VRX - Valeant Pharmaceuticals International Inc.

[original mungerville]

Good lord. I feel like people on both sides of this thread have lost their shit. From the Megamind movie...

 

http://www.quickmeme.com/img/70/7038c6b355e9a725b5a6411618bf17e4ce8a46b8b560c90031aaa051febf027c.jpg

 

Btw, as a former math major (Is that bona fides enough to make a comment on IRRs? I was discrete and not continuous focused, if that matters. Also, I prefer a protein shake to IRRs for breakfast, if that also matters.), I'd like to step in to the IRR discussion with three things to point out:

 

(1) Dan Kahan of Yale Law had a fantastically good piece of research on how ideology motivates people's mathematical abilities (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2319992) indicating that two people might see the exact same information and yet interpret things completely differently.

 

(2) Both OM & Picasso were talking completely past one another (ergo my posting of Megamind). You're both technically correct, but I suspect that your reasonings were colored the moment the two of you decided that you were on opposite sides of this debate. IRRs are heavily weighted towards the beginning few years, so OM was basically saying that if they could decrease costs immediately and/or increase sales immediately and maintain this amount w/ a not-substantial-drop once it hits the patent cliff, then they can make their IRRs. Picasso (& AZ) was saying that if they start from a lower base and ease into the decrease of costs and/or increase of sales, then the amount of compounding for the cash flows has to be large in order for the IRRs to work out as promised. See? Like I said before, you're both pretty.

 

(3) I've seen people on this thread confuse IRRs for CAGRs, and they are not the same. If you invest $100 in year 0 and then collect 10 years of $20 payments that you stick in a bank yielding you 0% and then sell the company again in year 10 for $200 (0% growth seems like a 10x-er), then your CAGR is not 20% -- it's 15%. Similarly, if your cash flows are high in the first 10 years but lower in the years after that, you can achieve a high IRR but have a low CAGR because of the lack of value on the back end. (Imagine going from $20 in years 1-10 to $10 from years 11 and beyond -- that drops your CAGR to 11%.) Incidentally, in a situation like the latter one, you'd require the cash flows you take out in the first decade to be reinvested in something to provide you with a CAGR that matches your IRR. (Someone check my logic on this -- it's late, and I'm in the Bahamas and sometimes my brain doesn't work right on the beach.)

 

FWIW, unless I missed it, everyone has glommed onto the IRR discussion but no one has made an effort to reconcile the difference between $11 billion in claimed cash from acquisitions and the $6 billion in total cash flow from operations during that time. A quick glance at cash flow from investments (possible divestments) indicates that it does not account for the $4 billion of difference once you've accounted for the Medicis sales, but I'll readily admit again that I might have missed it.

 

http://3.bp.blogspot.com/-8FPz1xTTuVA/Vd0CIM1PqHI/AAAAAAAAAPA/aRqd3ZaPqa8/s1600/2014%2BCash%2BPayback%2BTable%2B2.JPG

 

Disclosure #1: No position in VRX either long, short, etc. I definitely have a long position in popcorn though.

 

Disclosure #2: I'm long Fannie Mae preferreds, so if you'd like to attack my credibility (from either side), that's probably the easiest way to do it. ;)

 

We weren't talking past each other. I said the IRR methodology in AZ's analysis was wrong and provided a numerical example of why it is wrong. Picasso said that was not the case. Its not pretty, its wrong - very wrong. Its inflating his analysis while he tries to prove Valeant has inflated their numbers.

 

The cash flow stuff in that analysis is as poor as the IRR methodology but since we take so long to agree that AZ can't do IRRs, why the hell would I want to drag myself through dissecting how messed up that cash flow analysis is?

[Liberty]

I'm still waiting for a bear to address the fact that the products are durable and growing, which pretty much invalidates the rest of the bear thesis about the decline and threadmill and debt load wall (we also saw during the Allergan saga that when they stop making big acquisitions, the GAAP numbers rise to meet adjusted, and not the other way around). After that we're just arguing over whether they will get good returns on their investments or not, not whether we're facing some calamity...

 

If the company's numbers are good enough for Sequoia, Lou Simpson, Bill Ackman, John Paulson, Glenn Greenberg, and Jeff Ubben, they are good enough for me. I'm humble enough to know where I stand in comparison to those guys and the resources that they have (including board access and raw numbers access for some).

[original mungerville]

Dan Kahan! Really? Merket, are you telling me that when you model a business with an IRR, you should halt it at Year 10 with no terminal value? Why not do an "IRR" for 2 years with no terminal value for Valeant's acquirees?

 

I am glad you are a mathematician, but in this competition not everybody gets a medal for participating. You get a medal for being right, and you don't if you are wrong.

 

For what it is worth I have a graduate degree in Engineering/Operations Research and also a CFA. And you don't want to know what my compounded returns on investing have been for 15 years now.

[KCLarkin]

FWIW, unless I missed it, everyone has glommed onto the IRR discussion but no one has made an effort to reconcile the difference between $11 billion in claimed cash from acquisitions and the $6 billion in total cash flow from operations during that time. A quick glance at cash flow from investments (possible divestments) indicates that it does not account for the $4 billion of difference once you've accounted for the Medicis sales, but I'll readily admit again that I might have missed it.

 

They appear to be referring to cash before interest and taxes. They are probably backing out restructuring charges too. In 2014 alone, interest and restructuring were well over $1 billion.

 

Someone mentioned above that they use EBITA in their IRR numbers.

 

For those concerned about debt, in 2014 when they didn't make a major acquisition, they rapidly de-levered. This seems to fit managements narrative well.

[original mungerville]

Sorry, take out $14.5 billion in debt off of your 38 billion so 23.5/38 ths of your interest expense as well.

 

"The companies said the deal had an enterprise value of $14.5 billion, which would include Salix's debt and any cash on hand. Valeant will pay $158.00 a share, valuing the all-cash transaction at about $10.1 billion."

 

http://www.reuters.com/article/2015/02/23/us-valeantpharms-salixpharms-idUSKBN0LQ0V420150223

 

so I took the debt value as of Q2/15.....the article is as of Feb 2015 with the deal closing shortly after. Why would my debt number be wrong? Also, before you point out the numbers don't match, it's because I'm looking at it in CAD, but then again my earnings are also Cad, so net, the ratios are the same.

 

Well if you took the value as of Q2 2015, with a December 31 year-end, would that not be debt as at June 30th 2015 which would include debt to finance an acquisition closing shortly after February 2015?

 

Unless they decide to pay down debt between now and December 2015, the number I gave you is what it stands at as of today. Cash on the books is only 995 USD,so call net debt like $29B USD. ... VRX needs big acquisitions to keep the party going.

 

OMG. You talkin' in circles now, right? We said $38B in debt minus 14.5B in debt = 23.5B. On top of that Schwabb corrected us, its actually $15.8B for Salix in cash so call that $16B. So, IF they had $38B in debt as of Q2 2015, given the deal closed prior to that, without Salix they would have had $38B minus $16 or $22 billion. So I said 23.5B, and got corrected to $22B.

 

So without Salix, they would have had $22B on the books. With only one quarter of Salix EBITDA, in your original "analysis" you chose to record the full $38B in debt, yet only include one quarter of Salix EBITDA by using a trailing twelve month EBITDA figure for Valeant!! Even worse than that, as I explained, that one quarter of EBITDA is probably not representative given the huge synergies Valeant has stated. Add to that the IBD confirmation which will generate even more EBITDA from the $16Billion in debt they took on. So, basically, in your figures you have the full debt related to Salix, but have probably less than 1/10th of its annual EBITDA going forward.

 

And then you finish with "...VRX needs big acquisitions to keep the party going." Why should anyone believe your conclusion when you can't compare basic apples to apples when running financial ratios? Same for AZ_Value, the guy can't do an IRR calculation correctly!

 

So let's take a look at Salix EBITDA, actually lets look at gross profit (I could do this on a straight revenue number if you prefer)

 

(All in USD millions)

2014: $579

2013: $709

2012: $565

 

So let's assume they get some ridiculous synergies, and they can pull out gross margins in cash in year 1.  What absurd growth rate would you need on those numbers to 1) pay back the $12 billion 2) and after factoring principal/interest payments still meet the 20% IRR hurdle. I'm not even going to bother running the math, just add up those numbers and let me know if it sounds reasonable in whatever possible combination you can think of.

 

You are also right about my leverage numbers, they are wrong, I used a site to pull the data in a pinch, so let me redo the leverage calcs now that I have bloomberg here. VRX has $30.88bn in total debt, and to be fair they carry a 1 billion on the books, so lets go with net debt of $29.88B. VRX did $2.614 billion in LTM EBITDA, after I give them a 20% bump for going into next year we get $3.138B.  Let's say Salix adds $700 million in EBITDA (almost 3 years worth). We get 7.8x. If you think I'm light on the growth of 20%, remember, I'm going on an organic growth basis, more acquisitions means more debt, so my guess would be that the ratio goes higher if anything. Doesn't seem to far off my off the cuff calculation the first time.

 

Now with interest.

 

If you take a look back in the notes, they issue debt around what 5%, but lets just go with 3%. Looking at the 2014 annual, EBITDA/interest expense is about 4x. But without really doing a lot of work, we know they took on about $10B in debt, net, pretty much for Salix. So we take my Salix number up top of $700M and we divide that by the interest expense on the new debt only ($10B*3%) we get $700/$300=2.3x. So the consolidated EBITDA/Interest expense ratio should drop since the Salix deal has a worse ratio than the whole company. It could look better if they get solid growth, but I doubt they will reach the number I provided in the first couple of years.

 

Now you tell me I'm crazy for thinking debt could catch up to them. Salix typically averaged about $80 million in CFFO, in 2013, they benefited from changes in working cap and got about $450. Again, run the math on some growth numbers, what would you need to pay back $10B.

 

I know you won't do the math, so let me give it to you.

 

Here are my assumptions

Debt: $10B

Cash flow yr 1: $700M (Remember I pretty much tripled the current EBITDA for Salix)

Cash Flow Growth Rate: 20%

Interest rate: 3%

 

Here is the answer.  It would take between 9-10 years to pay back. 9 to 10 years!, and I'm giving them the benefit of using interest based on debt at the lowest point each year, rather than averaging 2 years. And now, I'll refer you back to my first point on IRR because right now, the hurdle isn't looking to hot.

 

We can keep going at this, I can do this for VRX as a whole, and the picture wouldn't be much better. So when I mention that they need to keep acquiring to keep the party going, it's because they do. They just don't make enough cash, and like I said before, the bank is going to want hard cash, not 10% of the principal and some monopoly money.

 

If I'm clearly wrong, let me know, like I mentioned before, I have never read the 10-k and spent at most an hour looking at everything today. One way or another, here are some hard numbers to think about.

 

So now we are changing topics? What happened to the other numbers we were looking at, don't want to discuss that any more? We goin' to go around in circles and then when you have no more answers, we switch topics?  Why should I engage in another topic when you can't prove your first point and won't admit you should not have made that point?

[Valueguy134]

Dan Kahan! Really? Merket, are you telling me that when you model a business with an IRR, you should halt it at Year 10 with no terminal value? Why not do an "IRR" for 2 years with no terminal value for Valeant's acquirees?

 

I am glad you are a mathematician, but in this competition not everybody gets a medal for participating. You get a medal for being right, and you don't if you are wrong.

 

For what it is worth I have a graduate degree in Engineering/Operations Research and also a CFA. And you don't want to know what my compounded returns on investing have been for 15 years now.

 

Go on.....

[merkhet]

Sometimes, the retired lawyer in me won't let me just let stuff go. Occasionally, I have to let him out to play. You said:

 

We weren't talking past each other. I said the IRR methodology in AZ's analysis was wrong and provided a numerical example of why it is wrong. Picasso said that was not the case. Its not pretty, its wrong - very wrong. Its inflating his analysis while he tries to prove Valeant has inflated their numbers.

 

The cash flow stuff in that analysis is a poor as the IRR methodology but since we take so long to agree that AZ can't do IRRs, why the hell would I want to drag myself through dissecting how messed up that cash flow analysis is?

 

I suspect that you were referencing this:

 

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?

 

Except, I don't think either AZ or Picasso was assuming that the company goes bankrupt in Year 11. In fact, Picasso says as much here:

 

For someone who crunches IRR's and NPV's for breakfast I am surprised that you are so far off base on this one.  You don't need to list year 11, he's only showing you the IRR's over ten years.  It's a good thing he didn't go to year 30, 40, 50 because you're going to be looking at cash flows bigger than Berkshire Hathaway's market cap and the time value of money isn't going to give them much difference value versus what you are paying today. 

 

Like I said you can get a 6 year payback but end up with a very low IRR depending on what the returns after a few years look like.  Management says 20% IRR but gives you no time frame for that to occur.  If it's a 5-6 year time frame then there's no reason to even say there is a 5-6 year payback because that already implies a 20% IRR.

 

Well, who's correct?

 

 

You're saying that calculating an IRR where N is < many years out past 10 (possibly infinite) is not useful for evaluating the total cash flows of a product whose lifespan is greater than 10 years. That is, in fact, correct. Picasso is saying that because of the nature of the IRR calculation where N is a number that is picked with some discretion from the person doing the calculations, that provides substantial wiggle room and that the front loading of C (sub n) during an IRR calculation matters greatly. That is, in fact, also correct.

 

Dan Kahan! Really? Merket, are you telling me that when you model a business with an IRR, you should halt it at Year 10 with no terminal value? Why not do an "IRR" for 2 years with no terminal value for Valeant's acquirees?

 

I think you've missed the point. The point of the Kahan research is to show that when two sides have decided ahead of time that they're in disagreement, they will both pick the parts of a fact pattern and conform their thinking around it -- causing them to miss the forest for the trees as it were. And that's especially going to be the case if both sides are going to spend a large amount of time flinging insults at one another rather than focusing on the damn agreement.

 

I am glad you are a mathematician, but in this competition not everybody gets a medal for participating. You get a medal for being right, and you don't if you are wrong.

 

For what it is worth I have a graduate degree in Engineering/Operations Research and also a CFA. And you don't want to know what my compounded returns on investing have been for 15 years now.

 

If we're just going to be comparing intellectual dick size, I suspect that you will lose. I have two graduate degrees in law and business from two of the top universities in the country, and I can't recall ever scoring below the 98th or 99th percentile in much of anything. Of course, we could both drop trou and compare, but then we'd have fully completed the transition of taking this board from Charlie Rose to Jerry Springer -- something that seems to have been happening over the last three years or so. Perhaps we should stop short of that and, oh, I don't know, discuss things that actually matter to the issue at hand.

[Phaceliacapital]

[Valueguy134]

Sometimes, the retired lawyer in me won't let me just let stuff go. Occasionally, I have to let him out to play. You said:

 

We weren't talking past each other. I said the IRR methodology in AZ's analysis was wrong and provided a numerical example of why it is wrong. Picasso said that was not the case. Its not pretty, its wrong - very wrong. Its inflating his analysis while he tries to prove Valeant has inflated their numbers.

 

The cash flow stuff in that analysis is a poor as the IRR methodology but since we take so long to agree that AZ can't do IRRs, why the hell would I want to drag myself through dissecting how messed up that cash flow analysis is?

 

Awesome.

I suspect that you were referencing this:

 

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?

 

Except, I don't think either AZ or Picasso was assuming that the company goes bankrupt in Year 11. In fact, Picasso says as much here:

 

For someone who crunches IRR's and NPV's for breakfast I am surprised that you are so far off base on this one.  You don't need to list year 11, he's only showing you the IRR's over ten years.  It's a good thing he didn't go to year 30, 40, 50 because you're going to be looking at cash flows bigger than Berkshire Hathaway's market cap and the time value of money isn't going to give them much difference value versus what you are paying today. 

 

Like I said you can get a 6 year payback but end up with a very low IRR depending on what the returns after a few years look like.  Management says 20% IRR but gives you no time frame for that to occur.  If it's a 5-6 year time frame then there's no reason to even say there is a 5-6 year payback because that already implies a 20% IRR.

 

Well, who's correct?

 

 

You're saying that calculating an IRR where N is < many years out past 10 (possibly infinite) is not useful for evaluating the total cash flows of a product whose lifespan is greater than 10 years. That is, in fact, correct. Picasso is saying that because of the nature of the IRR calculation where N is a number that is picked with some discretion from the person doing the calculations, that provides substantial wiggle room and that the front loading of C (sub n) during an IRR calculation matters greatly. That is, in fact, also correct.

 

Dan Kahan! Really? Merket, are you telling me that when you model a business with an IRR, you should halt it at Year 10 with no terminal value? Why not do an "IRR" for 2 years with no terminal value for Valeant's acquirees?

 

I think you've missed the point. The point of the Kahan research is to show that when two sides have decided ahead of time that they're in disagreement, they will both pick the parts of a fact pattern and conform their thinking around it -- causing them to miss the forest for the trees as it were. And that's especially going to be the case if both sides are going to spend a large amount of time flinging insults at one another rather than focusing on the damn agreement.

 

I am glad you are a mathematician, but in this competition not everybody gets a medal for participating. You get a medal for being right, and you don't if you are wrong.

 

For what it is worth I have a graduate degree in Engineering/Operations Research and also a CFA. And you don't want to know what my compounded returns on investing have been for 15 years now.

 

If we're just going to be comparing intellectual dick size, I suspect that you will lose. I have two graduate degrees in law and business from two of the top universities in the country, and I can't recall ever scoring below the 98th or 99th percentile in much of anything. Of course, we could both drop trou and compare, but then we'd have fully completed the transition of taking this board from Charlie Rose to Jerry Springer -- something that seems to have been happening over the last three years or so. Perhaps we should stop short of that and, oh, I don't know, discuss things that actually matter to the issue at hand.

 

Awesome.

[giofranchi]

Valueguy134-

The more you do this, you are going to slowly and painfully realize that this is some sort of religion or cult you are making a bear case against. It's impossible to even doubt management speak here..

 

Eventually you are going to have to answer are you better than Valueact, Sequoia and Ackman to be taken seriously. Are you?

 

I was part of this cult unknowingly. The sermons I heard last August were good. The church was being attacked and they let me in at half the price.

 

This August I saw light and I ran outside.

 

It's hard to pull the Kool Aid away when their hands are taped to the jug.

 

I agree, but really all I'm saying is that it doesn't take much little leg work to show how absurd some of the claims management make, and AZ shows us. Back to an earlier point I mentioned. It's clear that there is doubt over some of the claims and you would have to make some pretty big leaps of faith to prove the numbers.  People here have made a lot of money off the stock, and probably have a large portion of their portfolio invested in it. All I'm saying is scale back, there is a shadow cast over the stock, so why not de-risk a bit and pull out the house money and let the rest ride if you think Pearson is a genius.

 

Why do you bears post something like that? It disqualifies you very much…

 

1) Words like “religion” or “cult”… Come on! Haven’t you seen there is a poll on this thread? A poll started by a bull, not a bear? I really don’t understand if yours is only cheap sarcasm, or you are serious… I hope the former! It would just mean you have a poor sense of humor… Furthermore, what I find truly hilarious is those same people who talk about “religion” and “cult” might be investing right now in big banks!!

 

2) “Little work to show how absurd some of the claims management make”… Here again, I don’t understand if you are joking or incredibly naïve… You know what? I own and personally manage 3 businesses, 2 of which are substantial, the third not so much. I have lots of people I trust who help me. Yet, to know everything there is to know about them (or, as Mr. Ergen would put it “to sign all the checks”) is a full time job for me! Now, let’s suppose I am a lazy guy… And AZ_Value can do twice what I am able to do in half the time… Do you really think he could be able to prove anything about a business he has never worked for, whose management he has never met, without the least piece of insider information, a business which has made 140 acquisitions so far all over the world?!... Sincerely, I don’t know how Pearson himself is able to keep track of all these things!!... Probably, he doesn’t need sleep… Therefore, no, I don’t think you are able to prove anything about VRX, no matter the amount of research you think you are doing. You have neither the time nor the information required to prove anything about VRX.

 

Cheers,

 

Gio

 

[merkhet]

FWIW, unless I missed it, everyone has glommed onto the IRR discussion but no one has made an effort to reconcile the difference between $11 billion in claimed cash from acquisitions and the $6 billion in total cash flow from operations during that time. A quick glance at cash flow from investments (possible divestments) indicates that it does not account for the $4 billion of difference once you've accounted for the Medicis sales, but I'll readily admit again that I might have missed it.

 

They appear to be referring to cash before interest and taxes. They are probably backing out restructuring charges too. In 2014 alone, interest and restructuring were well over $1 billion.

 

Someone mentioned above that they use EBITA in their IRR numbers.

 

For those concerned about debt, in 2014 when they didn't make a major acquisition, they rapidly de-levered. This seems to fit managements narrative well.

 

I thought about the EBITA calculation too but I wasn't sure if that only related to IRR numbers or if it related to the cash from acquisitions number as well. FWIW, I think if you use EBITA, you get closer to the number, but it doesn't quite close the full gap. Of course, AZ is using estimates as well based on the chart of payback ratios, so perhaps the fuzziness around the edges of such a calculation could also close the gap.

[ScottHall]

If we're just going to be comparing intellectual dick size, I suspect that you will lose. I have two graduate degrees in law and business from two of the top universities in the country, and I can't recall ever scoring below the 98th or 99th percentile in much of anything. Of course, we could both drop trou and compare, but then we'd have fully completed the transition of taking this board from Charlie Rose to Jerry Springer -- something that seems to have been happening over the last three years or so. Perhaps we should stop short of that and, oh, I don't know, discuss things that actually matter to the issue at hand.

 

Yeah, well, I dropped out of fourth grade. So there.

 

This thread has become a circus.

[Valueguy134]

Sorry, take out $14.5 billion in debt off of your 38 billion so 23.5/38 ths of your interest expense as well.

 

"The companies said the deal had an enterprise value of $14.5 billion, which would include Salix's debt and any cash on hand. Valeant will pay $158.00 a share, valuing the all-cash transaction at about $10.1 billion."

 

http://www.reuters.com/article/2015/02/23/us-valeantpharms-salixpharms-idUSKBN0LQ0V420150223

 

so I took the debt value as of Q2/15.....the article is as of Feb 2015 with the deal closing shortly after. Why would my debt number be wrong? Also, before you point out the numbers don't match, it's because I'm looking at it in CAD, but then again my earnings are also Cad, so net, the ratios are the same.

 

Well if you took the value as of Q2 2015, with a December 31 year-end, would that not be debt as at June 30th 2015 which would include debt to finance an acquisition closing shortly after February 2015?

 

Unless they decide to pay down debt between now and December 2015, the number I gave you is what it stands at as of today. Cash on the books is only 995 USD,so call net debt like $29B USD. ... VRX needs big acquisitions to keep the party going.

 

OMG. You talkin' in circles now, right? We said $38B in debt minus 14.5B in debt = 23.5B. On top of that Schwabb corrected us, its actually $15.8B for Salix in cash so call that $16B. So, IF they had $38B in debt as of Q2 2015, given the deal closed prior to that, without Salix they would have had $38B minus $16 or $22 billion. So I said 23.5B, and got corrected to $22B.

 

So without Salix, they would have had $22B on the books. With only one quarter of Salix EBITDA, in your original "analysis" you chose to record the full $38B in debt, yet only include one quarter of Salix EBITDA by using a trailing twelve month EBITDA figure for Valeant!! Even worse than that, as I explained, that one quarter of EBITDA is probably not representative given the huge synergies Valeant has stated. Add to that the IBD confirmation which will generate even more EBITDA from the $16Billion in debt they took on. So, basically, in your figures you have the full debt related to Salix, but have probably less than 1/10th of its annual EBITDA going forward.

 

And then you finish with "...VRX needs big acquisitions to keep the party going." Why should anyone believe your conclusion when you can't compare basic apples to apples when running financial ratios? Same for AZ_Value, the guy can't do an IRR calculation correctly!

 

So let's take a look at Salix EBITDA, actually lets look at gross profit (I could do this on a straight revenue number if you prefer)

 

(All in USD millions)

2014: $579

2013: $709

2012: $565

 

So let's assume they get some ridiculous synergies, and they can pull out gross margins in cash in year 1.  What absurd growth rate would you need on those numbers to 1) pay back the $12 billion 2) and after factoring principal/interest payments still meet the 20% IRR hurdle. I'm not even going to bother running the math, just add up those numbers and let me know if it sounds reasonable in whatever possible combination you can think of.

 

You are also right about my leverage numbers, they are wrong, I used a site to pull the data in a pinch, so let me redo the leverage calcs now that I have bloomberg here. VRX has $30.88bn in total debt, and to be fair they carry a 1 billion on the books, so lets go with net debt of $29.88B. VRX did $2.614 billion in LTM EBITDA, after I give them a 20% bump for going into next year we get $3.138B.  Let's say Salix adds $700 million in EBITDA (almost 3 years worth). We get 7.8x. If you think I'm light on the growth of 20%, remember, I'm going on an organic growth basis, more acquisitions means more debt, so my guess would be that the ratio goes higher if anything. Doesn't seem to far off my off the cuff calculation the first time.

 

Now with interest.

 

If you take a look back in the notes, they issue debt around what 5%, but lets just go with 3%. Looking at the 2014 annual, EBITDA/interest expense is about 4x. But without really doing a lot of work, we know they took on about $10B in debt, net, pretty much for Salix. So we take my Salix number up top of $700M and we divide that by the interest expense on the new debt only ($10B*3%) we get $700/$300=2.3x. So the consolidated EBITDA/Interest expense ratio should drop since the Salix deal has a worse ratio than the whole company. It could look better if they get solid growth, but I doubt they will reach the number I provided in the first couple of years.

 

Now you tell me I'm crazy for thinking debt could catch up to them. Salix typically averaged about $80 million in CFFO, in 2013, they benefited from changes in working cap and got about $450. Again, run the math on some growth numbers, what would you need to pay back $10B.

 

I know you won't do the math, so let me give it to you.

 

Here are my assumptions

Debt: $10B

Cash flow yr 1: $700M (Remember I pretty much tripled the current EBITDA for Salix)

Cash Flow Growth Rate: 20%

Interest rate: 3%

 

Here is the answer.  It would take between 9-10 years to pay back. 9 to 10 years!, and I'm giving them the benefit of using interest based on debt at the lowest point each year, rather than averaging 2 years. And now, I'll refer you back to my first point on IRR because right now, the hurdle isn't looking to hot.

 

We can keep going at this, I can do this for VRX as a whole, and the picture wouldn't be much better. So when I mention that they need to keep acquiring to keep the party going, it's because they do. They just don't make enough cash, and like I said before, the bank is going to want hard cash, not 10% of the principal and some monopoly money.

 

If I'm clearly wrong, let me know, like I mentioned before, I have never read the 10-k and spent at most an hour looking at everything today. One way or another, here are some hard numbers to think about.

 

So now we are changing topics? What happened to the other numbers we were looking at, don't want to discuss that any more? We goin' to go around in circles and then when you have no more answers, we switch topics?  Why should I engage in another topic when you can't prove your first point and won't admit you should not have made that point?

 

Did you even read what I wrote?

[merkhet]

If we're just going to be comparing intellectual dick size, I suspect that you will lose. I have two graduate degrees in law and business from two of the top universities in the country, and I can't recall ever scoring below the 98th or 99th percentile in much of anything. Of course, we could both drop trou and compare, but then we'd have fully completed the transition of taking this board from Charlie Rose to Jerry Springer -- something that seems to have been happening over the last three years or so. Perhaps we should stop short of that and, oh, I don't know, discuss things that actually matter to the issue at hand.

 

Yeah, well, I dropped out of fourth grade. So there.

 

This thread has become a circus.

 

Jerry Springer >> Ringling Brothers

 

And with that, I'm off to the beach.

[giofranchi]

If we're just going to be comparing intellectual dick size, I suspect that you will lose. I have two graduate degrees in law and business from two of the top universities in the country, and I can't recall ever scoring below the 98th or 99th percentile in much of anything.

 

I am sure you are a genius. But let me ask you: do you think even someone with your IQ and intellectual prowess could prove VRX is a fraud or that it isn’t, reading 10-Ks and listening to results reported by management?

 

If your answer is “yes”, I sincerely fear your genius is too detached from reality.

 

Cheers,

 

Gio

 

[AZ_Value]

Holy crap guys.

 

Surely life is too short to spend it like this.

 

So I'll address a few things as I'm reading them.

 

I'm sympathetic to the terminal value guys and the cash extending far into the future and perpetually growing and stuff. I really am. I don't buy it but, I'm sympathetic. But your issue is not with me guys. You should take it up with management:

 

J. Michael Pearson - Chairman and Chief Executive Officer

 

"Yes, if it doesn't really play into it. When we look at possible acquisition targets of small, medium or large, we base our analysis on

cash flow projections and in terms of what we believe we could do with these companies. What we do is we look, again, for a certain return to our shareholders. And then we also look at the payback period because we don't believe in putting huge value on terminal

values, 10-year plus on cash flow streams. "

 

5-8-14 Q1 conf call

 

 

Howard Bradley Schiller

 

Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Director

 

"We also focus -- laser-focused on our payback periods, which we believe is a strong governor against overly optimistic forecasts in the later years and overly optimistic terminal value assumptions. And we've targeted 6 years or less."

 

Q4 2014 conference call

 

 

 

Howard Schiller – 6/21/12 Investor day

 

We do rigorous financial modeling. We're looking for 20 percent plus returns at statutory tax rates. We're targeting cash payback periods in the six-year range. Very important, we're not relying on 15-year models with a whole bunch of the value and the terminal value to get our returns. We're not going to get our money back quickly, we're not going to make the investment.

[Bagehot]

Good lord. I feel like people on both sides of this thread have lost their shit. From the Megamind movie...

 

http://www.quickmeme.com/img/70/7038c6b355e9a725b5a6411618bf17e4ce8a46b8b560c90031aaa051febf027c.jpg

 

Btw, as a former math major (Is that bona fides enough to make a comment on IRRs? I was discrete and not continuous focused, if that matters. Also, I prefer a protein shake to IRRs for breakfast, if that also matters.), I'd like to step in to the IRR discussion with three things to point out:

 

(1) Dan Kahan of Yale Law had a fantastically good piece of research on how ideology motivates people's mathematical abilities (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2319992) indicating that two people might see the exact same information and yet interpret things completely differently.

 

(2) Both OM & Picasso were talking completely past one another (ergo my posting of Megamind). You're both technically correct, but I suspect that your reasonings were colored the moment the two of you decided that you were on opposite sides of this debate. IRRs are heavily weighted towards the beginning few years, so OM was basically saying that if they could decrease costs immediately and/or increase sales immediately and maintain this amount w/ a not-substantial-drop once it hits the patent cliff, then they can make their IRRs. Picasso (& AZ) was saying that if they start from a lower base and ease into the decrease of costs and/or increase of sales, then the amount of compounding for the cash flows has to be large in order for the IRRs to work out as promised. See? Like I said before, you're both pretty.

 

(3) I've seen people on this thread confuse IRRs for CAGRs, and they are not the same. If you invest $100 in year 0 and then collect 10 years of $20 payments that you stick in a bank yielding you 0% and then sell the company again in year 10 for $200 (0% growth seems like a 10x-er), then your CAGR is not 20% -- it's 15%. Similarly, if your cash flows are high in the first 10 years but lower in the years after that, you can achieve a high IRR but have a low CAGR because of the lack of value on the back end. (Imagine going from $20 in years 1-10 to $10 from years 11 and beyond -- that drops your CAGR to 11%.) Incidentally, in a situation like the latter one, you'd require the cash flows you take out in the first decade to be reinvested in something to provide you with a CAGR that matches your IRR. (Someone check my logic on this -- it's late, and I'm in the Bahamas and sometimes my brain doesn't work right on the beach.)

 

FWIW, unless I missed it, everyone has glommed onto the IRR discussion but no one has made an effort to reconcile the difference between $11 billion in claimed cash from acquisitions and the $6 billion in total cash flow from operations during that time. A quick glance at cash flow from investments (possible divestments) indicates that it does not account for the $4 billion of difference once you've accounted for the Medicis sales, but I'll readily admit again that I might have missed it.

 

http://3.bp.blogspot.com/-8FPz1xTTuVA/Vd0CIM1PqHI/AAAAAAAAAPA/aRqd3ZaPqa8/s1600/2014%2BCash%2BPayback%2BTable%2B2.JPG

 

Disclosure #1: No position in VRX either long, short, etc. I definitely have a long position in popcorn though.

 

Disclosure #2: I'm long Fannie Mae preferreds, so if you'd like to attack my credibility (from either side), that's probably the easiest way to do it. ;)

 

I think I did. VRX uses an APV methodology for calculating NPV, so the correct comparison is really EBITDA, not CFFO.

 

Also, for all you guys, you can see lightly redacted actual boardroom presentations here:

 

http://www.hsgac.senate.gov/subcommittees/investigations/hearings/impact-of-the-us-tax-code-on-the-market-for-corporate-control-and-jobs

 

If you go to the "related files" pdf in the upper left hand corner, and scroll down to the exhibits pps 126-128, you can see the actual sensitivity analysis VRX showed in the boardroom for the Salix deal. You might also note that a couple of pages before that, Salix's internal management estimates called for ~$4B of EBITDA in 2020 as a standalone company without any VRX cost synergies and $6B by 2024. You might further note that they assume a 38% cash tax rate. If Salix management was right, then this will be an excellent deal. Even if you go the AZ Value approach and assume that the business is worthless, literally 0 cash flow or terminal value from 2025 onward, then VRX will still earn a ~10% IRR on these EBITDA numbers at a 5% cash tax rate and generate ~$31B of Unlevered Free Cash over the 10 year period. If you assume they can sell it at 1/1/2025 for 6x 2024 cash flow, then the IRR becomes 18%. At 8x, then it is ~20%. Etc.

[Liberty]

Nice find, Bagehot.

[mvalue]

Cooler heads on this thread came up with great insights into problems with aspects of the analysis in question.

 

Those who lost their minds about this blog should not be investing - at some point you will need to make tough rational decisions on a position. If some blog that clearly was an earnest attempt at analysis, flawed or not, made you this bonkers, you're in trouble.

[ScottHall]

Cooler heads on this thread came up with great insights into problems with aspects of the analysis in question.

 

Those who lost their minds about this blog should not be investing - at some point you will need to make tough rational decisions on a position. If some blog that clearly was an earnest attempt at analysis, flawed or not, made you this bonkers, you're in trouble.

 

[Ross812]

It seems like nobody here and done their due diligence on Valeant. We've got OM, Gio, Liberty, and (EDIT Wellmont not Writster!) saying we trust management. This is a bet on people, not numbers.

 

The conversation devolved into a spat about AZ's IRR calcs not taking terminal value into account. I don't think he was doing a super detailed IRR calc... Come on guys, he just assumed flat cash flow over 10 years. He was just demonstrating what management repeats over and over again about their focus on 5-6 year pay back.

 

I went back and looked at the Sanitas earnings from 2010, just to get rid of any divestitures and complicated accounting that happened when they were acquired:

 

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.   

 

Valueguy did the same thing for Salix. AZ did the same thing for the whole company. All we are asking for is how do you make the numbers add up? 1+1 doesn't equal 2 in this situation.

 

It is quite apparent that VRX isn't using operations CF for their 5-6 year payback period. We can't reconcile the number with EBITA either, so what metric are they using when showing they are on track for a 5-6 year payback?

 

I don't own any VRX and I never have, but in order for me to invest in something I at least have to understand how to measure its success. I am genuinely interested in VRX if some one can demonstrate how they get their money back from an acquisition in 5-6 years.

 

 

[Phaceliacapital]

Also, for all you guys, you can see lightly redacted actual boardroom presentations here:

 

http://www.hsgac.senate.gov/subcommittees/investigations/hearings/impact-of-the-us-tax-code-on-the-market-for-corporate-control-and-jobs

 

 

Very cool, thanks.

[AZ_Value]

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.

 

KC, I saw the IP transfer and you're right their system is based around setting up holding companies to own the IP, that's how tax savings happen anyways because that probably gets set up in their most favorable tax jurisdiction. But that will just be transfer pricing intercompany stuff that gets eliminated at the parent level when consolidating.

 

But it's really not affecting how we look at Sanitas, the business, and how it is presented to us.

 

Just take a step back and forget than I'm critical of VRX and you have to disprove everything I say and just look at the business itself.

 

The four quarters prior to acquisition, That's Q3 2010 thru Q2 2011. No IP transfer, none of that. Just Sanitas.

 

Revenue was $133M - Gross Profit was $77M - Cash from ops was $ 33M

 

After acquisition - Thats Q3 2011 thru Q2 2012

 

Revenue was $130M - Gross Profit was $80M - Cash from ops was $11M (this is mostly due to Q3 2011 where there's a big $13M cash burn which makes sense. That's when the deal is happening so you'll have all kind of expenses, legal, integration etc.)

 

KC, this is the same business you're looking at before and after.

 

Only way your point makes sense is if somehow by magic the minute after they're acquired by VRX, Sanitas became so special that they could send up to the parent company all their IP that generated $130M in revenue the year before and STILL manage to keep $130M for themselves.

 

Surely that's not the claim you're making, is it?

 

 

 

 

 

 

 

[mvalue]

Any idea if they have any drug(s) they could have significantly raised prices on immediately? If so, not impossible...

 

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.

 

KC, I saw the IP transfer and you're right their system is based around setting up holding companies to own the IP, that's how tax savings happen anyways because that probably gets set up in their most favorable tax jurisdiction. But that will just be transfer pricing intercompany stuff that gets eliminated at the parent level when consolidating.

 

But it's really not affecting how we look at Sanitas, the business, and how it is presented to us.

 

Just take a step back and forget than I'm critical of VRX and you have to disprove everything I say and just look at the business itself.

 

The four quarters prior to acquisition, That's Q3 2010 thru Q2 2011. No IP transfer, none of that. Just Sanitas.

 

Revenue was $133M - Gross Profit was $77M - Cash from ops was $ 33M

 

After acquisition - Thats Q3 2011 thru Q2 2012

 

Revenue was $130M - Gross Profit was $80M - Cash from ops was $11M (this is mostly due to Q3 2011 where there's a big $13M cash burn which makes sense. That's when the deal is happening so you'll have all kind of expenses, legal, integration etc.)

 

KC, this is the same business you're looking at before and after.

 

Only way your point makes sense is if somehow by magic the minute after they're acquired by VRX, Sanitas became so special that they could send up to the parent company all their IP that generated $130M in revenue the year before and STILL manage to keep $130M for themselves.

 

Surely that's not the claim you're making, is it?

[Liberty]

It seems like nobody here and done their due diligence on Valeant. We've got OM, Gio, Liberty, and Writster saying we trust management. This is a bet on people, not numbers.

 

Your signature shows your portfolio, right? You understand all the numbers at American Express? Fairfax? Liberty Media (what's the IRR on the Braves? Are the Live Nation financials completely clear to you?)? Lancashire? Gilead?

 

Who here can reconcile every line for ever division and acquisition at Danaher or Berkshire (let's not even talk about Berkshire a few decades ago when it was a bunch of cross-holdings with Blue Chip Stamps.. so messy the SEC pushed them to simplify and suspected fraud)? Anyone understands all the recent acquisitions at Mastercard? Anyone can untangle Google and every one of its investments, acquisitions, and side projects?

 

If you think trusting management isn't a big part of investing, you are deluding yourself. Valeant was battle-tested in one of the most aggressive campaigns that I've seen. They came back with rebuttals to Allergan's and Hempton's attacks that satisfied me. Then their GAAP numbers even converged with adjusted. I believe that AZ is working really hard and probably has good intentions, but he has incomplete information, and I think the chances are much higher that things don't line up because he's missing pieces of the puzzle rather than because the company is defrauding the market (because that's what it would be if they claimed a certain business performance while it actually is something else). Would the world be a better place if all the pieces of the puzzle were out there and VRX published a phone book every quarter? Probably. But like other companies I've mentioned previously, we have to make a decision with the level of disclosure that we have.

 

AZ, have you considered picking one or two questions that you really want answers to and contacting VRX IR?