VRX - Valeant Pharmaceuticals International Inc.

[giofranchi]

The pupil,

If you listen to the Q2 2015 conference call, you'd hear management say that organic growth was due 50% to price increase and 50% to volume increase...

Therefore, however you put it, if your bear thesis n.1 is true, management is telling lies... And that imo is the definition of a fraud.

On the other hand, if management is telling the truth, your bear thesis n.1 has no real substance.

 

Cheers,

 

Gio

[merkhet]

Here we go...

 

I have voted "No", simply because imo it is too good of a business to be a fraud. No need to lie, when you can make money, lots of money!, honestly instead! To lie would be like risking to lose what they need and already have for what they do not need at all (to borrow from Buffett).

 

But of course I cannot be sure... Who can, right? Therefore, I am listening to whatever people have to say on the subject.

 

Cheers,

 

Gio

 

I have no position in Valeant, but I would just like to point out a possible cognitive bias here.

 

You probably believe it is a good business because the concept makes sense to you. The company buys other companies/products that are not being utilized to their full potential and restructures them in a way that gushes cash flow. You verify that it is a good business because the numbers and/or the explanations from management confirm that it is.

 

If management is lying about the numbers, then you have to consider that it is, in fact, not a good business at all -- so your underlying assumption might be wrong.

 

Let's put it another way. You think that someone that has a good business on their hands has no real incentive (outside of personal derangement) to tinker with the numbers. And you're probably right. You should, however, consider the possibility that it looks like a good business because someone has tinkered with the numbers.

[rpadebet]

Here we go...

 

I have voted "No", simply because imo it is too good of a business to be a fraud. No need to lie, when you can make money, lots of money!, honestly instead! To lie would be like risking to lose what they need and already have for what they do not need at all (to borrow from Buffett).

 

But of course I cannot be sure... Who can, right? Therefore, I am listening to whatever people have to say on the subject.

 

Cheers,

 

Gio

 

I have no position in Valeant, but I would just like to point out a possible cognitive bias here.

 

You probably believe it is a good business because the concept makes sense to you. The company buys other companies/products that are not being utilized to their full potential and restructures them in a way that gushes cash flow. You verify that it is a good business because the numbers and/or the explanations from management confirm that it is.

 

If management is lying about the numbers, then you have to consider that it is, in fact, not a good business at all -- so your underlying assumption might be wrong.

 

Let's put it another way. You think that someone that has a good business on their hands has no real incentive (outside of personal derangement) to tinker with the numbers. And you're probably right. You should, however, consider the possibility that it looks like a good business because someone has tinkered with the numbers.

 

+1

Betting on the business model is believing a story. The story is always only as good as the story teller. You are betting on the story teller here Pearson. He says all the right things in the conference calls, but do we really "know" him? If his legal documents don't tell the same story as his marketing presentations, that is a really big red flag. Why not disclose the same things in legal docs? I am sure good lawyers can find a way to cover your butt in those legal docs if necessary.

 

 

[thepupil]

The pupil,

If you listen to the Q2 2015 conference call, you'd hear management say that organic growth was due 50% to price increase and 50% to volume increase...

Therefore, however you put it, if your bear thesis n.1 is true, management is telling lies... And that imo is the definition of a fraud.

On the other hand, if management is telling the truth, your bear thesis n.1 has no real substance.

 

Cheers,

 

Gio

 

understood. like i said, it's not my thesis, so I may be relaying it poorly.

[giofranchi]

VRX is my biggest position. I bought into the bull thesis completely and it has been good for me this past year.

However, the az_value post and this Sprout acquisition is making me question my thesis.

 

At the core of the bull thesis, to be completely honest, is the trust placed by Value Act,Sequoia and Ackman in Pearson and VRX. If these investors were not there and everything else was same, how many of us would feel comfortable with VRX disclosures, financial leverage, acquisition spree etc.

 

Yes the business model makes sense. Avoiding wasteful R&D can save money theoretically, but they pay high prices for successful R&D, so part of the cost of wasteful R&D is baked into the prices of successful R&D purchased.

 

I wouldn't bet too much on the low Cash EPS multiple for the equity. That is not an indicator that only low growth is priced in. The correct measure is (Cash EPS+interest-tax benefit)/EV as a highly leveraged business can post a high Cash EPS relative to equity in a low interest rate environment and with below average tax rates. Also maintenance cap ex here takes the form of continuously buying "successful R&D", that needs to be subtracted as well to get to true FCF to firm.

 

The simple fact that no one has been able to argue the facts put forth by az_value and are just hoping ValueAct and other investors must have done their job is a big concern for me. Cloning is a good way to get ideas, but not an investment thesis in itself. The longs should either put in the work to provide a fact based counter point to issues raised by az_value or admit our laziness and close out the position, to save some money.

 

I think it is quite possible this could go ENRON way someday. Things ENRON did was also accepted in the financial world as kosher during those days until the public campaign against it started and public opinion changed to think of it as fraud. I can't say VRX is a fraud, I can only say, enough questions are now raised to be able to say "I don't know if its genuine".

 

I think I will reduce my exposure until further clarity on the numbers.

 

How would you argue with AZ_Value?

He pointed out a couple of instances in which VRX seems to have reported infilated revenues that the evidence seems to suggest they were lower instead... There is nothing to argue with that imo... He took the AR of a company that was purchased by VRX 99%, and for two years it reported revenues that were slightly lower than what VRX reported instead... How would you argue with that?

 

It is what he seems to infer from this single find that should be argue with: that that single find means lots of other bad things were done by management, and that therefore VRX is a fraud.

 

To this AZ_Value has given no clear evidence either until now... Otherwise, we wouldn't be here discussing about it.

 

Cheers,

 

Gio

[giofranchi]

Here we go...

 

I have voted "No", simply because imo it is too good of a business to be a fraud. No need to lie, when you can make money, lots of money!, honestly instead! To lie would be like risking to lose what they need and already have for what they do not need at all (to borrow from Buffett).

 

But of course I cannot be sure... Who can, right? Therefore, I am listening to whatever people have to say on the subject.

 

Cheers,

 

Gio

 

I have no position in Valeant, but I would just like to point out a possible cognitive bias here.

 

You probably believe it is a good business because the concept makes sense to you. The company buys other companies/products that are not being utilized to their full potential and restructures them in a way that gushes cash flow. You verify that it is a good business because the numbers and/or the explanations from management confirm that it is.

 

If management is lying about the numbers, then you have to consider that it is, in fact, not a good business at all -- so your underlying assumption might be wrong.

 

Let's put it another way. You think that someone that has a good business on their hands has no real incentive (outside of personal derangement) to tinker with the numbers. And you're probably right. You should, however, consider the possibility that it looks like a good business because someone has tinkered with the numbers.

 

1) I like the pharma and biotechnology industry in general: imo it is the best industry to be in.

 

2) I like those companies which grow both organically and through acquisitions. All investments of mine have this characteristic, not only VRX.

 

3) I like those businesses which have a "zero budget" approach and are very focused on ROIC. VRX in its R&D efforts seems to behave that way.

 

4) This being said, I have always said I want to see good business results... Recently I have also added I want to see both short term and long term very good business results... Therefore, at least in part I cannot but agree with you.

 

Remember though that I was invested in FFH for a long time even if business results weren't all that satisfactory!

 

Cheers,

 

Gio

[Bagehot]

the bearish arguments I have heard do not argue that VRX is a fraud in the Worldcom (accounting scandal) or chinese (assets aren't there, management fleecing company) way. I've never heard a Valeant bear (and i've only spoken to a couple and read a few analyses) say "they are fudging the numbers" or something like that.

 

The bearish arguments I have heard revolve around

 

1) organic growth being inflated by unsustainable, manifold pricing increases. Stuff like the below. They argue that volume growth is flat to negative and pricing is prone to regulatory scrutiny and that the house of cards will collapse once the price increases go away.

http://www.wsj.com/articles/bernie-sanders-elijah-cummings-question-valeant-on-heart-drug-price-increases-1439574723

 

2) related to point 1. management raising cheap debt and expensive equity financing and being kind of the sophisticated investors promotional stock / bull market vehicle, using inflated earnings power to juice the reflexivity / accretion machine.

 

I have no position and have done no research, just relaying info that may be helpful.

 

Valeant was down 6% yesterday because it is a momo growth stock, all those sold off hard yesterday. I don't think it was a reaction to the $1B female viagra thing or AZ value's thing making the rounds or some kind of fraud thesis suddenly coming to fruition; people have been skeptical of valeant for years, there hasn't been anything new.

 

Just a quick point of clarification on the Marathon drugs Bernie Sanders was questioning: they are not included in organic growth because they were just acquired in February. VRX will never show any organic growth benefit from those price increases because the prices were raised concurrent with the acquisition so when the drugs become same-store, they will be comping at the new "inflated" price.

 

Marathon identified the ability to raise prices but was essentially too scared to do it because they might face blowback elsewhere in their portfolio. So they sold to VRX who has minimal other points of contact with cardiologists/cardiac surgeons. It was a smart move for Valeant in a micro sense, in that the drugs were underpriced but their current owner couldn't raise prices again, so VRX got a good deal. It may not be so smart in a macro sense if this turns into some sort of full blown investigation. However I doubt they were completely taken off guard. Sanders was already coming after Marathon re: price increases on Isuprel and Nitropress even before the last round of price raises. See here:

 

http://www.sanders.senate.gov/download/letter-to-mr-aronin-chairman-and-ceo-marathon-pharmaceuticals-llc?inline=file

 

 

[KCLarkin]

maintenance cap ex here takes the form of continuously buying "successful R&D", that needs to be subtracted as well to get to true FCF to firm.

 

This is only true if there is no organic growth.

[Ross812]

Here we go...

 

I have voted "No", simply because imo it is too good of a business to be a fraud. No need to lie, when you can make money, lots of money!, honestly instead! To lie would be like risking to lose what they need and already have for what they do not need at all (to borrow from Buffett).

 

But of course I cannot be sure... Who can, right? Therefore, I am listening to whatever people have to say on the subject.

 

Cheers,

 

Gio

 

I have no position in Valeant, but I would just like to point out a possible cognitive bias here.

 

You probably believe it is a good business because the concept makes sense to you. The company buys other companies/products that are not being utilized to their full potential and restructures them in a way that gushes cash flow. You verify that it is a good business because the numbers and/or the explanations from management confirm that it is.

 

If management is lying about the numbers, then you have to consider that it is, in fact, not a good business at all -- so your underlying assumption might be wrong.

 

Let's put it another way. You think that someone that has a good business on their hands has no real incentive (outside of personal derangement) to tinker with the numbers. And you're probably right. You should, however, consider the possibility that it looks like a good business because someone has tinkered with the numbers.

 

1) I like the pharma and biotechnology industry in general: imo it is the best industry to be in.

 

2) I like those companies which grow both organically and through acquisitions. All investments of mine have this characteristic, not only VRX.

 

3) I like those businesses which have a "zero budget" approach and are very focused on ROIC. VRX in its R&D efforts seems to behave that way.

 

4) This being said, I have always said I want to see good business results... Recently I have also added I want to see both short term and long term very good business results... Therefore, at least in part I cannot but agree with you.

 

Remember though that I was invested in FFH for a long time even if business results weren't all that satisfactory!

 

Cheers,

 

Gio

 

Why do you like the pharma business? To me I view pharma as a miner or oil major. They explorer (R&D) for new resources (drugs) and mine the resource until the area is depleted (patent expiration).

 

I view VRX an oil major that acquires new fields through acquisition. For VRX to add value, they must enhance the productivity of the asset they purchase. I.e. they cut costs (which they do by suspending R&D) and expanding or enhancing the sales department.

 

This sounds like a good game plan, but the problem is, without R&D their drug pipeline eventually dries up meaning they have to be a serial acquirer. There really is no organic growth. They maximize the asset they buy and desire a certain level of return over the purchase price. This is fine except to continue to roll up the industry you have to go after bigger and bigger fish to move the needle. At some point you run out of targets and you are left with a collection of gutted pharma companies that are worth what their terminal cash flow will return.

 

I don't think VRX is a fraud, but it is a financial corporate raider company, not a pharma company. VRX is billed as a pharma rollup, but rollups only work if they add value to the companies they acquire. VRX maximizes value as they dispose of the company. They will eventually end up with nothing but a pile of cash and to be honest, I don't think dismantling pharma companies is making the world a better place. 

 

   

[Bagehot]

VRX is my biggest position. I bought into the bull thesis completely and it has been good for me this past year.

However, the az_value post and this Sprout acquisition is making me question my thesis.

 

At the core of the bull thesis, to be completely honest, is the trust placed by Value Act,Sequoia and Ackman in Pearson and VRX. If these investors were not there and everything else was same, how many of us would feel comfortable with VRX disclosures, financial leverage, acquisition spree etc.

 

Yes the business model makes sense. Avoiding wasteful R&D can save money theoretically, but they pay high prices for successful R&D, so part of the cost of wasteful R&D is baked into the prices of successful R&D purchased.

 

I wouldn't bet too much on the low Cash EPS multiple for the equity. That is not an indicator that only low growth is priced in. The correct measure is (Cash EPS+interest-tax benefit)/EV as a highly leveraged business can post a high Cash EPS relative to equity in a low interest rate environment and with below average tax rates. Also maintenance cap ex here takes the form of continuously buying "successful R&D", that needs to be subtracted as well to get to true FCF to firm.

 

The simple fact that no one has been able to argue the facts put forth by az_value and are just hoping ValueAct and other investors must have done their job is a big concern for me. Cloning is a good way to get ideas, but not an investment thesis in itself. The longs should either put in the work to provide a fact based counter point to issues raised by az_value or admit our laziness and close out the position, to save some money.

 

I think it is quite possible this could go ENRON way someday. Things ENRON did was also accepted in the financial world as kosher during those days until the public campaign against it started and public opinion changed to think of it as fraud. I can't say VRX is a fraud, I can only say, enough questions are now raised to be able to say "I don't know if its genuine".

 

I think I will reduce my exposure until further clarity on the numbers.

 

Have you ever bought a LEAP? That is what the Sprout deal is. VRX spent <1% of their EV on a drug that could be a homerun or could be a zero. If it had been 40% of their EV, I would be very concerned. At <1%, it looks like a nice risk/reward play that will be a good kicker if it works, and not cause any trouble if it doesn't.

 

On AZ Value, I'm not sure what there is to refute. Is it possible that IFRS has different revenue recognition standards than GAAP? Might Valeant have folded some other Eastern European product line into Sanitas that explains the $20M difference in sales? Is a $15-$20M difference (<10 bps of '16E sales) that could be easily explained by either of these two hypotheses a good reason to label the entire thing a fraud? And last, if Valeant were blatantly overstating sales like this, what to make of the sales performance for 3Q/4Q/1Q in which there were no large acquisitions and Valeant grew sales significantly? It's hard to fake sales for an extended period of time, and even if you do you have the problem that no cash is showing up. So then you have to start faking cash, which is very hard to do (albeit not impossible, see: Satyam). Now what are the odds that VRX is faking cash/sales with ValueAct on the board and Ackman doing diligence with material nonpublic info which restricted him for a year, after which he immediately made VRX his largest position? I'm not saying the answer is zero, but there are no absolutes in investing. The future is always uncertain.

 

A quick though experiment: What happened to Forest River's sales last year? Is the answer material to your thesis on Berkshire, if you have one? Sanitas is something like 1% of sales for VRX. Management can mess with the accounting all they want and it just isn't going to move the needle one way or the other.

[Patmo]

VRX is my biggest position. I bought into the bull thesis completely and it has been good for me this past year.

However, the az_value post and this Sprout acquisition is making me question my thesis.

 

At the core of the bull thesis, to be completely honest, is the trust placed by Value Act,Sequoia and Ackman in Pearson and VRX. If these investors were not there and everything else was same, how many of us would feel comfortable with VRX disclosures, financial leverage, acquisition spree etc.

 

Yes the business model makes sense. Avoiding wasteful R&D can save money theoretically, but they pay high prices for successful R&D, so part of the cost of wasteful R&D is baked into the prices of successful R&D purchased.

 

I wouldn't bet too much on the low Cash EPS multiple for the equity. That is not an indicator that only low growth is priced in. The correct measure is (Cash EPS+interest-tax benefit)/EV as a highly leveraged business can post a high Cash EPS relative to equity in a low interest rate environment and with below average tax rates. Also maintenance cap ex here takes the form of continuously buying "successful R&D", that needs to be subtracted as well to get to true FCF to firm.

 

The simple fact that no one has been able to argue the facts put forth by az_value and are just hoping ValueAct and other investors must have done their job is a big concern for me. Cloning is a good way to get ideas, but not an investment thesis in itself. The longs should either put in the work to provide a fact based counter point to issues raised by az_value or admit our laziness and close out the position, to save some money.

 

I think it is quite possible this could go ENRON way someday. Things ENRON did was also accepted in the financial world as kosher during those days until the public campaign against it started and public opinion changed to think of it as fraud. I can't say VRX is a fraud, I can only say, enough questions are now raised to be able to say "I don't know if its genuine".

 

I think I will reduce my exposure until further clarity on the numbers.

 

Have you ever bought a LEAP? That is what the Sprout deal is. VRX spent <1% of their EV on a drug that could be a homerun or could be a zero. If it had been 40% of their EV, I would be very concerned. At <1%, it looks like a nice risk/reward play that will be a good kicker if it works, and not cause any trouble if it doesn't.

 

On AZ Value, I'm not sure what there is to refute. Is it possible that IFRS has different revenue recognition standards than GAAP? Might Valeant have folded some other Eastern European product line into Sanitas that explains the $20M difference in sales? Is a $15-$20M difference (<10 bps of '16E sales) that could be easily explained by either of these two hypotheses a good reason to label the entire thing a fraud? And last, if Valeant were blatantly overstating sales like this, what to make of the sales performance for 3Q/4Q/1Q in which there were no large acquisitions and Valeant grew sales significantly? It's hard to fake sales for an extended period of time, and even if you do you have the problem that no cash is showing up. So then you have to start faking cash, which is very hard to do (albeit not impossible, see: Satyam). Now what are the odds that VRX is faking cash/sales with ValueAct on the board and Ackman doing diligence with material nonpublic info which restricted him for a year, after which he immediately made VRX his largest position? I'm not saying the answer is zero, but there are no absolutes in investing. The future is always uncertain.

 

A quick though experiment: What happened to Forest River's sales last year? Is the answer material to your thesis on Berkshire, if you have one? Sanitas is something like 1% of sales for VRX. Management can mess with the accounting all they want and it just isn't going to move the needle one way or the other.

 

Keep in mind AZ Value did not call anyone a fraud, at least not yet. His report showed reporting opaqueness and some sense of shadiness, but something being a fraud is another level. I think everybody has been quick to band into the black camp or the white camp, when reality is probably some shade of grey...

 

Personally I still can't wait to read AZ Value's next blog post. So far the bull side's main rebuttal on here has been that there are smart people involved with Valeant who have access to insider info. In my mind, this argument is a house of cards and pure speculation. If someone's investment thesis rests on there being someone else also invested in a company, they have no thesis to begin with. Right or wrong, AZ Value's post at least attempts to make an analysis of the facts before him, and I would be excited to read actual counter-arguments to his findings (yours being one for a start, so thank you).

[rpadebet]

How would you explain the way average growth is calculated? The thesis is basically pearson is very smart, maybe an outsider and a straight shooter right? How does it make sense to calculate growth averages that way then?

 

If 1% of my portfolio did 100% in a year and 99% was flat, did I grow my portfolio by 50%? This is either disingenuous or plain deceptive.

 

Pearson is clearly a smart guy, so it is hard for me to buy the argument that he is dumb about this particular thing or is trying to oversell or that's the way things are done. This guys claim to fame is he wanted to change how things are done in Pharma right?

[Jurgis]

How would you explain the way average growth is calculated? The thesis is basically pearson is very smart, maybe an outsider and a straight shooter right? How does it make sense to calculate growth averages that way then?

 

If 1% of my portfolio did 100% in a year and 99% was flat, did I grow my portfolio by 50%? This is either disingenuous or plain deceptive.

 

Pearson is clearly a smart guy, so it is hard for me to buy the argument that he is dumb about this particular thing or is trying to oversell or that's the way things are done. This guys claim to fame is he wanted to change how things are done in Pharma right?

 

I am not VRX bull.

 

However, sometimes smart people do dumb things in overselling. Like the Google driverless car TED talk where the guy had a facepalm slide trying to persuade the audience that driverless car has to make decisions 5000 times a second while the forward-collision-avoidance system has to make a decision once a month or something. That was completely false. Why did he do it? Not really a fraud. I guess he tried to oversell... It's tough to not exaggerate stupidly sometimes. The question for investors to decide is whether this is systemic and whether it crosses a threshold beyond which you don't want to deal with the company involved.

[giofranchi]

Here we go...

 

I have voted "No", simply because imo it is too good of a business to be a fraud. No need to lie, when you can make money, lots of money!, honestly instead! To lie would be like risking to lose what they need and already have for what they do not need at all (to borrow from Buffett).

 

But of course I cannot be sure... Who can, right? Therefore, I am listening to whatever people have to say on the subject.

 

Cheers,

 

Gio

 

I have no position in Valeant, but I would just like to point out a possible cognitive bias here.

 

You probably believe it is a good business because the concept makes sense to you. The company buys other companies/products that are not being utilized to their full potential and restructures them in a way that gushes cash flow. You verify that it is a good business because the numbers and/or the explanations from management confirm that it is.

 

If management is lying about the numbers, then you have to consider that it is, in fact, not a good business at all -- so your underlying assumption might be wrong.

 

Let's put it another way. You think that someone that has a good business on their hands has no real incentive (outside of personal derangement) to tinker with the numbers. And you're probably right. You should, however, consider the possibility that it looks like a good business because someone has tinkered with the numbers.i

 

1) I like the pharma and biotechnology industry in general: imo it is the best industry to be in.

 

2) I like those companies which grow both organically and through acquisitions. All investments of mine have this characteristic, not only VRX.

 

3) I like those businesses which have a "zero budget" approach and are very focused on ROIC. VRX in its R&D efforts seems to behave that way.

 

4) This being said, I have always said I want to see good business results... Recently I have also added I want to see both short term and long term very good business results... Therefore, at least in part I cannot but agree with you.

 

Remember though that I was invested in FFH for a long time even if business results weren't all that satisfactory!

 

Cheers,

 

Gio

 

Why do you like the pharma business? To me I view pharma as a miner or oil major. They explorer (R&D) for new resources (drugs) and mine the resource until the area is depleted (patent expiration).

 

I view VRX an oil major that acquires new fields through acquisition. For VRX to add value, they must enhance the productivity of the asset they purchase. I.e. they cut costs (which they do by suspending R&D) and expanding or enhancing the sales department.

 

This sounds like a good game plan, but the problem is, without R&D their drug pipeline eventually dries up meaning they have to be a serial acquirer. There really is no organic growth. They maximize the asset they buy and desire a certain level of return over the purchase price. This is fine except to continue to roll up the industry you have to go after bigger and bigger fish to move the needle. At some point you run out of targets and you are left with a collection of gutted pharma companies that are worth what their terminal cash flow will return.

 

I don't think VRX is a fraud, but it is a financial corporate raider company, not a pharma company. VRX is billed as a pharma rollup, but rollups only work if they add value to the companies they acquire. VRX maximizes value as they dispose of the company. They will eventually end up with nothing but a pile of cash and to be honest, I don't think dismantling pharma companies is making the world a better place. 

 

 

 

1) Why do I like the pharma industry?

 

I think this century will be remembered as the century of biotechnology, like last century is remembered as the century of oil. Endless opportunities in biotechnology imo for those who don't waste money and are focused on financial returns...

 

2) There is no organic growth?

 

If so, VRX is a fraud.

Management said that organic growth for the whole company has been over 15% for 4 quarters in a row, and last quarter organic growth for their top 20 products has been an unbelievable 37%!!

 

The results VRX management talks about are almost too good to be true... That's why I started the poll!

 

Cheers,

 

Gio

[rpadebet]

And they keep saying they use conservative numbers....

Averaging the way they average is not at all conservative, i think the only way you could be more aggressive is asking the investor community to focus only on the small products and ignore the mature products. Or use some metric like "Same New store sales"..

 

At this valuation, a lot of organic growth is baked in EV/EBIT is 25+.

the bet here is only on the jockey. If they jockey says he is a straight shooter and conservative, but there is evidence  (even small one) that he isn't, then the prudent thing to do is sell and then wait to watch....

 

If this is not a fraud and if organic growth is only half of what it is touted to be, given the debt levels, given the stock comp, given the current low tax rate, given the growth in revenues attributable to price increases, IMO the fair value is below 140 for this.

[BraveChieftain]

I don't have a view on VRX, but if you assume that they are legit and actually doing good deals, it's not fair to look at them on an EV/EBIT multiple. EV/EBITA is much more appropriate given all the deals they've done.

[rpadebet]

I don't have a view on VRX, but if you assume that they are legit and actually doing good deals, it's not fair to look at them on an EV/EBIT multiple. EV/EBITA is much more appropriate given all the deals they've done.

 

That's not fair. As discussed before their R&D takes the form of tuck ins and acquisitions. So 'A' is a real cost but most likely understated at this point because they are doing bigger and bigger deals, the current 'A' is from previous smaller deals. So EV/EBIT of 25 is conservative.

 

Also tax rate of 5% is not sustainable, probably need to use 15%

 

And interest rate, they offer their debt at 5.5% or so, refinancing is going to be a big risk if HY market goes how it is going and if their actual cash eps is indeed inflated.

[original mungerville]

So Valeant spends $1 billion today and market cap down over $5 billion. I would say much of that decline is due to overall stock market / pharma - say $3 billion of it; but I am guessing around $2 billion (certainly over $1 billion) of it relates to the female Viagra acquisition.

 

So apparently the rational market is saying they can lose more than the $1 billion they put in (despite that $1 billion being paid out in two $500 million tranches the second of which has milestones attached to it).

 

For Valeant bulls, any further declines will make this a cheap entry point (at least relative to the market). Note: I think the S&P may correct significantly here (or over next few months).

 

Original mungerville,

I think the market is divided over a much more serious topic, the following: is VRX a fraud?

 

Everything else pales in comparison.

 

I don't know how to, but I would start a poll on the board titled "Is VRX a fraud?", and listen to what people have to say.

 

Cheers,

 

Gio

 

Do you think AZ_Value's post is moving the entire market in Valeant shares??! ...and that is the reason for the recent decline?...rather than the general weakness in the healthcare and overall market, combined with the market's view on the latest acquisition?

 

Remember, the only things which have changed in last week is 1) significant weakness in overall stock market and healthcare high-flyers - Valeant getting more of that because high-yield bond market also under pressure, and the latest acquisition.

 

Prior, Salix acquisition is looking great and internal organic growth well-above expectations.

[rpadebet]

Not likely, but we will know when he posts the other parts and if the shares tumble more

[BraveChieftain]

If you believe the VRX story and believe the business has real organic growth, you have to add back the amortization expense....

[original mungerville]

VRX is my biggest position. I bought into the bull thesis completely and it has been good for me this past year.

However, the az_value post and this Sprout acquisition is making me question my thesis.

 

At the core of the bull thesis, to be completely honest, is the trust placed by Value Act,Sequoia and Ackman in Pearson and VRX. If these investors were not there and everything else was same, how many of us would feel comfortable with VRX disclosures, financial leverage, acquisition spree etc.

 

Yes the business model makes sense. Avoiding wasteful R&D can save money theoretically, but they pay high prices for successful R&D, so part of the cost of wasteful R&D is baked into the prices of successful R&D purchased.

 

I wouldn't bet too much on the low Cash EPS multiple for the equity. That is not an indicator that only low growth is priced in. The correct measure is (Cash EPS+interest-tax benefit)/EV as a highly leveraged business can post a high Cash EPS relative to equity in a low interest rate environment and with below average tax rates. Also maintenance cap ex here takes the form of continuously buying "successful R&D", that needs to be subtracted as well to get to true FCF to firm.

 

The simple fact that no one has been able to argue the facts put forth by az_value and are just hoping ValueAct and other investors must have done their job is a big concern for me. Cloning is a good way to get ideas, but not an investment thesis in itself. The longs should either put in the work to provide a fact based counter point to issues raised by az_value or admit our laziness and close out the position, to save some money.

 

I think it is quite possible this could go ENRON way someday. Things ENRON did was also accepted in the financial world as kosher during those days until the public campaign against it started and public opinion changed to think of it as fraud. I can't say VRX is a fraud, I can only say, enough questions are now raised to be able to say "I don't know if its genuine".

 

I think I will reduce my exposure until further clarity on the numbers.

 

I have provided my remarks on AZ_Value's post - looking forward to his next one because the last one did not overwhelm me or change my mind on VRX. Secondly, I love the low price they are paying to the latest acquisition - $1 billion seems to be a low multiple if things work out OK, and a steal if things work out great in terms of how the market for this drug responds.  I think this acquisition makes Valeant more valuable, Salix acquisition has been great thus far and organic growth doing very well.

[rpadebet]

If you believe the VRX story and believe the business has real organic growth, you have to add back the amortization expense....

 

I don't believe so. If you add amortization expense, you have to subtract some other estimate for maintenance capex. No business sustains revenues by itself without additional expenses.

 

Organic growth is also not free, there is growth capex usually for that, but you don't subtract that to get an estimate of Free cash flow.

 

I have always assumed in VRX case, maintenance capex +growth capex+R&D is combined into the acquisition prices paid. They could be super smart and pay very low prices, thus almost ensuring maintenance capex is zero, but you not only have to believe they are super smart all the time, but also have to believe the sellers are always dumb or distressed.

 

Salix might be a good acquisition because it was a distressed sale. We just don't know how good until we see the organic growth 1-2 years down the line without the acquisition costs and inventory issues.

 

Sprout, I don't know. If the drug is ineffective and placebo, then it will bomb. But at 1 bill, I think they probably might be using it more for getting the average organic growth higher in future :)

[original mungerville]

Here we go...

 

I have voted "No", simply because imo it is too good of a business to be a fraud. No need to lie, when you can make money, lots of money!, honestly instead! To lie would be like risking to lose what they need and already have for what they do not need at all (to borrow from Buffett).

 

But of course I cannot be sure... Who can, right? Therefore, I am listening to whatever people have to say on the subject.

 

Cheers,

 

Gio

 

I have no position in Valeant, but I would just like to point out a possible cognitive bias here.

 

You probably believe it is a good business because the concept makes sense to you. The company buys other companies/products that are not being utilized to their full potential and restructures them in a way that gushes cash flow. You verify that it is a good business because the numbers and/or the explanations from management confirm that it is.

 

If management is lying about the numbers, then you have to consider that it is, in fact, not a good business at all -- so your underlying assumption might be wrong.

 

Let's put it another way. You think that someone that has a good business on their hands has no real incentive (outside of personal derangement) to tinker with the numbers. And you're probably right. You should, however, consider the possibility that it looks like a good business because someone has tinkered with the numbers.

 

1) I like the pharma and biotechnology industry in general: imo it is the best industry to be in.

 

2) I like those companies which grow both organically and through acquisitions. All investments of mine have this characteristic, not only VRX.

 

3) I like those businesses which have a "zero budget" approach and are very focused on ROIC. VRX in its R&D efforts seems to behave that way.

 

4) This being said, I have always said I want to see good business results... Recently I have also added I want to see both short term and long term very good business results... Therefore, at least in part I cannot but agree with you.

 

Remember though that I was invested in FFH for a long time even if business results weren't all that satisfactory!

 

Cheers,

 

Gio

 

Why do you like the pharma business? To me I view pharma as a miner or oil major. They explorer (R&D) for new resources (drugs) and mine the resource until the area is depleted (patent expiration).

 

I view VRX an oil major that acquires new fields through acquisition. For VRX to add value, they must enhance the productivity of the asset they purchase. I.e. they cut costs (which they do by suspending R&D) and expanding or enhancing the sales department.

 

This sounds like a good game plan, but the problem is, without R&D their drug pipeline eventually dries up meaning they have to be a serial acquirer. There really is no organic growth. They maximize the asset they buy and desire a certain level of return over the purchase price. This is fine except to continue to roll up the industry you have to go after bigger and bigger fish to move the needle. At some point you run out of targets and you are left with a collection of gutted pharma companies that are worth what their terminal cash flow will return.

 

I don't think VRX is a fraud, but it is a financial corporate raider company, not a pharma company. VRX is billed as a pharma rollup, but rollups only work if they add value to the companies they acquire. VRX maximizes value as they dispose of the company. They will eventually end up with nothing but a pile of cash and to be honest, I don't think dismantling pharma companies is making the world a better place. 

 

 

 

Real simple: they buy late stage R&D, cut the rest, zero base budget, run product through wider global distribution, and thereby increase returns on the acquiree. Very importantly, they have a 5% tax rate which means they START OFF with a positive 10% IRR on most deals. Imagine if you could invest in any value investment where you get your alpha PLUS 10%? Personally, I would like that deal and that is the deal VRX seems to offer me but with Pearson as the value investor and healthcare/pharma the sector in which he operates. Its that simple.

[original mungerville]

VRX is my biggest position. I bought into the bull thesis completely and it has been good for me this past year.

However, the az_value post and this Sprout acquisition is making me question my thesis.

 

At the core of the bull thesis, to be completely honest, is the trust placed by Value Act,Sequoia and Ackman in Pearson and VRX. If these investors were not there and everything else was same, how many of us would feel comfortable with VRX disclosures, financial leverage, acquisition spree etc.

 

Yes the business model makes sense. Avoiding wasteful R&D can save money theoretically, but they pay high prices for successful R&D, so part of the cost of wasteful R&D is baked into the prices of successful R&D purchased.

 

I wouldn't bet too much on the low Cash EPS multiple for the equity. That is not an indicator that only low growth is priced in. The correct measure is (Cash EPS+interest-tax benefit)/EV as a highly leveraged business can post a high Cash EPS relative to equity in a low interest rate environment and with below average tax rates. Also maintenance cap ex here takes the form of continuously buying "successful R&D", that needs to be subtracted as well to get to true FCF to firm.

 

The simple fact that no one has been able to argue the facts put forth by az_value and are just hoping ValueAct and other investors must have done their job is a big concern for me. Cloning is a good way to get ideas, but not an investment thesis in itself. The longs should either put in the work to provide a fact based counter point to issues raised by az_value or admit our laziness and close out the position, to save some money.

 

I think it is quite possible this could go ENRON way someday. Things ENRON did was also accepted in the financial world as kosher during those days until the public campaign against it started and public opinion changed to think of it as fraud. I can't say VRX is a fraud, I can only say, enough questions are now raised to be able to say "I don't know if its genuine".

 

I think I will reduce my exposure until further clarity on the numbers.

 

Have you ever bought a LEAP? That is what the Sprout deal is. VRX spent <1% of their EV on a drug that could be a homerun or could be a zero. If it had been 40% of their EV, I would be very concerned. At <1%, it looks like a nice risk/reward play that will be a good kicker if it works, and not cause any trouble if it doesn't.

 

On AZ Value, I'm not sure what there is to refute. Is it possible that IFRS has different revenue recognition standards than GAAP? Might Valeant have folded some other Eastern European product line into Sanitas that explains the $20M difference in sales? Is a $15-$20M difference (<10 bps of '16E sales) that could be easily explained by either of these two hypotheses a good reason to label the entire thing a fraud? And last, if Valeant were blatantly overstating sales like this, what to make of the sales performance for 3Q/4Q/1Q in which there were no large acquisitions and Valeant grew sales significantly? It's hard to fake sales for an extended period of time, and even if you do you have the problem that no cash is showing up. So then you have to start faking cash, which is very hard to do (albeit not impossible, see: Satyam). Now what are the odds that VRX is faking cash/sales with ValueAct on the board and Ackman doing diligence with material nonpublic info which restricted him for a year, after which he immediately made VRX his largest position? I'm not saying the answer is zero, but there are no absolutes in investing. The future is always uncertain.

 

A quick though experiment: What happened to Forest River's sales last year? Is the answer material to your thesis on Berkshire, if you have one? Sanitas is something like 1% of sales for VRX. Management can mess with the accounting all they want and it just isn't going to move the needle one way or the other.

 

Bingo, AZ has to bring a lot more to the table to start to change my mind.

[original mungerville]

if organic growth is only half of what it is touted to be, given the debt levels, given the stock comp, given the current low tax rate, given the growth in revenues attributable to price increases, IMO the fair value is below 140 for this.

 

This is false. Fair value would be that low if the IRR on acquisition was materially below 25%. You just don't need greater than 10% organic growth to support a 15x 2016 multiple to owner earnings.