VRX - Valeant Pharmaceuticals International Inc.

[giofranchi]

For me though at this point in time Valeant is not investable.

 

At this point in time…?! ???

 

I take the exact opposite view. Like I have already said, this is precisely the time I feel the most comfortable with VRX’s business model (its high level of debt excluded…): if you are not comfortable with VRX's business model after all the attacks in 2014, and how successfully VRX has responded, you will never get comfortable with it!

 

Nothing wrong with that, of course. ;)

 

Cheers,

 

Gio

 

[Liberty]

I completely agree with Munger about Valeant. However, since this thread is fanboyfest, I won't defend this opinion.  8)

 

Liberty, if you seriously think that Munger said this because he read some media article, I think you are just underestimating him and showing your VRX owner bias.

 

This does not mean that you guys won't make money. You might.

 

For me though at this point in time Valeant is not investable.

 

 

Have fun guys.

 

Sadly, Munger didn't give enough detail to be able to judge if he knows what he's talking about, so you're just guessing too, but if you can explain to me how Valeant is like ITT or Pearson worse than ITT's CEO at the time, I'd love to hear it, or anything else you have to say.

 

But if you just want to imply negative things but not provide any substance, there's not much more I can say.

[rpadebet]

Jurgis,

Please don't mind "fanboys" attacking you and please share your thoughts on VRX. I am actively seeking for as much negative opinion as I can get on this one as it has quickly become one of my largest positions. I don't mind trimming/selling if you can help shine on anything which I haven't considered and/or which is detrimental to my investment health.

[giofranchi]

"fanboys"

 

“fanboys”… are usually people who don’t care about rational things… and who don’t look for great results…

 

I hope it is not me! ;)

 

Gio

 

 

[Liberty]

One more thing to add: If anyone re-reads this threads, you'll see that there were plenty of critical people. It's just that most of what they said didn't turn out to be right and they stopped commenting. It's not been a love fest from the start for sure, and I'm certainly always open to negative theses.

 

But so far, we've been told the organic growth would tank, it's gone up. That restructuring charges were not one-time, but when they stopped acquiring during the Allergan saga, restructuring dropped down and adjusted earnings and GAAP converged in the direction of GAAP. We've been told they couldn't get the promised synergies, but they exceeded them. There wasn't enough disclosure on their products, they now provide more than most pharmas. We've been told they'll never be able to buy a big public company, but they just did. We've been told the debt was too high, yet in less than a year they delevered significantly (they were at 3.5x at the end of 2014, they're no doubt lower now, though they're about to go up again because of Salix, but it's not as bad as it seems because Salix earnings are temporarily depressed while the inventory is reduced). Cash conversion is strong, margins are high, new products are doing well (Jublia going like gangbusters, as is CeraVe), ValueAct and Ackman are adding and Sequoia is holding, etc. Even Hempton has been silent for a while.

 

So if this thread seems positive, maybe it's because the company is doing well and it becomes harder to find negative things to say...

[Picasso]

One more thing to add: If anyone re-reads this threads, you'll see that there were plenty of critical people. It's just that most of what they said didn't turn out to be right and they stopped commenting. It's not been a love fest from the start for sure, and I'm certainly always open to negative theses.

 

But so far, we've been told the organic growth would tank, it's gone up. That restructuring charges were not one-time, but when they stopped acquiring during the Allergan saga, restructuring dropped down and adjusted earnings and GAAP converged in the direction of GAAP. We've been told they couldn't get the promised synergies, but they exceeded them. There wasn't enough disclosure on their products, they now provide more than most pharmas. We've been told they'll never be able to buy a big public company, but they just did. We've been told the debt was too high, yet in less than a year they delevered significantly (they were at 3.5x at the end of 2014, they're no doubt lower now, though they're about to go up again because of Salix, but it's not as bad as it seems because Salix earnings are temporarily depressed while the inventory is reduced). Cash conversion is strong, margins are high, new products are doing well (Jublia going like gangbusters, as is CeraVe), ValueAct and Ackman are adding and Sequoia is holding, etc. Even Hempton has been silent for a while.

 

So if this thread seems positive, maybe it's because the company is doing well and it becomes harder to find negative things to say...

 

+1

 

I'm sure the negative comments will come back if VRX has some kind of sustained drop in price.  Sort of hard to keep arguing the typical bear points when almost no accusation came true.

 

Not to say everything is perfect with VRX.  I am always mindful of something I might be missing but so far the negative arguments are quite weak.

[rpadebet]

Since not many negative comments are being posted these days, I will give it a shot....

It's a concern of mine more than a short thesis...

 

Given Valeant's size and reputation now, I think it will be harder to make big meaningful acquisitions which will move the needle like they did historically. I know they got Salix, but anyone care to put a list of future targets? Their reputation in media doesn't help in getting friendly deals done. Most likely they will have to end up in a bidding war unless their targets end up in "special" short term distress like Salix.

 

They can do small addon's but to get to the historical growth, they need big fish. Cash PE isn't very demanding yet, but it is not as cheap as it was just a few months back either. ENDP seems like a decent alternative, but the Cash PE on it is much higher. Also I don't understand whether their strategy is low margin generics or high margin branded speciality drugs.I guess if ENDP is successful over the next few years, VRX can buy them ;) and send Mr. De Silva out to do another roll up.

[giofranchi]

One more thing to add: If anyone re-reads this threads, you'll see that there were plenty of critical people. It's just that most of what they said didn't turn out to be right and they stopped commenting. It's not been a love fest from the start for sure, and I'm certainly always open to negative theses.

 

But so far, we've been told the organic growth would tank, it's gone up. That restructuring charges were not one-time, but when they stopped acquiring during the Allergan saga, restructuring dropped down and adjusted earnings and GAAP converged in the direction of GAAP. We've been told they couldn't get the promised synergies, but they exceeded them. There wasn't enough disclosure on their products, they now provide more than most pharmas. We've been told they'll never be able to buy a big public company, but they just did. We've been told the debt was too high, yet in less than a year they delevered significantly (they were at 3.5x at the end of 2014, they're no doubt lower now, though they're about to go up again because of Salix, but it's not as bad as it seems because Salix earnings are temporarily depressed while the inventory is reduced). Cash conversion is strong, margins are high, new products are doing well (Jublia going like gangbusters, as is CeraVe), ValueAct and Ackman are adding and Sequoia is holding, etc. Even Hempton has been silent for a while.

 

So if this thread seems positive, maybe it's because the company is doing well and it becomes harder to find negative things to say...

 

+1

 

I think my actions speak louder than words: when I wasn’t able to answer all the doubts that were raised about VRX’s business model in 2014 by myself, and needed the company to show all those criticisms were wrong, I sold out.

 

Now I am a VRX shareholder again, not because I am a “fanboy”, but because I believe the company has proven all those criticisms wrong.

 

Gio

[giofranchi]

Given Valeant's size and reputation now, I think it will be harder to make big meaningful acquisitions which will move the needle like they did historically.

 

Well… Valeant size and reputation have never been concerns of mine…

 

I guess if ENDP is successful over the next few years, VRX can buy them ;) and send Mr. De Silva out to do another roll up.

 

Good idea! :)

 

Gio

[Liberty]

Since not many negative comments are being posted these days, I will give it a shot....

It's a concern of mine more than a short thesis...

 

Given Valeant's size and reputation now, I think it will be harder to make big meaningful acquisitions which will move the needle like they did historically. I know they got Salix, but anyone care to put a list of future targets? Their reputation in media doesn't help in getting friendly deals done. Most likely they will have to end up in a bidding war unless their targets end up in "special" short term distress like Salix.

 

They can do small addon's but to get to the historical growth, they need big fish. Cash PE isn't very demanding yet, but it is not as cheap as it was just a few months back either. ENDP seems like a decent alternative, but the Cash PE on it is much higher. Also I don't understand whether their strategy is low margin generics or high margin branded speciality drugs.I guess if ENDP is successful over the next few years, VRX can buy them ;) and send Mr. De Silva out to do another roll up.

 

That's a good question. It was addressed to my satisfaction a few times, including in Ackman's presentation when they first did the Allergan bid.

 

The pharma industry is a trillion dollar industry just in the public markets, and many more trillions in private hands. They are looking for things globally. There are also asset sales by big public companies. I think the runway is pretty long.

 

But I don't think they're on a treadmill either. If they can't do a big merger of equals, oh well. It would probably create a lot of value, but it's not the only lever they can pull. Shorts were saying the wheels would fall off when the lapped the B&L transaction, but the reverse happened. They don't need to do transactions to "cover up" something...

 

There are tons of assets the size of B&L out there, and these will move the needle for a long time. The way they integrate things at the local level, in a very decentralized way, means that they can handle many more bolt-ons than very centralized companies that do everything via the bottleneck of the head office. A bunch of billion-dollar bolt-ons add up very quickly...

 

Maybe at certain times the best way to allocate capital will be to pay down debt, or buy back shares, or increase R&D or the salesforce. I think they've shown to be opportunistic and able to find good value out there.

 

In fact, it could be argued that one big mispricing right now is debt, and they've taken advantage of that by exchanging cheap debt for quality assets that they can make more profitable (lean operations + low tax rate) and keep growing in the future. That seems like a good trade. Maybe someday debt won't be mispriced and they'll have to make different tradeoffs to create value (maybe then they'll try to become investment grade), but that's the whole job of a capital allocator.

[cayale]

It's a big position of mine, but here are some concerns:

1. Salix is further afield than previous acquisitions in terms of reimbursement.  No aspect of it is cash pay.  Are they reaching for growth when they previously did not?

2. The restructuring and synergies associated with the Salix deal are not all Salix; there are VRX elements in there.  So yes, technically, "one-time" costs went away, but just barely; because they just came back, internally, with the announcement of the Salix deal.  Is this really one time, or is it financial engineering?

3. On the surface, it looks like they are paying a higher pro-forma multiple for Salix than they did for Bausch.  Are they reaching on price where they previously did not?

[Liberty]

1. Salix is further afield than previous acquisitions in terms of reimbursement.  No aspect of it is cash pay.  Are they reaching for growth when they previously did not?

 

I don't know the answer to that one. I'm sure we'll find out more over time. I doubt they just threw away their playbook. There are probably some factors that mitigate this.

 

2. The restructuring and synergies associated with the Salix deal are not all Salix; there are VRX elements in there.  So yes, technically, "one-time" costs went away, but just barely; because they just came back, internally, with the announcement of the Salix deal.  Is this really one time, or is it financial engineering?

 

I'm not sure I understand what you mean. The restructuring costs are one-time, in that they are one-time per deal. When you do new deals, you get new costs. And where you decide to cut depends; if you have 2 things and only need 1, you keep the best one, so sometimes that might mean cutting on the VRX side.

 

3. On the surface, it looks like they are paying a higher pro-forma multiple for Salix than they did for Bausch.  Are they reaching on price where they previously did not?

 

From memory, Bausch basically had no growth, or very little, when Valeant bought them. Despite the inventory issues, I don't think this can be said of Salix (revenues are up almost 5x in the past decade), so I think it's probably fair to expect them to be worth a higher price.

[merkhet]

I'll just pass along the short thesis that I heard (which might clarify what Munger said yesterday). As a disclaimer, I have absolutely no position long or short, and this is just what I heard from a well known investor.

 

"When Valeant buys a company, they play accounting games where they write down the assets and set up a reserve on their books. Similar to Tyco's spring loading in the late '90s, when Valeant needs to meet or beat expectations, they can always do it through releasing reserves."

 

I believe this is what Munger was referencing yesterday with accounting issues and ITT, but I've not done any digging into this myself, so I (or the well known investor) could be way off base.

[Liberty]

I'll just pass along the short thesis that I heard (which might clarify what Munger said yesterday). As a disclaimer, I have absolutely no position long or short, and this is just what I heard from a well known investor.

 

"When Valeant buys a company, they play accounting games where they write down the assets and set up a reserve on their books. Similar to Tyco's spring loading in the late '90s, when Valeant needs to meet or beat expectations, they can always do it through releasing reserves."

 

I believe this is what Munger was referencing yesterday with accounting issues and ITT, but I've not done any digging into this myself, so I (or the well known investor) could be way off base.

 

Wouldn't that be a way to game GAAP earnings, something that Valeant obvious doesn't care too much about, since until recently they didn't have much to show on that front? And wouldn't this be transparent when looking at the cashflows?

 

I'd love to see any evidence of this from the shorts. If it was true, I'm pretty sure that Allergan or Hempton would've uncovered it, but what I've seen from them was pretty weak.

 

Not to mention that I don't think Bill Ackman, Jeff Ubben, and Sequoia would fall for these types of accounting tricks.

[merkhet]

All great questions for which I have no answers.

 

Just did a search and realized that Chanos had gone public with his short last year -- so that was the investor that I was referencing earlier. He mentioned the short in class one day about a year ago.

 

http://blogs.wsj.com/moneybeat/2014/05/15/why-james-chanos-is-short-valeant-long-allergan/

 

It's an interesting situation to me from a financial soap opera perspective. On the one hand, Munger & Chanos are both sour on the company. On the other hand, Ackman, Ubben & the Sequoia folks are no dummies either. *shrug*

[loganc]

All great questions for which I have no answers.

 

Just did a search and realized that Chanos had gone public with his short last year -- so that was the investor that I was referencing earlier. He mentioned the short in class one day about a year ago.

 

http://blogs.wsj.com/moneybeat/2014/05/15/why-james-chanos-is-short-valeant-long-allergan/

 

It's an interesting situation to me from a financial soap opera perspective. On the one hand, Munger & Chanos are both sour on the company. On the other hand, Ackman, Ubben & the Sequoia folks are no dummies either. *shrug*

 

I believe the Chanos thesis was published in Grant's Interest Rate Observer and has been posted in this thread previously.  Based on the performance of the VRX base business over the last year, I think it is safe to say that his thesis has been largely disproved.  Ackman got access to the Chanos thesis and publicly stated that he was wrong.  Obviously, Ackman had more perfect information about VRX and Ackman has subsequently backed up his statements about VRX by becoming the second largest shareholder despite "losing" the AGN deal.

 

As I recall from the thesis, the only thing that struck me at the time was some comment about changes in revenue recognition accounting that were made around the Medicis transaction.  If you go back and read the explanation for why VRX made these changes, it is all perfectly sensible.

[merkhet]

Yea, I have no idea if Chanos is right or wrong -- I just think this is what Munger was talking about when he referenced ITT & Harold Geneen.

[original mungerville]

From a Chanos perspective, I am totally comfortable. He was also negative on Fairfax years ago.

 

Munger is probably talking from too high a level.

 

I am comfortable with Valeant.

 

On the plus side, for some reason I fully trust Pearson (I just listen to him speak, and I think this guy I can trust - both in general and from a capital allocation perspective) like I trusted Watsa years ago. But one lesson I took away years ago with Fairfax is even a great capital allocator can, at heart, be an entrepreneur - and can make a substantial mistake. When combined with debt, that mistake can lead to substantial losses. I don't expect that here but I don't totally rule it out either (eg, a 10-15% probability).

 

I am slightly concerned re the Salix ROI (as per the above board member) and the debt level (like Gio). But the upside in Valeant is huge longer-term. So I am long Valeant - it represents the largest notional exposure of any equity in my portfolio (like Sequoia Fund). Its a huge position for Ackman now, and also ValueAct - if you know one thing about Ackman, he is not going to get confused by the accounting, especially given his focus on roll-ups. For Munger to say what he did without explanation is a little weird - maybe he is just believing what he reads in the WSJ? I don't know. Maybe he knows some executives who are not happy with Valeant transforming part of the industry. Who knows.

 

 

 

[giofranchi]

I believe the Chanos thesis was published in Grant's Interest Rate Observer and has been posted in this thread previously.  Based on the performance of the VRX base business over the last year, I think it is safe to say that his thesis has been largely disproved.  Ackman got access to the Chanos thesis and publicly stated that he was wrong.  Obviously, Ackman had more perfect information about VRX and Ackman has subsequently backed up his statements about VRX by becoming the second largest shareholder despite "losing" the AGN deal.

 

I agree 100%! And that’s exactly why I am happy to be a VRX’s shareholder again, and why today I am buying more! :)

 

Business results! The only thing that matters to me:

1) One year ago it was not easy at all to understand the true performance of acquired and restructured businesses… today, instead, it is much clearer!

2) As a consequence, one year ago there was no clear evidence about organic growth… today, instead, they have largely demonstrated they will grow organically too!

3) One year ago there was no evidence they had their debt level under control… today, though debt remains the only concern I still have about VRX, they have demonstrated they are able to reduce debt quickly if they want or in case of need!

4) One year ago the gap between Cash EPS and GAAP EPS was attacked by the shorts… today, instead, they have demonstrated that just a few months without new acquisitions are enough to make Cash EPS and GAAP EPS converge!

 

Imo very clear and convincing business results.

 

Cheers,

 

Gio

 

[giofranchi]

For Munger to say what he did without explanation is a little weird - maybe he is just believing what he reads in the WSJ? I don't know. Maybe he knows some executives who are not happy with Valeant transforming part of the industry. Who knows.

 

I would say he is just pissed off about the relocation of Valeant to Canada for tax reasons… Something Berkshire could never do… ;)

 

Gio

 

[constructive]

I suspect Munger is talking about VRX more statistically than specifically. In his lifetime he has seen a lot of companies that take on lots of debt to make acquisitions, with low GAAP earnings, and aggressive targets for cost-cutting. I guess he perceives that most of the time this has not worked very well.

[original mungerville]

Usually it doesn't. Even Fairfax almost went to zero because of lots of debt/leverage and two large acquisitions in 1999.

[Bagehot]

I'll just pass along the short thesis that I heard (which might clarify what Munger said yesterday). As a disclaimer, I have absolutely no position long or short, and this is just what I heard from a well known investor.

 

"When Valeant buys a company, they play accounting games where they write down the assets and set up a reserve on their books. Similar to Tyco's spring loading in the late '90s, when Valeant needs to meet or beat expectations, they can always do it through releasing reserves."

 

I believe this is what Munger was referencing yesterday with accounting issues and ITT, but I've not done any digging into this myself, so I (or the well known investor) could be way off base.

 

There are a couple of ways you can do this. The first is to just completely be a serial acquirer, of small companies that lack public financials, like Tyco. You are constantly showing cash outflows in the investing section of the CF statement, and you onboard the cash flow generating capability in the operating section. This can make sustainable, reported CFFO look higher than it really is as long as you stay on the treadmill. A more aggressive way of doing this is to convince the acquired company to really build their working capital (build inventory, don't collect receivables, pay down payables aggressively, etc.) in the period just before the acquisition closes. Then when working capital reverts to historic norms after the acquisition closes, there is a nice boost to reported CFFO that is clearly unsustainable. Not saying this was intentional, but B+L somewhat fit this pattern just before the VRX acquisition closed (you can do some digging in 8-Ks on 10/21/13 and 6/10/13 to verify) and I think this was a critical cog in Chanos' thesis, which to others' point has been debunked now that B+L has annualized and no other sizable acquisitions have taken place with no adverse effect to cash flows.

 

The other major way of gaming acquisition accounting, by the way, is to make a bunch of post-closing adjustments from tangible assets to intangible assets. This is what CBI has been accused of. It's easy to track this for Valeant, they have pretty good acquisition disclosures, and it hasn't been an issue.

 

[original mungerville]

So for Munger to be right, Ackman, ValueAct, Sequoia Fund and Lou Simpson - among many other extremely prominent value investors - all have to be wrong.

 

The debt is risky, but hey

 

1. A 5% tax rate when everyone else has 20% plus isn't risky.

2. And cutting bloated middle management isn't risky either.

3. Neither is cutting bloated research.

 

Leverage works with utilities because the returns are certain. Well, #1 is certain, #2 is near-certain, and #3 has worked reliably for Valeant in the past. 

[loganc]

I have reviewed a fair amount of the Salix deal information over the last couple of days to re-check my work on VRX and here are a few thoughts that I would like to share:

 

(1) The numbers appear to me to indicate that the IBS-D indication for Xifaxan is not baked in to the 7.5B Adj EBITDA guidance number provided for 2016.  As mentioned on the call, it appears that they believe that the market for the IBS-D indication is larger than the current Xifaxan market.  Given the organic growth profile  and current sales run rate (ex-inventory issues) of Xifaxan, the IBS-D indication should represent quite considerable upside.  Further, there may be an additional pricing opportunity with the Salix portfolio, as I would imagine the run rate sales in the Q4 slide deck were conservative.  Why would you want to advertise the optimistic case for Salix and invite other bids?

 

(2) The leverage currently appears fairly high given that synergy numbers are baked into the 5.6x net debt leverage number, but the growth from Salix and the VRX base business should be pretty substantial over the next couple of years and the business should de-lever pretty quickly as stated by management.  As stated, getting the IBS-D indication for Xifaxan and the potential pricing opportunity provides further upside to the de-levering time frame.   

 

(3) On a higher level, I think there is truth to some of the skeptical comments about the Salix deal relative to the traditional VRX acquisition targets.  In other words, Xifaxan is a very large part of the value of Salix, so it doesn't appear that they are avoiding "blockbusters" in this particular case.  That being said, I think this deal makes sense from the standpoint that it is very opportunistic.  I don't think VRX would be doing this deal had the inventory issue not happened, since the price for the asset would likely have been too high given the growth profile.

 

Happy to hear any comments.