VRX - Valeant Pharmaceuticals International Inc.

[bmichaud]

AZ,

 

If 85% of VRX's business is durable, then the annual R&D budget takes care of any required annual replacement, no?

 

Then the 15% patent business is treated as a run off stream. Hence why Ackman came up with the two-part SOTP analysis where he valued the run off at 6X cash flow, and the core at 20X.

 

My guess is VRX management does not work very hard to replace any lost sales from the run off segment. Once the acquisition machine stops, then the Core ultimately takes over by virtue of its positive growth and run-off's negative growth.

 

If VRX's pro forma organic ex generic numbers are to be believed, my guess is a lot of the "growth spending" is buried in income statement versus the capex line for most companies. Sales, marketing, R&D etc...

 

Bmichaud,

 

That is a very good story and one that makes sense which is what makes it even more dangerous because that's all it is: a story.

 

I've asked this before and I am yet to see someone take me up on it: Can someone please show me how this is true? How are VRX drugs/products durable and not subject to patent cliffs? Any metric to share with us maybe? And as you probably know, a slide in a presentation generated to drive a transaction or management talking points is not sufficient.

 

If we were discussing J&J a person would give an answer that includes say: BandAid - Babycare - Listerine - Tylenol etc... Or if it was P&G, the answer would presumably include names like: Tide - Pantene - Old Spice - Duracell -  Pampers and many more. See, very easy.

 

Similarly a good answer for VRX would name, say VRX' top 10 or 20 of their drugs and then show us how they fit that profile. You will very quickly find that people aren't able to do that, actually they can't even name those drugs.

 

If you'll bear with me, I was working on a post to flush out my thoughts but got caught up with other opportunities that took up all my time but I'll get back to it. VRX is no holding of mine so it had to take a backseat, wouldn't own it and would be crazy to short it given how the market loves the name.

However I see many of my Corner friends here evidently stepping way out of their circle of competence and telling stories to justify it, which is how it usually happens, so I will chime in if you'll bear with me for a bit.

 

AZ,

 

You are correct - I cannot name VRX products off the top of my head like I can for Kraft, PG, Coke, Pepsi, JNJ or Nestle. I chalk this up to the products VRX deals in:

 

- Dermatology

- Dental

- Lens

- Surgical

- Ophthamology

- Neurology

- Aesthetics/PDT

- Consumer (only 14% of revenue)

 

How am I supposed to know whether VRX products within the Dental, Surgical or Ophthamology units are "JNJ/PG/KFT-like"? I have no idea. But when one of the greatest investors on the planet with a penchant for sniffing out fraudulent companies, who has never once invested in a pharma company, after four months of intensive due diligence comes out and declares:

 

1. 85% of the product portfolio is consumer products-like

2. The accounting stands up to the bear case

3. The CEO is on par with 8 of the greatest CEOs in corporate history....

 

.....then I perk up and listen.

 

Now the investment thesis comes down to analyzing the situation, the financials and the valuation. With the bear case fully refuted by Ackman's involvement, I can look at the financials and do my own analysis of the earnings, cash flow and balance sheet without worrying about whether the cash flow numbers are somehow fake.

 

Based on my work, the cash flow statement confirms the adjusted income statement. As long as VRX is not literally lying about its financials, then I'm 100% comfortable.

 

Also based on Ackman's confirmation, I can safely assume that the "durable" side of VRX's portfolio is not somehow at risk of deterioration beyond what normal on-going R&D can replace. VRX is not looking to replace its run-off business, hence the R&D budget is low.

 

VRX is projected to earn ~$8.62 per share in 2014 at say a 5% tax rate. Pre-tax earnings are $9.07. Assuming a full 25% tax rate, 2014 earnings are $6.81 per share. 85% of these earnings, or $5.78 are durable.

 

If the durable side grows at 15% per annum via organic growth and acquisitions for the next 6 years, and trades at 17.5X terminally, the stock is worth $145 today before giving any effect to the run-off side or the on-going tax benefits. At a 20% growth rate it's worth $188 today.

 

It's not dissimilar to the SHLD situation. We receive the FREE benefit of many investors' analyses of the real estate value. Now it's up to us to analyze the situation, the valuation and whether Lampert is going to piss away everything in pursuit of the "transformation".

[lu_hawk]

Bmichaud,

 

That is a very good story and one that makes sense which is what makes it even more dangerous because that's all it is: a story.

 

I've asked this before and I am yet to see someone take me up on it: Can someone please show me how this is true? How are VRX drugs/products durable and not subject to patent cliffs? Any metric to share with us maybe? And as you probably know, a slide in a presentation generated to drive a transaction or management talking points is not sufficient.

 

If we were discussing J&J a person would give an answer that includes say: BandAid - Babycare - Listerine - Tylenol etc... Or if it was P&G, the answer would presumably include names like: Tide - Pantene - Old Spice - Duracell -  Pampers and many more. See, very easy.

 

Similarly a good answer for VRX would name, say VRX' top 10 or 20 of their drugs and then show us how they fit that profile. You will very quickly find that people aren't able to do that, actually they can't even name those drugs.

 

If you'll bear with me, I was working on a post to flush out my thoughts but got caught up with other opportunities that took up all my time but I'll get back to it. VRX is no holding of mine so it had to take a backseat, wouldn't own it and would be crazy to short it given how the market loves the name.

However I see many of my Corner friends here evidently stepping way out of their circle of competence and telling stories to justify it, which is how it usually happens, so I will chime in if you'll bear with me for a bit.

 

+1

 

Completely agree with you. A portion of the Valeant product line would have a limited life span and that part needs to be amortized. As an approximation I am adjusting the cash earnings down by about 10%.

 

Vinod

 

How do you get to a 10% adjustment factor?

 

Cash earnings in q1 were $599.7mm.  Amortization of finite-lived intangibles was $364.1mm.  A 10% reduction to cash eps is $60mm, and $60mm is 1/6th of the total amortization of finite-lived intangibles.  So 5/6th of that line item represents non-economic expense and is related only to products that do not have a limited life span?  How did you come to that conclusion?

 

 

[CorpRaider]

Retin-A,  Bausch & Lomb?

[AZ_Value]

Retin-A,  Bausch & Lomb?

 

Thank you CorpRaider. I wanted to drop a line and thank you because you're officially the first to answer.

Frankly, I had hoped for a while that some of the fervent bulls would at least say the obvious ones like Retin-A or even the CeraVe lotion as they seem to be clear candidates.

However, for the readers of 10-Ks out here you'd see disclosures like this when the company is talking about the decline in sales for products not related to acquisitions

 

"decrease in product sales in the Developed Markets segment of $293.9 million, in the aggregate, in 2013, primarily related to a decline in sales of the Zovirax® franchise, Retin-A Micro®, BenzaClin® and Cesamet® due to the impact of generic competition"

[lu_hawk]

Retin-A,  Bausch & Lomb?

 

Thank you CorpRaider. I wanted to drop a line and thank you because you're officially the first to answer.

Frankly, I had hoped for a while that some of the fervent bulls would at least say the obvious ones like Retin-A or even the CeraVe lotion as they seem to be clear candidates.

However, for the readers of 10-Ks out here you'd see disclosures like this when the company is talking about the decline in sales for products not related to acquisitions

 

"decrease in product sales in the Developed Markets segment of $293.9 million, in the aggregate, in 2013, primarily related to a decline in sales of the Zovirax® franchise, Retin-A Micro®, BenzaClin® and Cesamet® due to the impact of generic competition"

 

Come on, 10-Ks aren't necessary when dealing with a luminary like Pearson.  I don't even need to read 1-K when I can look at the VRX Investor Presentations instead.

 

 

[bmichaud]

"Due to the impact of generic competition"

[Liberty]

"decrease in product sales in the Developed Markets segment of $293.9 million, in the aggregate, in 2013, primarily related to a decline in sales of the Zovirax® franchise, Retin-A Micro®, BenzaClin® and Cesamet® due to the impact of generic competition"

 

Yeah, they have some patent cliffs on a relatively small part of their portfolio. All that matters is the IRRs they got on those products. It doesn't matter to me that they obscure the organic growth in another part of the portfolio. Valeant has thousands of small products and few big ones. They can get those for better prices (including branded generics), there's less competition (generics makers don't bother with many small products, especially those that are a bit complex to manufacture) and these acne and fungus creams, moisturizers, and contact lens solutions need very little maintenance to keep going (some reformulation work once in a while). Durable products still need some minimum maintenance investment, just like P&G needs to invest in its durable brands, but they don't face cliffs and discontinuities like most of the big blockbusters that others focus on.

 

I guess it matters if you believe that Pearson and Ackman have the skills and resources to identify durable products or not, because none of us - including the bears - knows the whole Valeant porfolio of products.

 

They manage the business based on cash models with IRRs based on statutory tax rates and they include restructuring costs in the cost of acquisition to calculate those IRRs. I'll take that over GAAP, because that's closer to the true economics, and in the end, that's what will matter.

[lu_hawk]

Correct me if I am wrong: by adding back all amortization expense and deal expense, and then by valuing it based on the market cap, wouldn't you be valuing it as if the acquisitions were acquired for free?  This is a serious question.

 

Just an example: target has $100mm in earnings and VRX acquires them for $1bn, using debt. 

 

Deal expenses are incurred and those are added back.  The amortization expenses arising from the acquired business are also added back.  And then, you value VRX based on the market cap (I.e. P/E ratio).

 

Wouldn't the result  just be an extra $100mm in VRX's cash earnings?  And the numerator in the p/e would be unchanged because debt was used to acquire.  The only remnant of then$1bn cost would be the interest expense on the debt.

 

Isn't this how bulls are valuing the company?  As if the acquisitions WERE FREE?

[loganc]

Correct me if I am wrong: by adding back all amortization expense and deal expense, and then by valuing it based on the market cap, wouldn't you be valuing it as if the acquisitions were acquired for free?  This is a serious question.

 

Just an example: target has $100mm in earnings and VRX acquires them for $1bn, using debt. 

 

Deal expenses are incurred and those are added back.  The amortization expenses arising from the acquired business are also added back.  And then, you value VRX based on the market cap (I.e. P/E ratio).

 

Wouldn't the result  just be an extra $100mm in VRX's cash earnings?  And the numerator in the p/e would be unchanged because debt was used to acquire.  The only remnant of then$1bn cost would be the interest expense on the debt.

 

Isn't this how bulls are valuing the company?  As if the acquisitions WERE FREE?

 

Not exactly.  The cost would show up in the form of increase in share count and/or interest expense, depending on deal structure. 

[lu_hawk]

Ok so apart from interest expense, longs are valuing this company as if $26bn in acquisitions were totally free.  That is the conclusion I reach if I think about the "price to cash eps" valuation method.  It's hard for me to believe anybody would actually do that, but is that really true?

[loganc]

Ok so apart from interest expense, longs are valuing this company as if $26bn in acquisitions were totally free.  That is the conclusion I reach if I think about the "price to cash eps" valuation method.  It's hard for me to believe anybody would actually do that, but is that really true?

 

How do you value LBTYA after they did the Virgin Media deal?  Where does the deal cost show up other than increased interest expense and share count? 

[Liberty]

Valeant is more levered than most other pharmas. But it also has a lot less product and R&D risks (it certainly sucks when a product that you've spent hundreds of millions bringing to phase III fails..). It's a tradeoff. Personally, I'd rather take a risk on that side than on the other side, especially since they've stated that they intend to delever this year (the AGN deal would do that, but if it doesn't happen, they still plan to bring their leverage below 4x before the end of the year).

[lu_hawk]

Ok so apart from interest expense, longs are valuing this company as if $26bn in acquisitions were totally free.  That is the conclusion I reach if I think about the "price to cash eps" valuation method.  It's hard for me to believe anybody would actually do that, but is that really true?

 

How do you value LBTYA after they did the Virgin Media deal?  Where does the deal cost show up other than increased interest expense and share count?

 

 

I don't value LBTYA, either before or after the Virgin Media deal.  I am asking if VRX is being valued as if the $26bn in acquisitions have been given to them for free, and it appears that it is. 

 

(I would note that LBTYA is likely valued using EV/EBITDA or a similar metric.  This DOES at least partly account for the cost of the deal by adding debt to the numerator).

 

Strange times we live in.  This is going to be an interesting one to look back on and wonder how people could be so foolish as to value a company whose entire business is making acquisitions as if the acquisitions were made for free.

 

 

[AZ_Value]

"decrease in product sales in the Developed Markets segment of $293.9 million, in the aggregate, in 2013, primarily related to a decline in sales of the Zovirax® franchise, Retin-A Micro®, BenzaClin® and Cesamet® due to the impact of generic competition"

 

Yeah, they have some patent cliffs on a relatively small part of their portfolio. All that matters is the IRRs they got on those products. It doesn't matter to me that they obscure the organic growth in another part of the portfolio. Valeant has thousands of small products and few big ones. They can get those for better prices (including branded generics), there's less competition (generics makers don't bother with many small products, especially those that are a bit complex to manufacture) and these acne and fungus creams, moisturizers, and contact lens solutions need very little maintenance to keep going (some reformulation work once in a while). Durable products still need some minimum maintenance investment, just like P&G needs to invest in its durable brands, but they don't face cliffs and discontinuities like most of the big blockbusters that others focus on.

 

I guess it matters if you believe that Pearson and Ackman have the skills and resources to identify durable products or not, because none of us - including the bears - knows the whole Valeant porfolio of products.

 

They manage the business based on cash models with IRRs based on statutory tax rates and they include restructuring costs in the cost of acquisition to calculate those IRRs. I'll take that over GAAP, because that's closer to the true economics, and in the end, that's what will matter.

 

Liberty,

 

I hear you and I will concede the part about Pearson and Ackman because my whole point is that as long as you realize that you're basing your whole thesis on what they tell you and not fool yourself to think that you're doing due dilligence.

 

Because you see, I didn't need you to tell me any of the things you wrote above because I've already heard/read it from them directly.

 

I've heard/read about their products, have you ever tried to see what additional info about them you can get from their 10-k? Or as they make claims about differences with the other pharma companies tried to read the annual reports of said other pharma companies and critically review those claims?

I've read/heard about generics / branded generics. Given that a lot of them are in Europe through acquisitions like the PharmaSwiss one, as someone who has at least taken a brief look at all their acquisitions would know (I have, have you?) - And given that, say, Teva Pharmaceutical is the single biggest generic pharma company in the World, something like 1 out of every 5 generic prescription written in the US is a Teva product, they have more than 1,000 generics approved in Europe and thousands more authorizations pending approval in dozens of European countries, have you read Teva's annual report to see if VRX claims make sense especially when they use their 1,500 products as an explanation for what they say and especially what they don't say?

A lot of stuff they say can be critically reviewed, you know, to come to a better informed decision. That's usually where circle of competence comes into play in this game (P.S. even with my background in pharma and the work I put in, I'm lucid enough to know that I barely breach that circle).

All I'm saying is that I've already heard and understood all their points and no matter how compelling a story they make, repeating them doesn't add to the analysis. I just want you to also be conscious of that.

At the very least I can see a separation in work done when Logan points out something like a Zovirax US and Canadian rights price tag of $300M and what it has brought to VRX, it's very easy to pick that up by reading what is posted here.

 

Correct me if I am wrong: by adding back all amortization expense and deal expense, and then by valuing it based on the market cap, wouldn't you be valuing it as if the acquisitions were acquired for free?  This is a serious question.

 

Just an example: target has $100mm in earnings and VRX acquires them for $1bn, using debt. 

 

Deal expenses are incurred and those are added back.  The amortization expenses arising from the acquired business are also added back.  And then, you value VRX based on the market cap (I.e. P/E ratio).

 

Wouldn't the result  just be an extra $100mm in VRX's cash earnings?  And the numerator in the p/e would be unchanged because debt was used to acquire.  The only remnant of then$1bn cost would be the interest expense on the debt.

 

Isn't this how bulls are valuing the company?  As if the acquisitions WERE FREE?

 

Not exactly.  The cost would show up in the form of increase in share count and/or interest expense, depending on deal structure.

 

Where I'm from, after you're done valuing a set of assets, if they carry debt with them, it's generally a good idea to add that debt on top to get the true cost because debt has this annoying effect of not belonging to you and having to be paid back.

 

I actually wonder if there is a soul in this universe who has even attempted  a good old reliable valuation based on cash flows (you know, the one that WEB does) that would even come close to justifying the current price tag for VRX of $44B in mkt cap + $17B in debt. I would really love to see that one.

I have to run but I promise to be back when my post is done.

[loganc]

I don't value LBTYA, either before or after the Virgin Media deal.  I am asking if VRX is being valued as if the $26bn in acquisitions have been given to them for free, and it appears that it is. 

 

(I would note that LBTYA is likely valued using EV/EBITDA or a similar metric.  This DOES at least partly account for the cost of the deal by adding debt to the numerator).

 

Strange times we live in.  This is going to be an interesting one to look back on and wonder how people could be so foolish as to value a company whose entire business is making acquisitions as if the acquisitions were made for free.

 

It is interesting that you accuse VRX bulls of psychological bias and then you act like this is all over and that you are 100% correct.  At least I still know that I could be wrong. 

[loganc]

Where I'm from, after you're done valuing a set of assets, if they carry debt with them, it's generally a good idea to add that debt on top to get the true cost because debt has this annoying effect of not belonging to you and having to be paid back.

 

I actually wonder if there is a soul in this universe who has even attempted  a good old reliable valuation based on cash flows (you know, the one that WEB does) that would even come close to justifying the current price tag for VRX of $44B in mkt cap + $17B in debt. I would really love to see that one.

I have to run but I promise to be back when my post is done.

 

I appreciate the posts that you have made.  Of all of the "bear" VRX analysis that I have read, you make respectful arguments and minimize the hyperbole (e.g. VRX is Enron, VRX bulls are idiots that don't understand accounting, etc.). 

 

Indeed, when I look at valuing companies I am looking at FCF per share or "owner earnings" per share in the parlance of Buffett.  When you value something like VRX there is much discretion that is involved when one computes such metrics.  Obviously, if one substantially disagrees with the process of adding back certain "one time" items or the intangible amortization, then one is going to arrive at an "owner earnings" value that would render VRX unattractive from a valuation standpoint.

 

In my analysis, I compute my own FCF per share based on the add backs that I believe are sensible and my numbers are not necessarily the numbers that VRX presents in "Cash EPS" or other Non-GAAP numbers they present.  Further, my work at evaluating the cash on cash returns of the transactions indicates that the majority have been very successful (i.e. very close to their target IRR of 20%).  By my analysis, VRX seems reasonably priced at present and the valuation looks quite attractive assuming the AGN deal is consummated.

 

Obviously, the current leverage at VRX is a risk.  Only a fool would ignore this risk factor.  However, I believe that the leverage is not obscene and is manageable.  Ultimately, I could be completely wrong.  I do not have a monopoly on the truth.       

 

 

[Liberty]

I certainly am looking forward to that post of yours, AZ, because you imply a lot of things, and I wish I had the fully grown version of those seeds.

 

You talk about Teva, but I don't think it's that simple. Valeant has a certain model and picks certain products in certain markets. They don't just go for "generics" in general. You already know all this so you can skip it, but they focus on products where a relationship with the doctor matters more, products were branded does better (eye and skin stuff is very personal), focus on countries where there's less competition, faster growth, where branded generics have more traction, focus on cash pay, etc. They have zero-based budgeting for everything and look at the real economics rather than optimize for GAAP. It's not just about one thing such as "generics". I don't believe Teva has the same model, so it's not surprising that they have different requirements and results.

 

I'm not the best investor, but I've done what I consider a lot of work on this and I've become satisfied that this company could provide me very satisfactory returns going forward. Maybe I'm wrong, but I find it strange that the bears talk as if the only way to ever like Valeant is to not understand it. Somehow I don't think it's likely that Mr. detail work Ackman has put 30%+ of his fund/net worth into it, elected to get all stock and leave cash on the table, publicly said he'd be a long-term holder and wanted to do more deals with VRX, without understanding and trusting the basic accounting of the company. Same for Greenberg, Sequoia, ValueAct, etc. Maybe you don't like what's there, but there is something real and not just a basic accounting illusion.

 

I also don't understand everything about BAC and AIG yet feel I understand enough of what's important about them to own them. Maybe I'm just being stupid...

[Spekulatius]

Somehow I don't think it's likely that Mr. detail work Ackman has put 30%+ of his fund/net worth into it, elected to get all stock and leave cash on the table, publicly said he'd be a long-term holder and wanted to do more deals with VRX

 

I would discount Ackman, because he got a sweetheart deal buying his AGN stock options for a huge and instant return. Of course, he would love to do more deals like that, who wouldn't!

 

Ackman has been very wrong before, just read about his leveraged Target hedge fund and of course HLF. He also has been spectacularly right of course. In any case, I would never like to depend on somebody else's homework, in particular if they have their own Agenda.

[loganc]

Somehow I don't think it's likely that Mr. detail work Ackman has put 30%+ of his fund/net worth into it, elected to get all stock and leave cash on the table, publicly said he'd be a long-term holder and wanted to do more deals with VRX

 

I would discount Ackman, because he got a sweetheart deal buying his AGN stock options for a huge and instant return. Of course, he would love to do more deals like that, who wouldn't!

 

Ackman has been very wrong before, just read about his leveraged Target hedge fund and of course HLF. He also has been spectacularly right of course. In any case, I would never like to depend on somebody else's homework, in particular if they have their own Agenda.

 

Please provide more information about Ackman's "Agenda" as you seem to be well informed about the topic. 

 

[Liberty]

Somehow I don't think it's likely that Mr. detail work Ackman has put 30%+ of his fund/net worth into it, elected to get all stock and leave cash on the table, publicly said he'd be a long-term holder and wanted to do more deals with VRX

 

I would discount Ackman, because he got a sweetheart deal buying his AGN stock options for a huge and instant return. Of course, he would love to do more deals like that, who wouldn't!

 

It's not a return until he's sold the shares, and he said he doesn't intend to after the merger, so he's still putting about a third of his funds into this company for at least the medium term. Whatever quick paper gain he made, it wouldn't be worth it if he didn't have a high level of conviction that his money is safe in the hands of valeant. He wouldn't tie his hands like this if he had doubts and wanted to just do a trade.

 

He even said he's already working on the next deal with Valeant in the original merger presentation...

 

Ackman has been very wrong before, just read about his leveraged Target hedge fund and of course HLF. He also has been spectacularly right of course. In any case, I would never like to depend on somebody else's homework, in particular if they have their own Agenda.

 

You're talking about results, I'm talking about process. (and I don't think HLF can be scored one way or the other yet)

 

We'll see the results later, but I trust Ackman's due diligence process. I suggest you read that book about his MBIA investment (Confidence Game, iirc).

 

But I don't depend on Ackman. I invested in VRX before he came on the scene. But I do take very close note of what certain investors are doing because they've proven multiple times to do better and deeper DD work than is possible for me (Berkowitz, Buffett, etc), so while I still have to become personally comfortable with something before considering it, it's always nice to see that people I respect came to similar conclusions.

[ZenaidaMacroura]

On the ackman tangent I think it would be very profitable to just follow in that guy's wake.  He has a penchant for finding opportunities (sometimes you join him going long, othertimes you go long when he shorts).  He gave me two great HLF round trips (buying sub $30 selling over $70, and then rebuying sub $50).

 

And I feel like he was one of the few people surprised by borders going under...  And I've always noticed that he likes to employ hyperbole when talking his book (each new idea is the "most compelling" he's ever encountered).

 

That said I like VRX but no position as of yet.

[giofranchi]

Gio et al.,

 

Others have clarified this but I keep seeing it being repeated, maybe you misspoke and can clarify but to be crystal clear about this: Goodwill doesn't get amortized.

 

Goodwill (like all intangibles actually) gets tested for impairment on a regular basis. The test is really just an analysis of the estimated cash flows related to the asset discounted back to today and then compared to the carrying value of the asset and when it's less an impairment charge is taken.

 

Unlike goodwill however, other intangibles that have a finite life are amortized - this would be for example amortizing the patent on Zovirax. That is the amortization that is being discussed.

And to put it simply, adding this cost back as to try to represent the true economic reality of the company is nuts. Just like depreciation on aging machinery or other assets is a real cost, this cost is very very real.

Just wanted to point this out as I see you engaging in accounting rebuttals with other folks with facts that are wrong.

 

AZ_Value et other bears, ;)

 

I have closed my position in VRX at $130 yesterday, together with my position in ENDP…

 

I needed some capital to invest in my own businesses, and VRX + ENDP simply was the stock investment of mine in which I had the least conviction…

 

But, please hear me, it has nothing to do with accounting! I have more conviction in other stock investments of mine simply because their business model is easier to predict. Period.

 

By the way, I don’t see how your example of Zovirax should work: capital expenditures on “aging machinery” are depreciated, right? But they are not expensed, right? Therefore, to calculate fcf, from net earnings you add back depreciation and subtract capital expenses, right? R&D costs, instead, are already expensed. Then why shouldn’t we simply add back to net earnings patents amortization? Like every other pharma company actually does?

 

I have great respect and esteem for Mr. Pearson (as an entrepreneur of course!), and accounting would be an issue only if Mr. Pearson’s integrity would be put in doubt… But there really is no logical basis to put his integrity in doubt! I have been listening to Mr. Pearson talk about VRX’s strategy for 3 years now, and I have never find anything unreasonable. He has always been very straightforward and sharp about this simple goal: how to rationalize costs in the pharma industry.

 

The only question that really matters is this one: is he right, or is he wrong?

 

If he is right, VRX shareholders will go on making tons of money, whatever you and others say about accounting! No doubt about this.

 

Unfortunately, I must admit I cannot answer that question with the same certainty I answer questions about other stock investments of mine… It is an entrepreneurial question, and I must admit I am not such a good entrepreneur to answer it with great conviction… I needed capital… Therefore, not without regrets I have sold…

 

Gio

 

[Spekulatius]

I agree Ackman does make a lot of waves.

 

His "Agenda" of course is to get the AGN - VRX deal done, if the deal falls apart, he will loose a lot of money, at least on paper.

 

My personal opinion is that he is a crook. Just read up on Gotham Golf and the Union Real estate estate merger attemp, where he tried to save his failed Golf course company with other peoples money basically. This and other things lead to him closing Gotham Partners.

 

He does good research and likes to make big bets. He is either spectaculary right or very wrong.

[giofranchi]

My personal opinion is that he is a crook.

 

In my business experience “crooks” and “saints” are hard to find… Instead, I find everyday people who are right and people who are wrong, people who reason clearly and people who live in confusion.

So, I much prefer to check the logic in everything, rather than to give some kind of moral judgment… And I find the logic behind Mr. Ackman’s investment thesis to be very sound most of the times… Other times, admittedly, I don’t understand them…

 

Gio

 

[vinod1]

Bmichaud,

 

That is a very good story and one that makes sense which is what makes it even more dangerous because that's all it is: a story.

 

I've asked this before and I am yet to see someone take me up on it: Can someone please show me how this is true? How are VRX drugs/products durable and not subject to patent cliffs? Any metric to share with us maybe? And as you probably know, a slide in a presentation generated to drive a transaction or management talking points is not sufficient.

 

If we were discussing J&J a person would give an answer that includes say: BandAid - Babycare - Listerine - Tylenol etc... Or if it was P&G, the answer would presumably include names like: Tide - Pantene - Old Spice - Duracell -  Pampers and many more. See, very easy.

 

Similarly a good answer for VRX would name, say VRX' top 10 or 20 of their drugs and then show us how they fit that profile. You will very quickly find that people aren't able to do that, actually they can't even name those drugs.

 

If you'll bear with me, I was working on a post to flush out my thoughts but got caught up with other opportunities that took up all my time but I'll get back to it. VRX is no holding of mine so it had to take a backseat, wouldn't own it and would be crazy to short it given how the market loves the name.

However I see many of my Corner friends here evidently stepping way out of their circle of competence and telling stories to justify it, which is how it usually happens, so I will chime in if you'll bear with me for a bit.

 

+1

 

Completely agree with you. A portion of the Valeant product line would have a limited life span and that part needs to be amortized. As an approximation I am adjusting the cash earnings down by about 10%.

 

Vinod

 

How do you get to a 10% adjustment factor?

 

Cash earnings in q1 were $599.7mm.  Amortization of finite-lived intangibles was $364.1mm.  A 10% reduction to cash eps is $60mm, and $60mm is 1/6th of the total amortization of finite-lived intangibles.  So 5/6th of that line item represents non-economic expense and is related only to products that do not have a limited life span?  How did you come to that conclusion?

 

I assumed that about 30% of sales are tied to products that have finite lives of say 10 years to 30 years. At 30 years, the economic amortization would be roughly about 1% of sales and at 10 years it would be 3% of sales or about $80 million to $240 million per year.

 

I also made adjustments for normalized restructuring and litigation expenses at about 1% of sales each. Including all these they are roughly about $300 million per year in additional expenses compared to cash EPS estimates of ~$3 billion for 2014 (if you add back all the expected savings for B&L).

 

Thus a 10% cut to management cash EPS seems to be closer to owner's earnings.

 

Vinod