on durable products, where returns are higher.  How do they come to the conclusion that their model is better than Allergan (e.g. they mention 9.5b R&D spend for Allergan and say it would only have cost them 2b).

 

This was put on my radar after the Baush and Lomb acquisition, now I am revisiting.  But it seems like an easy decision given the price to projected cash earnings, projected growth rates, and having Ackman, Valueact, Simpson, etc. in it, who probably have analyzed past acquisitions in a level of detail that I will never be able to.

[bmichaud]

This tax rate issue makes no sense to me.

 

VRX operates all over the world in various tax jurisdictions that range from say 10% to 35%....yet magically VRX only has to pay only 5% because it has set up a sub in Bermuda that always for an ultra low tax rate on IP assets? Something doesn't add up.

 

I get that Canada might not tax repatriated earnings. But you still need to pay tax in other countries. So say you are US based with a 35% rate and you earn 50% of your income in Canada at the 27% rate. If repatriated, you are required to pay the difference 7% difference to US authorities, resulting in an effective tax rate of 35%....

 

Were the US to not tax repatriated earnings, your effective tax rate would be 31%.

 

$4.8B of 2013 revenue was from Developed markets. So I assume the US, EU and Canada predominately. I believe the US is around $2B. Developed markets have an average tax rate of at least 20%.

 

So I ask - how is it possible for VRX to funnel all developed market profits through some Bermuda corporation without paying the appropriate authorities? The money that leaves the US....is it not taxed at the US rate somehow?

 

It does not pass the straight face test, therefore I will look at VRX as if it will ultimately be taxed at its statutory rate, because the only logical way to have a 5% effective tax rate is to have a massive tax shield, and in this case the tax shield runs out once acquisitions stop.

[biaggio]

I am trying to understand the R&D efficiencies.  What makes VRX's model different?  I assumed that their R&D record was better because they don't chase "trophy" drugs and spend on durable products, where returns are higher.  How do they come to the conclusion that their model is better than Allergan (e.g. they mention 9.5b R&D spend for Allergan and say it would only have cost them 2b).

 

This was put on my radar after the Baush and Lomb acquisition, now I am revisiting.  But it seems like an easy decision given the price to projected cash earnings, projected growth rates, and having Ackman, Valueact, Simpson, etc. in it, who probably have analyzed past acquisitions in a level of detail that I will never be able to.

 

Jay, I believe the idea is that they don t invest dollars in pre phase, phase 1, 2 when the failure rate is high.

 

They prefer to buy when R&D is mostly done, or buy companies where purchase price is low enough that they get R&D for free-even then I would think they will spend capital  on high probability products in the R&D pipeline

 

This is one of the potential knocks on the company--are they not spending enough to replace products. Not a big issue if products are durable

 

Interesting in the video that Liberty mentioned that management bonuses at Allergan are based on how much they spend on R&D and not the outcomes. Maybe the inverted question is why is big pharma R&D so inefficient (and ineffective?) ?

[biaggio]

This tax rate issue makes no sense to me.

 

VRX operates all over the world in various tax jurisdictions that range from say 10% to 35%....yet magically VRX only has to pay only 5% because it has set up a sub in Bermuda that always for an ultra low tax rate on IP assets? Something doesn't add up.

 

I get that Canada might not tax repatriated earnings. But you still need to pay tax in other countries. So say you are US based with a 35% rate and you earn 50% of your income in Canada at the 27% rate. If repatriated, you are required to pay the difference 7% difference to US authorities, resulting in an effective tax rate of 35%....

 

Were the US to not tax repatriated earnings, your effective tax rate would be 31%.

 

$4.8B of 2013 revenue was from Developed markets. So I assume the US, EU and Canada predominately. I believe the US is around $2B. Developed markets have an average tax rate of at least 20%.

 

So I ask - how is it possible for VRX to funnel all developed market profits through some Bermuda corporation without paying the appropriate authorities? The money that leaves the US....is it not taxed at the US rate somehow?

 

It does not pass the straight face test, therefore I will look at VRX as if it will ultimately be taxed at its statutory rate, because the only logical way to have a 5% effective tax rate is to have a massive tax shield, and in this case the tax shield runs out once acquisitions stop.

 

They present the investment thesis as if the tax rate is an long term competitive advantage for them?

 

I agree this would worry me.

 

They talk about holding their "IP's" off shore in ?ireland (or is it Bermuda)--is that short for intellectual properties---Would their US subsidiary be billed by their irish subsidiary for use of their intellectual properties where they have very low tax base.

 

Why don t all health care companies do this?

 

It seems that IRS and revenue canada are missing out on a lot of tax dollars

 

I am by no means an expert whatsoever.

[EliG]

Why don t all health care companies do this?

 

The article below claims that Endo bought Paladin Labs to mirror Valeant tax structure.

 

http://business.financialpost.com/2014/03/09/how-a-u-s-tax-loophole-gave-paladin-labs-founder-an-opportunity-to-start-over/

 

To better compete with Valeant and other rivals, Endo concluded it had to take advantage of the so-called inversion loophole under which U.S. companies can merge with smaller foreign firms and re-incorporate the combined company in a more tax-friendly country.

 

Paladin was foreign, profitable, and well-managed. Most importantly, at 23% of Endo’s size, it was exactly the right proportions needed to take advantage of the tax measures under U.S. law. and set up in Ireland.

[Liberty]

I am trying to understand the R&D efficiencies.  What makes VRX's model different?

 

A big part of it is zero-based budgeting and focus on ROI and durable assets.

 

Other pharmas have high R&D fixed costs that they carry, and this year's budget it based on last year's budget (with an increase thrown in, probably). They have X dollars and figure out how to spend them.

 

VRX doesn't carry most of those fixed costs, it outsources when it needs to do R&D, and the budget for all R&D has to be justified from the ground up every time, so there's a lot less inertia in the system.

 

Basically, a lot of pharmas are not very shareholder-friendly, so they don't mind spending shareholder money on things that have been shown not to have good ROIs because "that's what we do, that's what others do, that's how it's always been done" rather than "it makes financial sense". The incentives matter a lot too; as has been mentioned a few times, Allergan management is incentivized based on the absolute dollar amount spent on R&D (looking at inputs rather than outputs). No wonder productivity is low.

[Spekulatius]

Has anyone sanity checked the numbers that management is giving out? on a steady state run rate, I see roughly 8B$ with 27B$ in assets. The 8B$ in revenues are probably good for 2-2.B$ In EBIT, so that is an earnings yield of 7-8% (ballpark) for every dollar invested. It does not look like VRX buys their assets cheap enough to get a good ROI, even after all those adjustments and cash charges from acquisitions. If VRX is harvesting assets like some suspect, it is downright expensive.

 

Also, it is almost impossible to get a steady state picture because VRX is constantly acquiring assets.

[bmichaud]

I'm struggling to reconcile the fact managemt indicates "cash earnings" are higher than "adjusted operating cash flow".

 

In 2013, AOCF was $1.8B, yet cash earnings were closer to $2B. Small difference yes, but why would normalized earnings be higher than OCF, which in theory comes before maintenance capex.

[moody202]

Does anyone know the exchange Perishing Square (PS) is going to get for their Allergan shares? I ask because PS committed to all stock exchange (no cash).

[Liberty]

Perishing Square (PS)

 

That's a great typo!

[moody202]

Perishing Square (PS)

 

That's a great typo!

 

That's how it was feeling like in 2013 :) ....looks like 2014 is going better for them!

[Fairfaxnut]

Perishing Square (PS)

 

That's a great typo!

 

Someone should tweet that to Icahn  ;)

[Guest wellmont]

I'm struggling to reconcile the fact managemt indicates "cash earnings" are higher than "adjusted operating cash flow".

 

In 2013, AOCF was $1.8B, yet cash earnings were closer to $2B. Small difference yes, but why would normalized earnings be higher than OCF, which in theory comes before maintenance capex.

 

just a guess. I am not very good with detailed fin statement analysis...could it have something to do with Working Capital adjustments, which are not a component of the cash earnings calculation?

[Guest wellmont]

Does anyone know the exchange Perishing Square (PS) is going to get for their Allergan shares? I ask because PS committed to all stock exchange (no cash).

 

it depends how many other investors want stock. if more investors want stock PS will be prorated and be forced to take some cash. He already indicated he wanted all stock because he is Boolish on Valgen, and wanted the world to know!

[bmichaud]

Doubt it.

 

I can get to their $1.8 number by adding back restructuring costs to OCF before changes in working capital. GAAP OCF is $1B after WC changes, and $1.5 if you add back restructuring.

[original mungerville]

Taxes:

 

My guess on how the taxes work is that developed world subsidiaries pay a IP/patent type fee to a Bermuda (or Irish) subsidiary. In this manner, all profits are booked at the latter locations, none in the developed world market subsidiaries. Then, the Canadian holdco repatriates after-tax earnings from the Bermuda (or Irish) subsidiary - and no further taxes are due in Canada (as repatriated earnings from Bermuda are not taxed).

 

This is my hypothesis, it needs confirmation.

 

 

[original mungerville]

Below link is a good overview of their tax structure (high-level):

 

http://business.financialpost.com/2014/04/26/skin-in-the-game-how-valeant-is-using-low-canadian-taxes-to-become-a-global-dermatological-power/

[Liberty]

http://basehitinvesting.com/great-investor-glenn-greenberg-discusses-his-investment-philosophy/

 

Article on Glenn Greenberg. I thought it was interesting that 30% of his portfolio is in Valeant. I wasn't familiar with him before reading this, but he apparently has a very good long-term track record (mid 20%s since the early 1980s).

[cubsfan]

Glenn Greenberg is one of the best. Keeps quiet and runs a concentrated fund. Knows his companies inside out, looks for

high return on capital LT compounders and goes in big.

[giofranchi]

Doubt it.

 

I can get to their $1.8 number by adding back restructuring costs to OCF before changes in working capital. GAAP OCF is $1B after WC changes, and $1.5 if you add back restructuring.

 

bmichaud,

if you look at VRX New Release for its 2013 year end Results, you find on Table 5 (5.2) how Adjusted cash flow from operations (Non-GAAP) is calculated. While on Table 2 you find the Reconciliation of GAAP EPS to Cash EPS.

 

http://ir.valeant.com/investor-relations/news-releases/news-release-details/2014/Valeant-Pharmaceuticals-Reports-Fourth-Quarter-And-Full-Year-2013-Financial-Results/default.aspx

 

Hope this helps. :)

 

Gio