VRX - Valeant Pharmaceuticals International Inc.

[Bagehot]

Seems to me that all your IRR analysis is pretty flawed when you only look at the first 10 years. Especially when you model high growth the majority of the value will be far in the future. Otherwise good piece.

 

That's fine.  I tought about that.

 

What I want to see  is what numbers other people are using because IRR returns always seem to be instant when diacussing VRX. So I want to see what numbers they're using past 10 years, let's say over 20 for a company that cuts RD immediately. We'll talk about all of that with durability and stuff.

So people should take you up on your comment and lay out their own assumptions. Let's see for instance the growth assumptions you use if the majority of the cash will come in year 20 vs year 5 to achieve 20% IRR. Oh also square that with a payback period of 5 years.  That should be interesting.  I don't mind different assumptions, like I said. I just want to see them. That's all I want.

 

I've spoken with IR about this, management uses an Adjusted Present Value approach to valuing deals. They use EBITA as a proxy for unlevered FCF for their cash-on-cash returns calc. As a practical matter, it is impossible to track true CFFO for acquisitions once integrated. In VRX's case, true depreciation (ie excluding intangibles amortization) approximates capex and in any event is not a meaningful driver. Taxes are, obviously, minimal and taken into account. Since this is an unlevered calculation, Interest is not included, they are calculating the return before the impact of financing. The only real quibble is how they adjust for changes in working capital, something I didn't really get what I would qualify as a great answer to. I think most of the discrepancies you noted are driven by this methodological difference, they aren't doing a levered DCF, they are doing an APV which is before interest (the theory being that one values the free cash flow to the enterprise, which is independent of financing, obviously, and then subtracts the value of the debt to arrive at equity value). The only impact debt has to equity value in such a calculation is to increase it by the value of the debt tax shield, and decrease it by the probabilistic costs of financial distress.

 

Not sure if this helps, but given their methodology,a better proxy to compare the cash flows they are presenting in the deal table is really EBITDA and not Cash From Operations.

[Liberty]

AZ, I see a major flaw in your analysis of Sanitas. You only look at the cash flow directly attributable to Sanitas. Sanitas transferred all of their IP and other assets to Valeant IPM.

 

- Did Valeant IPM generate cash flow from these assets which don't appear on Sanitas' annual report?

- Did Valeant or it's subsidiaries increase cash flow because of this transaction? Remember, Valeant generates synergies on both sides when it makes an acquisition. There are usually major layoffs within Valeant after an acquisition.

- Was Valeant able to transfer any of the deferred tax assets to the parent? It doesn't look like it.

 

I haven't read the new installment yet, so I can't comment, but that's my main problem with all this. It feels like a blindfolded man feeling around an elephant and going "this is definitely a snake, this is definitely a tree trunk" (all I mean by this metaphor is: You don't have all the data you would need to see the whole). Taking numbers of of context (unknowingly), comparing apples with oranges, extrapolating stuff, not knowing what you don't know (impact of tax attributes, IP movements, restructuring charges, various possible accounting rules (especially international differences), the way certain deal models might be more front-loaded or back-loaded, etc). This is very similar to a lot of claims made by Hempton and Allergan, and when Valeant actually took the time to address them, there were good reasons for all the supposed discrepancies.

 

Allergan waged an all-out war against Valeant. They hired no-expenses-spared consultants and bankers to dig deep and attack Valeant, and the best they came up with didn't stick. I doubt that trying to reconcile fragmentary numbers is going to tell much. And what this has been so far has been an accusation of fraud - businesses performing one way but Valeant saying they are performing another way - which the 10K overall revenue and cashflow numbers either prove or disprove. Since these numbers are the aggregate of all M&A, and since it is claimed that the acquired companies are actually performing much worse than claimed, then why are overall revenue and cash numbers what they are? Did Valeant lie about revenue and cash too?

[Picasso]

We wouldn't have to grope around an elephant if Valeant provided a way for us to measure the performance independently.  Instead we have to rely on increasingly more complicated financials which cannot be explained solely from the acquisition strategy.  Why not break it out in the 10-K if that is in fact true?  It seems that they already have the numbers if they're constantly talking about it.

 

And if we do not have all the data to make a conclusive bear case, then how can you make a conclusive bull case either?  Relying on the expertise of Ubben, Ackman, Sequoia, and other can only go so far before you realize this isn't margin of safety investing.

[Liberty]

We wouldn't have to grope around an elephant if Valeant provided a way for us to measure the performance independently.  Instead we have to rely on increasingly more complicated financials which cannot be explained solely from the acquisition strategy.  Why not break it out in the 10-K if that is in fact true?  It seems that they already have the numbers if they're constantly talking about it.

 

And if we do not have all the data to make a conclusive bear case, then how can you make a conclusive bull case either?  Relying on the expertise of Ubben, Ackman, Sequoia, and other can only go so far before you realize this isn't margin of safety investing.

 

Why doesn't John Malone do that? Why doesn't Buffett allow us to figure out what's going on at every small division, break out the IRR of every acquisition, and make it easy to understand every major reinsurance contract? Some stuff is just inherently complex, and some people will always want more disclosure than you provide. No company is perfect in that regard.

[Valueguy134]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

[Green King]

Wouldn't that be stealing? since Valeant doesn't have 100% Control of the Business.

 

No because Sanitas received an equity stake in Valeant IPM in exchange for the assets.

 

Source please.

 

TIA

[jay21]

Wouldn't that be stealing? since Valeant doesn't have 100% Control of the Business.

 

No because Sanitas received an equity stake in Valeant IPM in exchange for the assets.

 

Source please.

 

TIA

 

The Sanitas financials that people were supposed to have read right?

 

As at 30 December 2011 Jelfa S.A. transferred all its intangible assets, related to the medicines licenses, which in total

amounted to LTL 20,042 thousand as contribution in kind to 36.56% of the associate company Valeant IPM sp. z o.o.

The Group value of the transferred intangible assets is equal to LTL 19,576 thousand (Note 9). In addition to this,

Jelfa S.A. transferred cash in amount of LTL 210 thousand, LTL 59 thousand of trade receivables and LTL 124 thousand

of trade payables. Total Group cost to this associate company amounts to LTL 19,721 thousand.

As at 31 December 2011, 100% of Valeant IPM sp. z o.o. total assets fair value amounted to LTL 1,337,105 thousand,

total liabilities fair value amounted to LTL 4,763 thousand, while 2011 revenues were LTL 65,115 thousand and 2011

profit was equal to LTL 948 thousand.

The fair value of Valeant IPM sp. z o.o. net assets, attributable for the Group, amounted to LTL 487,104 thousand and

exceeded the cost of the Group to this associated entity by LTL 467,383 thousand, which was recognized in the Group

profit or loss as negative goodwill on the associate entity acquisition, respectively.

 

http://www.nasdaqomxbaltic.com/upload/reports/san/2011_q4_en_ltl_con_ias.pdf

 

Not a VRX expert at all. Lmk if this is the wrong disclosure.  Also look at the cash flow from operations. Very different from CapIQ.

[Picasso]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Don't forget to call your company "Platform Bean Products."  Your stock will immediately sport a 30% premium which will help you with deal making.

[Valueguy134]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Don't forget to call your company "Platform Bean Products."  Your stock will immediately sport a 30% premium which will help you with deal making.

 

Very true, also thinking about getting a big bean guy from one of the 3 elite consulting firms to run the business.  Guy might have no operational experience, but he knows some stuff.

[Liberty]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Yeah, it's not like the Malone/3G/Capital Cities model could ever work in the pharma industry, right? That's just ridiculous!  It's not like the past 7 years that they've been doing this really shows anything, right? Let's wait another 10, and wait for a few more handfuls of sophisticated big bulls and bears to dig deep in the company before we start to consider that maybe it's happening.

 

You might have described Martin Franklin, though. Anyone who's an expert in consumer products, industrial chemicals, and packaged food must also be an expert in beans, right?

[100 Shares]

Wouldn't that be stealing? since Valeant doesn't have 100% Control of the Business.

 

No because Sanitas received an equity stake in Valeant IPM in exchange for the assets.

 

Source please.

 

TIA

 

The Sanitas financials that people were supposed to have read right?

 

As at 30 December 2011 Jelfa S.A. transferred all its intangible assets, related to the medicines licenses, which in total

amounted to LTL 20,042 thousand as contribution in kind to 36.56% of the associate company Valeant IPM sp. z o.o.

The Group value of the transferred intangible assets is equal to LTL 19,576 thousand (Note 9). In addition to this,

Jelfa S.A. transferred cash in amount of LTL 210 thousand, LTL 59 thousand of trade receivables and LTL 124 thousand

of trade payables. Total Group cost to this associate company amounts to LTL 19,721 thousand.

As at 31 December 2011, 100% of Valeant IPM sp. z o.o. total assets fair value amounted to LTL 1,337,105 thousand,

total liabilities fair value amounted to LTL 4,763 thousand, while 2011 revenues were LTL 65,115 thousand and 2011

profit was equal to LTL 948 thousand.

The fair value of Valeant IPM sp. z o.o. net assets, attributable for the Group, amounted to LTL 487,104 thousand and

exceeded the cost of the Group to this associated entity by LTL 467,383 thousand, which was recognized in the Group

profit or loss as negative goodwill on the associate entity acquisition, respectively.

 

http://www.nasdaqomxbaltic.com/upload/reports/san/2011_q4_en_ltl_con_ias.pdf

 

Not a VRX expert at all. Lmk if this is the wrong disclosure.  Also look at the cash flow from operations. Very different from CapIQ.

 

Seems likely that if income is missing due to this then revenue is also missing which could further explain the differentials from the first installment from AZ

[Liberty]

[Guest wellmont]

Jesus the responses to a decent bear case are unbelievable.  Now numbers aren't that important?

 

This makes me want to short the crap out of VRX.

 

maybe you think it's a "decent" bear case. others are totally unconvinced. it seems like the market sure is unconvinced. I don't think this analysis at all gets to the heart of how much in owners earnings vrx is going to produce next year (estimates $16 a share), which is most important to the stock price. I guess we are supposed to believe that because someone has issues with the way they accounted for a small acquisition a few years ago that the whole thing is a fraud? And meanwhile the CEO owns close to $2b in stock that he can't sell for years.

 

if you have a lot of conviction that this is a fraud and the numbers are funny you can take advantage of that. See that's the thing. Everybody is saying that this analysis breaks new ground; but how many of you have acted on it and sold ALL your stock and or Shorted the stock? Because otherwise it's just noise right? $233 to zero is a looong way down. conviction is putting real money on the line. And the bulls who have billions on the line are not selling. That's conviction. Real money on the line.

 

If you read the Sequoia fund transcripts how many questions are there about arcane points of merger accounting on small acquisitions done years ago? how many questions address the important qualitative aspects of the business that owners need to, and would like to know more about?  Do the Sequoia managers even mention that there may be aggressive accounting involved here, something that their shareholders may wish to know about because it's a huge position? no. it doesn't even come up. they are totally comfortable with the accounting treatments here. To expect that an analysis like this is going to persuade incredibly sophisticated investors who have been following every move this company has made for years, that's just silly.

 

Focus on big impactful things that matter.

[ccplz]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Yeah, it's not like the Malone/3G/Capital Cities model could ever work in the pharma industry, right? That's just ridiculous!  It's not like the past 7 years that they've been doing this really shows anything, right? Let's wait another 10, and wait for a few more handfuls of sophisticated big bulls and bears to dig deep in the company before we start to consider that maybe it's happening.

 

You might have described Martin Franklin, though. Anyone who's an expert in consumer products, industrial chemicals, and packaged food must also be an expert in beans, right?

 

Why do you keep comparing Pearson to Malone and Buffett? He is not Malone or Buffett.

 

[Valueguy134]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Yeah, it's not like the Malone/3G/Capital Cities model could ever work in the pharma industry, right? That's just ridiculous!  It's not like the past 7 years that they've been doing this really shows anything, right? Let's wait another 10, and wait for a few more handfuls of sophisticated big bulls and bears to dig deep in the company before we start to consider that maybe it's happening.

 

You might have described Martin Franklin, though. Anyone who's an expert in consumer products, industrial chemicals, and packaged food must also be an expert in beans, right?

 

Nothing like buying a durable business and comparing it to an industry where once you hit the patent cliff your pricing and volumes go out the window. In theory the VRX model is fantastic, find someone to sell you a company at 80 cents on the dollar, cut expenses down to the bone, rinse and repeat 100 times, and say you are making a killing doing it.  However, you need to keep buying, you can't stop, because if you do the massive amount of debt will crush you once it catches up (interest is like 1/8th of revenues), and it will since VRX is not making as much money as they lead you to believe. Unlike VRX, 3G purchased a brand, a brand that has sold the same product for decades. It doesn't fall off a patent cliff, people will not stop eating ketchup, and people aren't going to be frugal and try to save 50 cents to buy a cheaper brand that tastes "different. So yes, stripping out the fat from Heinz makes sense, how much more could you possibly spend on R&D to improve your product, who else are you going to buy (you own the market). 3G saw an opportunity to make a lot of money in a stable business, and took advantage of it, however, they pick their spots, they know they won't find 100 businesses they can do this in an make a ridiculous amount of money.

[Ross812]

It seems like the asset transfer is making it difficult to reconcile the post merger cash generated since close in the Valeant power point. Maybe we can just take a look at 2010 CF from ops:

 

http://www.nasdaqomxbaltic.com/upload/reports/san/2011_q4_en_ltl_con_ias.pdf

 

Cash from Operation in 2010 was 63M LTL. In Q3 2012 USD (2.75 LTL : USD) this is $22.9M. Valeant uses 5 Qs of from Q3 11 to Q3 12. So lets give them a 5.7M bump to compare AZ values Q3'11 to Q3'12 CF from Ops of 14.8M to the 2010 CF from ops + an extra normalized quarter of ~$28.6M.

 

Bagehot says IR directs investors to use EBITA when calculating return.

 

EBITA for 2010 was:

 

108.2M LTL or $39.3M USD

 

Add in another 25% for the missing Q4 2011 and its up to $49M EBITA for 5 quarters ended Q4 2010.

 

Now they also have $57.5M USD worth of selling and distribution, R&D, Administrative, and regulatory expenses for 5 Quarters ended Q4 of 2010.

 

I have no idea how much of this 57.5M Valeant would be able to reduce. Maybe 50%?

 

So now we are up to 68.05M for the 5 Qs ended Q4'10. This is EBITA - 50% of non cost of sales Expenses.

 

This sounds a lot better than AZ's scenario, but I still have a really hard time believing:

 

Valeant could "organically" grow sales the instant they took the portfolio turning 49M in EBITA 20% to 59M

 

decrease costs by 70% to get to a 99M in cash generated.

 

The B&L and Salix examples of 20% IRR are a nice thought experiment too. Valeant might have a good business model but their "Deal Model" looks very suspect.     

 

 

 

[Liberty]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Yeah, it's not like the Malone/3G/Capital Cities model could ever work in the pharma industry, right? That's just ridiculous!  It's not like the past 7 years that they've been doing this really shows anything, right? Let's wait another 10, and wait for a few more handfuls of sophisticated big bulls and bears to dig deep in the company before we start to consider that maybe it's happening.

 

You might have described Martin Franklin, though. Anyone who's an expert in consumer products, industrial chemicals, and packaged food must also be an expert in beans, right?

 

Why do you keep comparing Pearson to Malone and Buffett? He is not Malone or Buffett.

 

Never said he was them. Just that he had a model with many of the same elements, and his ways of thinking are quite similar in many ways.

[Liberty]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Yeah, it's not like the Malone/3G/Capital Cities model could ever work in the pharma industry, right? That's just ridiculous!  It's not like the past 7 years that they've been doing this really shows anything, right? Let's wait another 10, and wait for a few more handfuls of sophisticated big bulls and bears to dig deep in the company before we start to consider that maybe it's happening.

 

You might have described Martin Franklin, though. Anyone who's an expert in consumer products, industrial chemicals, and packaged food must also be an expert in beans, right?

 

Nothing like buying a durable business and comparing it to an industry where once you hit the patent cliff your pricing and volumes go out the window. In theory the VRX model is fantastic, find someone to sell you a company at 80 cents on the dollar, cut expenses down to the bone, rinse and repeat 100 times, and say you are making a killing doing it.  However, you need to keep buying, you can't stop, because if you do the massive amount of debt will crush you once it catches up (interest is like 1/8th of revenues), and it will since VRX is not making as much money as they lead you to believe. Unlike VRX, 3G purchased a brand, a brand that has sold the same product for decades. It doesn't fall off a patent cliff, people will not stop eating ketchup, and people aren't going to be frugal and try to save 50 cents to buy a cheaper brand that tastes "different. So yes, stripping out the fat from Heinz makes sense, how much more could you possibly spend on R&D to improve your product, who else are you going to buy (you own the market). 3G saw an opportunity to make a lot of money in a stable business, and took advantage of it, however, they pick their spots, they know they won't find 100 businesses they can do this in an make a ridiculous amount of money.

 

I think patent cliffs strike the imagination so much for big blockbusters that people don't realize that there isn't as much generic competition in all parts of the pharma industry. You think generics-makers are as interested by every small product out there? You think it's as easy to get a skin cream right as a pill?

 

There are pros and cons to being in the pharma industry. Yes, patents are an issue. Valeant is quite good at mitigating that (lots of branded generics/OTC, stuff in therapeutic areas where generic competition is weak, where reformulation/extensions are easier (skin creams, for example), broad diversification, etc), as can be seen by the 2-3% of revenue that is facing patent risk per year over the foreseeable future. There are also benefits to being in the pharma industry, like gross margins in the 70-80s range, the ability to host IP in low-tax countries, etc. All things which I bet Heinz would love.

 

Valeant doesn't have to find someone to sell them a business for a lot less than what it's worth, as has been clear for a long time. They just need to find a business with good assets and sub-optimal management. They fix the bad management part (cut fat, sometimes optimize salesforce, get out of bad markets, etc) and that makes the asset more valuable by itself, which is further augmented by the superior tax rate. If they can find something at a bargain price (like Salix because of the scandal), even better, but the model doesn't require them magically finding huge bargains. Decent prices are enough. Not that there aren't always some bargains somewhere around the world (they just bought a big company in the middle-east)...

 

It's also annoying when people talk as if Valeant had zero reinvestment in the business, like it's just milking existing products waiting for them to die. They have had many very successful launches lately with more in the pipeline, and they are predicting double-digit organic growth for at least 2 years forward, saying they are confident they can sustain it to 2020 with 7 new products that have the potential to be billion-dollar in revenue (not all of them will work, but some probably will). Their generics business doesn't require much R&D, and the rest of their development has been very dollar-efficient (Jublia developed for 40m, now one of their biggest products). Unlike some here and many in the media and industry, I care more about the outputs of their R&D than the inputs... And sales also matters: They've grown many products from almost nothing to top products in a short period of time (ie. CeraVe), R&D isn't the only way to organic growth.

[Guest Schwab711]

I love reading these comments, because I feel like I could make a solid business selling beans and acquiring other bean manufacturers, each returning 20% IRR after I get my consultants in to strip down operations. I would then tell everyone I'm making a ton of cash and it keeps compounding, but none of it really comes to fruition, since it's all adjusted, I continue to change goal posts to justify my claim, and I add back my exorbitant expenses. In addition the company would be debt fueled, because there is nothing to stop me from growing, so I think a 5:1 debt to equity ratio would be A-OK, especially with no hard assets to back me up. Sure I would have some property and machinery, but just think how much goodwill I could backstop that debt with. The beans would be a durable product, and I would make sure people understood that. People have been eating them for years and I don't see it stopping anytime soon since demographics are in my favour with the world population continuing to grow. Furthermore, you don't have to worry about my growth pipeline, because I have a ton of companies willing to hand me the keys for 75 cents on the dollar, trust me. Sure my business model is unique, but what do the big guys in the industry know about beans.

 

As stupid as that sounds, while I am neither short or long VRX, and only read it for the story, I think people here have made a lot of money off the stock.  There is clearly doubt, whether you trust management or not, so why not scale back and play with house money rather than letting a huge capital gain cloud your confidence in understanding the company. Yes, it could compound forever at 20% (unlikely), but it's clear that the numbers don't truly add up 100% and do cause an overhang on the stock.

 

Yeah, it's not like the Malone/3G/Capital Cities model could ever work in the pharma industry, right? That's just ridiculous!  It's not like the past 7 years that they've been doing this really shows anything, right? Let's wait another 10, and wait for a few more handfuls of sophisticated big bulls and bears to dig deep in the company before we start to consider that maybe it's happening.

 

You might have described Martin Franklin, though. Anyone who's an expert in consumer products, industrial chemicals, and packaged food must also be an expert in beans, right?

 

Nothing like buying a durable business and comparing it to an industry where once you hit the patent cliff your pricing and volumes go out the window. In theory the VRX model is fantastic, find someone to sell you a company at 80 cents on the dollar, cut expenses down to the bone, rinse and repeat 100 times, and say you are making a killing doing it.  However, you need to keep buying, you can't stop, because if you do the massive amount of debt will crush you once it catches up (interest is like 1/8th of revenues), and it will since VRX is not making as much money as they lead you to believe. Unlike VRX, 3G purchased a brand, a brand that has sold the same product for decades. It doesn't fall off a patent cliff, people will not stop eating ketchup, and people aren't going to be frugal and try to save 50 cents to buy a cheaper brand that tastes "different. So yes, stripping out the fat from Heinz makes sense, how much more could you possibly spend on R&D to improve your product, who else are you going to buy (you own the market). 3G saw an opportunity to make a lot of money in a stable business, and took advantage of it, however, they pick their spots, they know they won't find 100 businesses they can do this in an make a ridiculous amount of money.

 

I think patent cliffs strike the imagination so much for big blockbusters that people don't realize that there isn't as much generic competition in all parts of the pharma industry. You think generics-makers are as interested by every small product out there? You think it's as easy to get a skin cream right as a pill?

 

There are pros and cons to being in the pharma industry. Yes, patents are an issue. Valeant is quite good at mitigating that (lots of branded generics/OTC, stuff in therapeutic areas where generic competition is weak, where reformulation/extensions are easier (skin creams, for example), broad diversification, etc), as can be seen by the 2-3% of revenue that is facing patent risk per year over the foreseeable future. There are also benefits to being in the pharma industry, like gross margins in the 70-80s range, the ability to host IP in low-tax countries, etc. All things which I bet Heinz would love.

 

Valeant doesn't have to find someone to sell them a business for a lot less than what it's worth, as has been clear for a long time. They just need to find a business with good assets and sub-optimal management. They fix the bad management part (cut fat, sometimes optimize salesforce, get out of bad markets, etc) and that makes the asset more valuable by itself, which is further augmented by the superior tax rate. If they can find something at a bargain price (like Salix because of the scandal), even better, but the model doesn't require them magically finding huge bargains. Decent prices are enough. Not that there aren't always some bargains somewhere around the world (they just bought a big company in the middle-east)...

 

It's also annoying when people talk as if Valeant had zero reinvestment in the business, like it's just milking existing products waiting for them to die. They have had many very successful launches lately with more in the pipeline, and they are predicting double-digit organic growth for at least 2 years forward, saying they are confident they can sustain it to 2020 with 7 new products that have the potential to be billion-dollar in revenue (not all of them will work, but some probably will). Their generics business doesn't require much R&D, and the rest of their development has been very dollar-efficient (Jublia developed for 40m, now one of their biggest products). Unlike some here and many in the media and inudstry, I care more about the outputs of their R&D than the inputs...

 

48 hours later and now I'm agreeing with Liberty!

 

First part, completely agree! There are dozens of examples you can find of pharmaceutical companies who continue earning their rev/profit post-patent expiration. There's a reason I didn't continue my patent-expiration concerns past the top-5 (though I probably could have continued through the top-10 or so). It's tough to make a case that some of these medicines will see generic competition when you consider the cost of manufacturing vs the future profits with competition. This is pretty similar to the Buffett quote about what it would cost to compete with Coca-Cola.

 

The majority of the patent-expiration I mentioned earlier is at least 10 years out and most expire between 2028-2032. I really think it is worth other folks' time to map out all the products from each acquisition and the associated patents or other relevant characteristics. As Liberty mentioned, this is an extremely complicated company. That doesn't mean it's good or bad, but investors should at least understand that many dozens of hours of work are required to have a basic understanding of the return mechanics. Any one sentence summary of VRX is likely going to be wrong.

 

I really enjoyed AZ's work because the points brought up are quite interesting if the work were complete, but I think it's is premature to claim fraud or anything of the sort. One should really have a rigorous and comprehensive case prior to any accusations. The onus is definitely on the investor when going in the negative direction and I have yet to see any work that makes a strong case.

 

Finally, I don't think following the cash from acquisitions is going to provide sufficient proof one way or the other with regards to fraud. As Liberty mentioned, a lot of these exact same claims could be made with regards to Berkshire. I do think the onus is on us, as investors, to reconcile the gaps cited by AZ towards the end of his 2nd post before making any acquisitions. Proof of fraud should be clear and complete. Ultimately, I think the true value of VRX is going to be determined by how they account as opposed to what they have reported. In my opinion, the single biggest value component of VRX has thus far gone unmentioned (I know that sounds cryptic and I normally wouldn't make such a comment before I finished my work on the topic, but it seems strange that there is so much concern over AZ's work without this data point even being mentioned!). I really don't think AZ's content from today should be much of a surprise considering I mentioned the 2Q15 cash payback slide 2 days ago without any response. Sanitas is the perfect example of more work is necessary to have a complete view of this, ultimately trivial, transaction (citations for how asset acquisition accounting differs from equity acquisition accounting should probably be made - I think that will at least partially reconcile the gap for Sanitas). A lot of the necessary details to value VRX are available, it's just spread out over many filings.

[KCLarkin]

It seems like the asset transfer is making it difficult to reconcile the post merger cash generated since close in the Valeant power point. Maybe we can just take a look at 2010 CF from ops:

 

http://www.nasdaqomxbaltic.com/upload/reports/san/2011_q4_en_ltl_con_ias.pdf

 

Cash from Operation in 2010 was 63M LTL. In Q3 2012 USD (2.75 LTL : USD) this is $22.9M. Valeant uses 5 Qs of from Q3 11 to Q3 12. So lets give them a 5.7M bump to compare AZ values Q3'11 to Q3'12 CF from Ops of 14.8M to the 2010 CF from ops + an extra normalized quarter of ~$28.6M.

 

There is one very interesting item in their income statement. A $125M gain on sale of investment. As far as I can tell, this is because the equity received in Valeant IPM was worth more than the assets transferred to Valeant IPM. Seems odd. Anyway, I suspect the full $99M might not be from operations. Not much we can conclude without seeing Valeant IPM's financials.

[original mungerville]

Seems to me that all your IRR analysis is pretty flawed when you only look at the first 10 years. Especially when you model high growth the majority of the value will be far in the future. Otherwise good piece.

 

That's fine.  I tought about that.

 

What I want to see  is what numbers other people are using because IRR returns always seem to be instant when diacussing VRX. So I want to see what numbers they're using past 10 years, let's say over 20 for a company that cuts RD immediately. We'll talk about all of that with durability and stuff.

So people should take you up on your comment and lay out their own assumptions. Let's see for instance the growth assumptions you use if the majority of the cash will come in year 20 vs year 5 to achieve 20% IRR. Oh also square that with a payback period of 5 years.  That should be interesting.  I don't mind different assumptions, like I said. I just want to see them. That's all I want.

 

I have modified my comments to be more in line with this board's culture:

 

No AZ, its not "fine", your IRRs are not "fine". Nobody, I MEAN NOBODY, does an IRR calculation for a business and in year 10 essentially assumes it goes bankrupt. What the!?!? Just how stupid do you think we are? 

[original mungerville]

AZ, I see a major flaw in your analysis of Sanitas. You only look at the cash flow directly attributable to Sanitas. Sanitas transferred all of their IP and some other assets to Valeant IPM.

 

- Did Valeant IPM generate cash flow from these assets which don't appear on Sanitas' annual report?

- Did Valeant or it's subsidiaries increase cash flow because of this transaction? Remember, Valeant generates synergies on both sides when it makes an acquisition. There are usually major layoffs within Valeant after an acquisition.

- Was Valeant able to transfer any of the deferred tax assets to the parent? It doesn't look like it.

 

And the only fuckin' thing in the whole AZ analysis that might have made a little sense (albeit Liberty had prior comments and KC yours seem valid) is this Sanitas discrepancy...I am not happy about this.

[giofranchi]

Jesus the responses to a decent bear case are unbelievable.  Now numbers aren't that important?

 

This makes me want to short the crap out of VRX.

 

maybe you think it's a "decent" bear case. others are totally unconvinced. it seems like the market sure is unconvinced. I don't think this analysis at all gets to the heart of how much in owners earnings vrx is going to produce next year (estimates $16 a share), which is most important to the stock price. I guess we are supposed to believe that because someone has issues with the way they accounted for a small acquisition a few years ago that the whole thing is a fraud? And meanwhile the CEO owns close to $2b in stock that he can't sell for years.

 

if you have a lot of conviction that this is a fraud and the numbers are funny you can take advantage of that. See that's the thing. Everybody is saying that this analysis breaks new ground; but how many of you have acted on it and sold ALL your stock and or Shorted the stock? Because otherwise it's just noise right? $233 to zero is a looong way down. conviction is putting real money on the line. And the bulls who have billions on the line are not selling. That's conviction. Real money on the line.

 

If you read the Sequoia fund transcripts how many questions are there about arcane points of merger accounting on small acquisitions done years ago? how many questions address the important qualitative aspects of the business that owners need to, and would like to know more about?  Do the Sequoia managers even mention that there may be aggressive accounting involved here, something that their shareholders may wish to know about because it's a huge position? no. it doesn't even come up. they are totally comfortable with the accounting treatments here. To expect that an analysis like this is going to persuade incredibly sophisticated investors who have been following every move this company has made for years, that's just silly.

 

Focus on big impactful things that matter.

 

But wellmont! Come on! You should have understood by now that those "important qualitative aspects" of the business are nothing but "stories"...

 

For what is worth, today I have bought more VRX.

 

Cheers,

 

Gio

 

[Picasso]

Lol wow, I nominate AZ Value as winner for 2015 in terms of making this thread interesting again.  We're even getting curse words and personal attacks! 

 

As far as IRR's, AZ already discussed the impact of long-term values when targeting 20% IRR's.  If you want to stick with 20% IRR's, the long-term value discounted back to today isn't that big of a difference in terms of valuation.  The real question is what the returns look like in 10-20 years.  Otherwise VRX is stuck on the acquisition hamster wheel.

[Picasso]

Jesus the responses to a decent bear case are unbelievable.  Now numbers aren't that important?

 

This makes me want to short the crap out of VRX.

 

maybe you think it's a "decent" bear case. others are totally unconvinced. it seems like the market sure is unconvinced. I don't think this analysis at all gets to the heart of how much in owners earnings vrx is going to produce next year (estimates $16 a share), which is most important to the stock price. I guess we are supposed to believe that because someone has issues with the way they accounted for a small acquisition a few years ago that the whole thing is a fraud? And meanwhile the CEO owns close to $2b in stock that he can't sell for years.

 

if you have a lot of conviction that this is a fraud and the numbers are funny you can take advantage of that. See that's the thing. Everybody is saying that this analysis breaks new ground; but how many of you have acted on it and sold ALL your stock and or Shorted the stock? Because otherwise it's just noise right? $233 to zero is a looong way down. conviction is putting real money on the line. And the bulls who have billions on the line are not selling. That's conviction. Real money on the line.

 

If you read the Sequoia fund transcripts how many questions are there about arcane points of merger accounting on small acquisitions done years ago? how many questions address the important qualitative aspects of the business that owners need to, and would like to know more about?  Do the Sequoia managers even mention that there may be aggressive accounting involved here, something that their shareholders may wish to know about because it's a huge position? no. it doesn't even come up. they are totally comfortable with the accounting treatments here. To expect that an analysis like this is going to persuade incredibly sophisticated investors who have been following every move this company has made for years, that's just silly.

 

Focus on big impactful things that matter.

 

But wellmont! Come on! You should have understood by now that those "important qualitative aspects" of the business are nothing but "stories"...

 

For what is worth, today I have bought more VRX.

 

Cheers,

 

Gio

 

Again nothing you guys have started involve numbers.  It's still a story guised under "platform value" and "qualitative business qualities."  The most wellmost said to this was cash EPS but has he even spent any time saying why we should use cash eps on the equity versus maybe cash eps + interest expense into the enterprise value?

 

That's all fine and dandy but that doesn't sound like sound value investing to me.