VRX - Valeant Pharmaceuticals International Inc.

[giofranchi]

ccplz,

Would I have started the poll, if I were "happy" as that quote means? Happy in that quote means "Satisfied with what is happening"... And therefore no more careful... Do you have the impression I am no longer careful about VRX?

Therefore, either you quote things not in the right context, or you don't understand the true meaning of what you are quoting.

 

Gio

[giofranchi]

Come on! It is simply amazing how people are willing to say the most stupid things just in order to attacking VRX... I understand success, extreme success!, might bother lots of people... But, please... Show a little decency!

 

Come on! It is simply amazing how people are willing to say the most stupid things just in order to defend VRX ... I understand success, extreme success!, might make lots of people emotionally attached to their stock... But, please... Show a little decency!

 

Ahahah!!

 

Cheers,

 

Gio

 

By the way, Jurgis, you are funny... But would you argue that VRX deal making abilities have been questioned many times now, and each time VRX has turned out to be right? Or would you argue that the FDA is a very conservative institution?

If you argue those things... Well, you are funny And I am right!

 

Cheers,

 

Gio

[tombgrt]

I repeat: imo those focusing on valuation are missing the forest for the tree...

 

Cheers,

 

Gio

I saw that you said that. But what do you mean? That price doesn't matter?

 

It doesn't matter simply because, if what they are reporting in their quarterly releases and conference calls is true, VRX is cheap today!

If they truly are able to get the results they talk about, opportunities out there abound, and they will be able to go on growing for at least the next 5 years.

 

Therefore, the question shareholders must answer is the following: are VRX's power point presentations reliable? Do they report business results that are true? Or, like AZ_Value has said, do they belong to the garbage can?

 

Cheers,

 

Gio

 

So it does matter because the word "cheap" indicates an opinion/judgement on current valuation? I'm confused!

 

If you're not looking at valuation when evaluating your stocks and portfolio in general, you are the patsy at the table.

 

VRX in particular had half the current market cap just a year ago and that is after a 10% drop in the stock. That is just to point out that there are a lot of people with big gains that are likely to sell out when fear hits. People aren't as likely to sell off losers, just look at the average holding period in the '30's for proof! It's a good reason not to be too fond of stocks that have run up a lot lately when you fear overall stock market levels (like I thought you did Gio). But that's just me. I hope you all make good returns with VRX but would personally hedge this.

[Jurgis]

By the way, Jurgis, you are funny... But would you argue that VRX deal making abilities have been questioned many times now, and each time VRX has turned out to be right? Or would you argue that the FDA is a very conservative institution?

If you argue those things... Well, you are funny And I am right!

 

Cheers,

 

Gio

 

I'd go with "I am funny and Gio is right", but unfortunately being right is reserved to my wife and she might not want to share this with you.  ;)

 

IMHO, FDA approval of Sprout is rather fishy, however, it is a call option for VRX more or less. The only risk above the price paid is if there are side effects and VRX gets sued for more money than they paid.

 

IMHO AZ Value and other VRX bears raise some valid issues. I don't have much to add. Of course it is up to everyone to make their own mind and bulls might be right too.

 

Disclosure: I do not have direct positions in VRX. I own small position in PSHZF.

[constructive]

Can anyone name some potential acquisitions that they think VRX can earn 25% ROI on?

 

The total pharmaceutical market is in the trillions, implying that there are plenty of potential acquisitions. But I think very very few earn good returns on capital, are the right scale, and trade for a reasonable price.

 

Anyone? I would assume that someone who knows the pharmaceutical industry well enough to make VRX a large position would have an opinion on this question.

 

Could they earn 25% ROI if they bought Taro? AMAG? Almirall? What else?

[giofranchi]

I repeat: imo those focusing on valuation are missing the forest for the tree...

 

Cheers,

 

Gio

I saw that you said that. But what do you mean? That price doesn't matter?

 

It doesn't matter simply because, if what they are reporting in their quarterly releases and conference calls is true, VRX is cheap today!

If they truly are able to get the results they talk about, opportunities out there abound, and they will be able to go on growing for at least the next 5 years.

 

Therefore, the question shareholders must answer is the following: are VRX's power point presentations reliable? Do they report business results that are true? Or, like AZ_Value has said, do they belong to the garbage can?

 

Cheers,

 

Gio

 

So it does matter because the word "cheap" indicates an opinion/judgement on current valuation? I'm confused!

 

If you're not looking at valuation when evaluating your stocks and portfolio in general, you are the patsy at the table.

 

VRX in particular had half the current market cap just a year ago and that is after a 10% drop in the stock. That is just to point out that there are a lot of people with big gains that are likely to sell out when fear hits. People aren't as likely to sell off losers, just look at the average holding period in the '30's for proof! It's a good reason not to be too fond of stocks that have run up a lot lately when you fear overall stock market levels (like I thought you did Gio). But that's just me. I hope you all make good returns with VRX but would personally hedge this.

 

I meant that, if they are truly able to deliver results like the ones they have posted in the last year (when the started declaring organic growth numbers), Ackman's valuation of VRX might even be conservative... And therefore they are cheap!

 

If, instead, they are making up the numbers, valuation doesn't matter... Any price is too high for a fraud, isn't it?

 

What does confuse you so much?

 

Cheers,

 

Gio

[ccplz]

The same questions goes: Why do not CEOs copy Warren Buffett since it seems right thing to do. The last time I checked zero CEO copied Buffett.

 

Fairfax, Greenlight re, Third Point re, Pershing Square Holdings, Arlington Value & Allan Meecham, Biglari Holdings ('BH') & Sardar Biglari etc.

[giofranchi]

The same questions goes: Why do not CEOs copy Warren Buffett since it seems right thing to do. The last time I checked zero CEO copied Buffett.

 

Fairfax, Greenlight re, Third Point re, Pershing Square Holdings, Arlington Value & Allan Meecham, Biglari Holdings ('BH') & Sardar Biglari etc.

 

I don't understand: you have made a list of billionaires or very successful entrepreneurs... To prove what exactly?...

 

Of course there is one Buffett, and that's what also Liberty says: there is one Pearson, those other managers who try to do like he is doing don't achieve the same results of course... See for instance AGN and PRGO. But they are nonetheless very successful, because the industry and the strategy are both great!... Just like the managers on your list are successful, though maybe not as much as Buffett!

 

Cheers,

 

Gio

[ccplz]

The question was, why haven't tried to do what Buffett was doing?

 

And the answer is, there have been people copying Buffett, or at least have been trying to. Some more successful than others.

 

Now we should ask the question, why haven't people tried to do what Pearson claims he's doing?

 

[Guest Schwab711]

The question was, why haven't tried to do what Buffett was doing?

 

And the answer is, there have been people copying Buffett, or at least have been trying to. Some more successful than others.

 

Now we should ask the question, why haven't people tried to do what Pearson claims he's doing?

 

Wasn't this business model tried throughout the 1980's and we called it corporate raiders?

[Liberty]

The same questions goes: Why do not CEOs copy Warren Buffett since it seems right thing to do. The last time I checked zero CEO copied Buffett.

 

Fairfax, Greenlight re, Third Point re, Pershing Square Holdings, Arlington Value & Allan Meecham, Biglari Holdings ('BH') & Sardar Biglari etc.

 

I don't understand: you have made a list of billionaires or very successful entrepreneurs... To prove what exactly?...

 

Of course there is one Buffett, and that's what also Liberty says: there is one Pearson, those other managers who try to do like he is doing don't achieve the same results of course... See for instance AGN and PRGO. But they are nonetheless very successful, because the industry and the strategy are both great!... Just like the managers on your list are successful, though maybe not as much as Buffett!

 

Cheers,

 

Gio

 

That's not quite what I meant with my comment. I meant that if succesful ideas were this easy to execute, there wouldn't be just a handful of Berkshire clones (of varying degrees of success, the best probably being Markel) out of tens of thousands of publicly traded companies around the world, just like it's possible for Valeant's model to be a good one and for it to not be widespread yet (it could either mean that it's hard to execute and there's inertia in the inudstry, or that they are among the firsts to do it and it'll be more common at some point in the future).

 

I don't think an idea has to be a well kept secret to be good. Otherwise, all phone makers would just do what Apple does and make hundreds of billions, right?

[Liberty]

The question was, why haven't tried to do what Buffett was doing?

 

And the answer is, there have been people copying Buffett, or at least have been trying to. Some more successful than others.

 

Now we should ask the question, why haven't people tried to do what Pearson claims he's doing?

 

Wasn't this business model tried throughout the 1980's and we called it corporate raiders?

 

No, because it's not the same model. Valeant is a lot closer to the 3G model, which also includes superficial similarities with the raiders, but which is fundamentally different (long-term orientation, rather than short term bump then looking for an exit and doesn't care how damaged the business is after that).

[rpadebet]

Endp tries to copy vrx model, of course ex - vrx guy runs it, but still same model.

 

The vrx model isn't that easy to copy because it's in this one industry unlike brk and others who can look anywhere. Also there is some efficiency in the market out there, especially in ideas. People copy ideas though they don't accept doing it. Best practises get copied all the time.

 

Companies don't live in a vacuum, people change jobs as bring ideas with them. It happens in all industries.

 

I don't have a problem with vrx model. It's sensible. It's rational. The question I have is the opportunity set available now that everyone knows what they do and how rewarding it is. When they were small not many probably paid attention, but after allergen I think many took serious notice. Maybe the motive was self preservation, but it happened.

 

Going forward 25% irr I think I'd terribly hard to do in size, unless there is a big dislocation.

[original mungerville]

No matter what else is going on with VRX, I do not understand this idea that they can do deals at a 25% IRR indefinitely.

 

1. 25% is a huge amount. To get 25% in this environment, especially when paying a control premium is a herculean task. And you're not talking about an opportunistic deal here and there, but a continuous stream.

2. The people that are selling aren't really a bunch of idiots.

3. Why could there be no competition to this model that drives down returns? It looks like VRX is basically a publicly traded P/E fund. Those guys are targeting 12% returns. Why wouldn't they (or someone else) get in on the action and drive down.

4. Given Valeant's size you will need big deals going forward to move the needle. I don't think there's any way you get 25% out of those unless you believe #2 is wrong.

 

I'm not going to weigh in on whether this is a fraud or not, the company's valuation isn't worth that kind of analysis. There are definitely easier things out there. All I'm saying is that some of the assumptions about the model that are being thrown around are really out there.

 

Given the valuation of the company and the lofty assumptions involved I think it is the shareholder's duty to look at it with a thorough and skeptical approach - it is your money and your property that's at stake. However it seems that the opposite is happening.

I think it's just the PE firm target return (12-15%) plus the tax advantage, plus the ability to leverage a global distribution channel, plus overlap with regards to Administrative and in certain cases sales force.

 

Gutting the shit out of R&D - which is what they do - can really improve margins - beyond any control premium. Now they also may cut a little too much, who knows, but they then often expand the sales force and run the product through their global distribution which targets higher growth markets. Let's say I call all that a wash, I'll throw out some ball park guestimates of what could make up a 25% IRR on deals with what remains:

 

1. 5% IRR for cutting excessive middle management fat and zero cost budget ideology - I guarantee that is there in most corporations let alone Pharma;

2. 10% IRR related to the underlying intrinsic value of the acquiree based on the value of the stock relative to earnings prior to Valeant paying for a control premium;

3. 10% IRR related to tax benefit alone.

 

Do these "pull them out of my ass" guestimates sound unreasonable? Some say #3. is unsustainable long-term. But on new acquisitions, if #3 lasts just 3 years, given compounding effects, and a 25% IRR, the purchase price is repaid. Then let us even say you take that out in years 4 and beyond and assume 15% returns not 25% returns. My assumption in all this is zero real organic growth for the acquiree.

 

Throw that into a spreadsheet and tell me what this is worth, its north of 13x 2016 owner earnings, I know that much.

 

The above is how they get 25% returns. Its not that difficult as I have explained.

[rpadebet]

I think at this point it's a self referencing loop of arguments. I know u have explained how they did it until now....

 

My point being, if it's so easy, don't you think target CEOs would do it themselves now in order to save their jobs and make their company less attractive to VRX ? Allergan tried it right as soon as VRX announced their intentions?

 

I think also initially VRX said they wanted 25%, before tax effects. I am okay with including it because I think without it, it's too damn hard.

[Guest Schwab711]

No matter what else is going on with VRX, I do not understand this idea that they can do deals at a 25% IRR indefinitely.

 

1. 25% is a huge amount. To get 25% in this environment, especially when paying a control premium is a herculean task. And you're not talking about an opportunistic deal here and there, but a continuous stream.

2. The people that are selling aren't really a bunch of idiots.

3. Why could there be no competition to this model that drives down returns? It looks like VRX is basically a publicly traded P/E fund. Those guys are targeting 12% returns. Why wouldn't they (or someone else) get in on the action and drive down.

4. Given Valeant's size you will need big deals going forward to move the needle. I don't think there's any way you get 25% out of those unless you believe #2 is wrong.

 

I'm not going to weigh in on whether this is a fraud or not, the company's valuation isn't worth that kind of analysis. There are definitely easier things out there. All I'm saying is that some of the assumptions about the model that are being thrown around are really out there.

 

Given the valuation of the company and the lofty assumptions involved I think it is the shareholder's duty to look at it with a thorough and skeptical approach - it is your money and your property that's at stake. However it seems that the opposite is happening.

I think it's just the PE firm target return (12-15%) plus the tax advantage, plus the ability to leverage a global distribution channel, plus overlap with regards to Administrative and in certain cases sales force.

 

Gutting the shit out of R&D - which is what they do - can really improve margins - beyond any control premium. Now they also may cut a little too much, who knows, but they then often expand the sales force and run the product through their global distribution which targets higher growth markets. Let's say I call all that a wash, I'll throw out some ball park guestimates of what could make up a 25% IRR on deals with what remains:

 

1. 5% IRR for cutting excessive middle management fat and zero cost budget ideology - I guarantee that is there in most corporations let alone Pharma;

2. 10% IRR related to the underlying intrinsic value of the acquiree based on the value of the stock relative to earnings prior to Valeant paying for a control premium;

3. 10% IRR related to tax benefit alone.

 

Do these "pull them out of my ass" guestimates sound unreasonable? Some say #3. is unsustainable long-term. But on new acquisitions, if #3 lasts just 3 years, given compounding effects, and a 25% IRR, the purchase price is repaid. Then let us even say you take that out in years 4 and beyond and assume 15% returns not 25% returns. My assumption in all this is zero real organic growth for the acquiree.

 

Throw that into a spreadsheet and tell me what this is worth, its north of 13x 2016 owner earnings, I know that much.

 

The above is how they get 25% returns. Its not that difficult as I have explained.

 

#1: Cutting management is a finite gain, the savings are "amortized" in earnings over an indefinite # of years (higher profits). The IRR will get smaller with each passing year. That implies that this portion of returns is unsustainable.

#2: Since Pearson/VRX are not oracle's, we know that their market timing skills will revert to mean (0% advantage) and that long-run [compounded] returns = [(1+m)*(1+r)^(N)]^(1/N) as N becomes larger. In the long run, VRX's returns for this category will roughly average the Operating Returns of a company (~ROIC). It's a lot to expect them to be excellent operators and capital allocators. Can't think of many that do both well (especially one person).

m:= multiple expansion

r:= operating returns

#3: The market will eventually correct for this, imo. Also, they are already paying well below the Canadian tax rate. Using the same formula as above, it shows that returns from the tax advantage cannot exceed 10% and will only approach them in the very long-term. Within a 10 year holding, your advantage will be much lower.

 

I really think you should have a stronger proof before assuming you are correct. History says this business model is going to create overconfidence in mgmt and then a single bad event will take them down (especially since they are so aggressive with debt). If their acquisitions are performing poorly then debt is going to cut profits as fast as it has increased them, credit will become more expensive, and they could go to zero quickly. You don't even need fraud to take VRX down, just a lack of confidence.

 

It makes me nervous to step out on a limb on this topic, but I honestly don't see how they can sustain what they promise. I'm not well-versed in the company, but the business model seems extremely dangerous. I don't know what the short-run will bring, but they are obviously dependent on higher debt and operating performance >= proj performance @ time of debt. I don't see how that is possible when total R&D < 2012 BOL R&D. It just increases your reliance on outperformance (which should be a low probability event). You are constantly gambling then each time you roll over debt. Return formulas dictate what you propose is impossible.

[original mungerville]

Can not follow anything you are saying. Not one point. Nice formulas though!

[giofranchi]

The question was, why haven't tried to do what Buffett was doing?

 

And the answer is, there have been people copying Buffett, or at least have been trying to. Some more successful than others.

 

Now we should ask the question, why haven't people tried to do what Pearson claims he's doing?

 

But they have!

I repeat: just look at AGN, PRGO, and ENDP!

Moreover, what they are doing is simply buying good values and fixing a bloated costs structure, concentrating on an industry with huge growth prospects and costs that are notoriously too high!... Therefore, imo it is once again nothing more than "Buffett + Icahn in pharma and biotechnology".

 

Liberty,

I get what you are saying.

In investing though my experience is that a sound method takes you much farer than in phone making... You remember the super investor of graham and doddsville, right? That's basically the idea: search for value in the best industry possible, and then focus on ROIC as much as you can... You might not get Pearson's results, but something good should still happen!

By the way, that describes AGN, PRGO, and ENDP perfectly imo.

 

Cheers,

 

Gio

[giofranchi]

Can not follow anything you are saying. Not one point. Nice formulas though!

 

Let me see if I can adress a couple of points here:

 

1) Multiple expansion: since I started following VRX very little multiple expansion has occurred. Instead, they have grown Cash EPS.

 

2) The business model: as I have said, they use free cash flow + cheap debt to buy good value, fixing a bloated cost structure, and concentrating on the industry with the best growth prospects out there. Let me put it very clearly: that is the best business model I could think of, and the most reliable in the long run. Debt was a concern of mine... But I have gradually changed my mind: they concentrate on an industry they know very well, and that lowers the probability of a serious mistake very much. At the same time they have chosen what's probably the largest industry in the world (or it will become so in the near future), therefore they have little constrains for growth.

If you think you know a better business model, think again: VRX's business model, as I described it "Buffett + Icahn in pharma and biotechnology" can hardly be beaten... That's why decades come and go, companies grow and then disappear, while Buffett and Icahn are always there doing what they do best.

Will they keep performing? Will Pearson keep performing? Of course no one knows! Such is business!

 

Imo it is as simple as this: either VRX is a fraud, or it is a wonderful machine for creating value.

 

Cheers,

 

Gio

[NBL0303]

AZ Value - can't wait for Part IV of the Valeant write-up - any idea when that is coming down the pike?

[Liberty]

Also, they are already paying well below the Canadian tax rate.

 

Have you looked into how they achieve a low cash tax rate? Most of their debt is in the US, so that's where they pay interest. That shields taxes there because when you don't have profits, you don't pay taxes. And since Canada has a territorial tax system, unlike the US, money made around the world doesn't face double taxation.

 

Unless the U.S. starts not considering interest expenses an expense that reduces your profits, and unless Canada decides to switch to a worldwide taxation system like the U.S., I think their cash tax rate is pretty safe. As Malone said, it's better to pay interest than pay taxes...

[rpadebet]

Also, they are already paying well below the Canadian tax rate.

 

Have you looked into how they achieve a low cash tax rate? Most of their debt is in the US, so that's where they pay interest. That shields taxes there because when you don't have profits, you don't pay taxes. And since Canada has a territorial tax system, unlike the US, money made around the world doesn't face double taxation.

 

Unless the U.S. starts not considering interest expenses an expense that reduces your profits, and unless Canada decides to switch to a worldwide taxation system like the U.S., I think their cash tax rate is pretty safe. As Malone said, it's better to pay interest than pay taxes...

 

Btw Liberty I am sure you know this...

Malone could do what he did mainly because his underlying cable business is as stable as it gets with slow organic growth. You can leverage such businesses and pay interest because refinancing stable cash flows is not a risk.

 

VRX tries to do it by saying they are investing in a diversified portfolio of durable products. They mostly have durable products but it is not all of it unlike Cable business, so they shouldn't be leveraging as much as Malone does, especially if their organic growth is suspect.

[Liberty]

As I said earlier in this thread, finding new targets isn't what worries me. The company seems very confident that this is not a problem, and when they went after AGN it was apparently just one name out of a list of ten big potential targets, and there are trillions of public pharmas and trillions more of private ones around the world. There are always pockets of values to be found, companies with the right kind of assets that are going at decent prices. Because they are very decentralized and integrate acquisitions at the local level, they can do many smaller deals that, together, add up to real money. Most other big pharmas are quite a bit more centralized and try to integrate things from central HQ, which is a bottleneck and a real source of inefficiency and reduced entrepreneurialism at the local level.

 

If they ever become too big for their own good, I wouldn't be surprised to see them do exactly what the new AGN did with its generics business; divest assets at top multiples, or maybe do spin-offs like DHR is doing now.

 

Pearson has clearly said that he's always open to offers for any part of the company, and that at the right price he'll do what's right for shareholders. People misinterpret the goal of being a "150bn" company from a few years ago as empire building. But if you listen to the actual commentary at the time and since, this was more about "we have a model that creates a lot of value, the more capital we can deploy the more value we'll create, so we're trying to deploy a lot and maybe do a big merger of equals". But absolute size doesn't interest him, and if someone offers him a crazy multiple for part of the business, he'll probably sell.

 

If all big pharmas become super expensive, making it hard for VRX to buy at a good price for cash, maybe VRX stock will also be more expensive and can be used as a currency. Or if it's all super-expensive, maybe it's time for a divestiture. There's always a way to create value. Singleton showed that.

 

So finding new targets isn't what worries me, my #1 concern is that they stay disciplined and keep executing their strategy well.

[Liberty]

Also, they are already paying well below the Canadian tax rate.

 

Have you looked into how they achieve a low cash tax rate? Most of their debt is in the US, so that's where they pay interest. That shields taxes there because when you don't have profits, you don't pay taxes. And since Canada has a territorial tax system, unlike the US, money made around the world doesn't face double taxation.

 

Unless the U.S. starts not considering interest expenses an expense that reduces your profits, and unless Canada decides to switch to a worldwide taxation system like the U.S., I think their cash tax rate is pretty safe. As Malone said, it's better to pay interest than pay taxes...

 

Btw Liberty I am sure you know this...

Malone could do what he did mainly because his underlying cable business is as stable as it gets with slow organic growth. You can leverage such businesses and pay interest because refinancing stable cash flows is not a risk.

 

VRX tries to do it by saying they are investing in a diversified portfolio of durable products. They mostly have durable products but it is not all of it unlike Cable business, so they shouldn't be leveraging as much as Malone does, especially if their organic growth is suspect.

 

Absolutely. But I don't think the organic growth is suspect, and I think they aren't as levered as the optics make it seem. If you normalize Salix for the inventory issues, they're lower than they seem. They also proved during the AGN pursuit that they can delever pretty quickly (even while doing a bunch of tuck-ins).

 

I think they're being shrewd. They are taking advantage of historically very low interest rates to pick up valuable assets in geographies and therapeutic areas that should grow faster than average for the foreseeable future. The previous CFO has said that he thought it was "inevitable" that at some point they would be investment grade. Not just yet, I guess. That remains to be seen, but I think it's their goal over time.

 

I think what's most likely to happen is that at some point they find someone of similar size to merge with - on a friendly basis this time - and that the transaction delevers them all in one fell swoop. The AGN transaction would have done that if it had happened...

[original mungerville]

I agree with all of Liberty's comments.

 

Even if "organic growth was suspect", my point has been that there is nothing magic about setting the threshold at 0 growth. Like Valeant is a failure if organic growth is negative, or Valeant is likely a success if organic growth is positive. That's how many organizations think, certainly those who have historically invested heavily in R&D - they need to think that way to justify it. So for the bears, hopefully that has not infected your thinking. Rationally and at Valeant, its all about IRRs first and foremost. You can have great IRRs even with negative growth.

 

This idea that they should not borrow heavily unless their growth is above the magic zero threshold is ridiculous. 

 

Having said that, it sure as hell looks like they do not have negative organic growth given results of the past 12 months! Their organic growth seems to have been very significant and well above almost everyone's expectations.