VRX - Valeant Pharmaceuticals International Inc.

[Guest Schwab711]

If you buy the stock you are assuming no earnings impairment which could lower the value of the business below the debt + equity value at the current price. That's like $62 billion, or it was before the stock started falling in price again.

 

But the bonds are trading at 80% of face value and earn 6% of face value a year. You're only going to lose owning those bonds if the equity is fully wiped out and the sum total of everything Valeant acquired is worth half of what they purchased it for. At least if we're looking out a few years to collect a few coupons. That's a pretty bad situation that no equity holder is thinking will happen.

 

I think the bonds are just mispriced rather than saying the equity is worthless.  If or when the cost of capital goes down for Valeant then that gap will change. But a large discount to face for Valeant bonds is strange because they have a ton of cash earnings coverage in the short term which is more important to the bond holders than equity holders. Amortization may be a cost for equity holders in the long term, but to the bond holders thats real cash to cover interest and principal. Also Valeant doesn't pay a lot of capex or taxes so the debt burden isn't as high as people think.

 

But regardless of which market is right (bonds or stock) that is a really large gap to fill. The bonds are getting close to a price where it's nearly impossible to lose over then years. Not really the case for the equity. Does that make sense?

 

tldr; bondholders dont like the risk of Valeant here, equity holders still think theres a ton of excess earnings

 

Picasso,

I get your point, however i think you are viewing this short term. Yes there is going to be lot of scrutiny and media/regulator attention for few months. It may even impact revenues, earnings in the next year or two. This is a news cycle which will pass once they find something else to focus their attention on.

 

Look past all this smoke and confusion that exists now. There are real assets here. They paid 40b for it. They made some improvements. They have their tax rate as an asset. Their products are small individually and diversified. Current management doesn't have to run it, these assets will have value in somebody else's hands too.

 

Few month ago, investors here were saying how 40b invested by VRX is suddenly worth 3x that amount, because of all these assets/capabilities VRX possessed. Now the market is saying it is worth only 1.5x of what they paid. To me 1.2-1.5x makes more sense in a decently efficient market.

 

In 2-3 of years as you noted their cashflow will enable them to pay off 20%-30% of current debt. Equity portion of firm value is going to go up by similar amount.

 

I am not predicting the price won't go down even more, but I think it is decent value here with lots of free optionality.

 

I hate to harp on this topic but I have yet to see a sufficient explanation for why it is reasonable to assume a low (single-digit) tax rate in perpetuity. Can someone explain how it will work since I guess I'm not understanding the assumption. I assume investors should only care about the long-term cash tax rate and not the book rate (which may be wrong?).

 

On p.9 of this thread (link below), the board came to the conclusion (which I agree with) that VRX's tax rate is only sustainable if they continue to purchase foreign assets or if they can transfer US-based IP to Barbados. As a side note, VRX is currently being investigated by the IRS and Canadian tax authority for potentially manipulating their IP transfers in the past (attributing large intangible asset balances to a company's "brand name" instead of cash flow producing assets, even in cases where VRX plans to discontinue the use of that brand). Some fine (and possibly a restatement) seems likely considering VRX's actual results.

 

In theory, VRX's tax structure shouldn't be possible since VRX should be paying FV at the time of IP transfer, as calculated by the tax savings as a result of the domicile transfer. The only difference between VRX and everyone else (GOOG, AAPL, MSFT, PFE, GSK, ect) is the use of Barbados instead of Ireland and the difference is negligible. Yet somehow, VRX expects a ~5% tax rate when others mentioned realize a 15-25% tax rate. I think this guidance (~5%) is accurate for book taxes due to the large non-deductible amortization expense, but the cash tax rate seems destined to be materially higher. We know for sure that SLXP's IP is still in the US so all future SLXP cash flows will be taxed at US corporate rates + costs of DTL repayment on these cash flows. I get the debt shield, but the majority of intangible asset amortization is non-deductible which should result in a wash (means book taxes will generally be much lower than cash taxes). VRX's cash taxes are already significantly higher than book taxes even though SLXP has been unprofitable thus far (inventory).

 

Assuming a 20-30% cash tax rate will materially change future FCF estimates. Am I wrong to think about the tax structure in this way?

 

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/valeant-pharmaceutilcals-international-inc-(vrx)/80/

[rishig]

If you buy the stock you are assuming no earnings impairment which could lower the value of the business below the debt + equity value at the current price. That's like $62 billion, or it was before the stock started falling in price again.

 

But the bonds are trading at 80% of face value and earn 6% of face value a year. You're only going to lose owning those bonds if the equity is fully wiped out and the sum total of everything Valeant acquired is worth half of what they purchased it for. At least if we're looking out a few years to collect a few coupons. That's a pretty bad situation that no equity holder is thinking will happen.

 

I think the bonds are just mispriced rather than saying the equity is worthless.  If or when the cost of capital goes down for Valeant then that gap will change. But a large discount to face for Valeant bonds is strange because they have a ton of cash earnings coverage in the short term which is more important to the bond holders than equity holders. Amortization may be a cost for equity holders in the long term, but to the bond holders thats real cash to cover interest and principal. Also Valeant doesn't pay a lot of capex or taxes so the debt burden isn't as high as people think.

 

But regardless of which market is right (bonds or stock) that is a really large gap to fill. The bonds are getting close to a price where it's nearly impossible to lose over then years. Not really the case for the equity. Does that make sense?

 

tldr; bondholders dont like the risk of Valeant here, equity holders still think theres a ton of excess earnings

 

Picasso,

I get your point, however i think you are viewing this short term. Yes there is going to be lot of scrutiny and media/regulator attention for few months. It may even impact revenues, earnings in the next year or two. This is a news cycle which will pass once they find something else to focus their attention on.

 

Look past all this smoke and confusion that exists now. There are real assets here. They paid 40b for it. They made some improvements. They have their tax rate as an asset. Their products are small individually and diversified. Current management doesn't have to run it, these assets will have value in somebody else's hands too.

 

Few month ago, investors here were saying how 40b invested by VRX is suddenly worth 3x that amount, because of all these assets/capabilities VRX possessed. Now the market is saying it is worth only 1.5x of what they paid. To me 1.2-1.5x makes more sense in a decently efficient market.

 

In 2-3 of years as you noted their cashflow will enable them to pay off 20%-30% of current debt. Equity portion of firm value is going to go up by similar amount.

 

I am not predicting the price won't go down even more, but I think it is decent value here with lots of free optionality.

 

Why are these assets that they bought for $40B worth 1.2x - 1.5x? Say, they are worth 1.5x - that gets you $60B, the current enterprise value i.e. the fair value based on that multiple.

 

The levers that Valeant could pull on these acquisitions

i) price increases

ii) flow through specialty pharmacy to boost organic growth

iii) cut SG&A

iv) cut R&D

v) low taxes

 

(i) is not sustainable from Marathon's case.

(iii) and (iv) are not sustainable if you want to maintain a long life for the asset acquired.

(v) is questionable for IP currently housed in US.

On (i) and (ii), the theory was that these drugs are cash pay and durable Well, PBMs are not stupid, as we have recently found out.

 

So again why is this worth more than 1.5x what they paid in any reasonable scenario?

 

[jay21]

The common bear pt has always been they need to do R&D to support their current drugs. What percent of R&D do pharmas spend doing this vs attempting to find new drugs? I am basically asking what is maintenance R&D vs growth R&D.

 

[Picasso]

I don't know if anyone really knows that answer jay.  The current spend on R&D seems to have provided a decent return (Jublia alone probably paid for all their R&D to date) but I've wondered about the R&D spend by other pharmas.  A new, better drug can make an existing Valeant product essentially worthless.  But the argument has been that no one really wants to compete with some of these smaller drugs.

 

The R&D question has probably not been properly answered by any of the large shareholders.  You might get returns on the spend (growth R&D), but you also need to protect the rest of the asset base (maintenance R&D).

[maxthetrade]

If true this doesn't sound good:

http://pdfsr.com/pdf/the-missing-piece

[jay21]

I don't know if anyone really knows that answer jay.  The current spend on R&D seems to have provided a decent return (Jublia alone probably paid for all their R&D to date) but I've wondered about the R&D spend by other pharmas.  A new, better drug can make an existing Valeant product essentially worthless.  But the argument has been that no one really wants to compete with some of these smaller drugs.

 

The R&D question has probably not been properly answered by any of the large shareholders.  You might get returns on the spend (growth R&D), but you also need to protect the rest of the asset base (maintenance R&D).

 

For things like saline solution and footcream, the brand probably matters more than the actual product. I don't know enough about the rest of the portfolio to categorically say most of their products are like that but I think it's equally misguided for some posters to say they NEED to spend X% on R&D because other pharmas do so. When you look at R&D returns in aggregate, cutting R&D seems like it can provide some value.

[rishig]

I have an open mind and I am willing to change my mind, if someone can tell me with a high degree of confidence why he or she understands the underlying assets are definitely worth significantly more than the current enterprise value of $60B, i.e. 1.5x the sum of all acquisition prices of $40B. This can be supported using anything other than because "Mr. Pearson is a great allocator of capital and their deal model says they only do acquisitions at 20% IRR and that's why".

 

Salix, their last acquisition had $1.1B in revenue in 2014 and even at Valeant's cost structure, no more than $650M in EBITDA (50% EBITDA margin as per Ackman's slides). And for sake of argument, let's say that *all* of that converts into free cash flow (how about 0 taxes, 0 interest). That is a payback period of 23 years! You need some massive organic growth to match their "deal model" of 20% IRR. We all know that they have fewer levers to pull, no one can say exactly which ones. But like Ben Graham said "You don't have to know a man's exact weight to know that he's fat"

[Picasso]

Well how much does Alcon spend on R&D?  How much do Salix competitors spend on R&D?  And how much of that spend is growth vs. maintenance.

 

I think it's kind of like retail.  If you stand still you are actually moving backwards because the rest of the industry is plowing a ton of resources for future growth.

[Picasso]

rishig,

 

They put terminal values (oh boy here we go again!) on their deal models for stuff like B+L or Salix so it's not just cash flows.  I think EBITDA guidance for Salix in 2016 was $1.1 billion.

 

There's a slide deck somewhere in the congressional testimony showing their deal model for Salix.

[rishig]

rishig,

 

They put terminal values (oh boy here we go again!) on their deal models for stuff like B+L or Salix so it's not just cash flows.  I think EBITDA guidance for Salix in 2016 was $1.1 billion.

 

There's a slide deck somewhere in the congressional testimony showing their deal model for Salix.

 

Salix 10-K shows revenue of $1.1B. How does one go from $1.1B in revenue to $1.1B in EBITDA in two years. That is some kick ass growth!

[Liberty]

Salix, their last acquisition had $1.1B in revenue in 2014 and even at Valeant's cost structure, no more than $650M in EBITDA (50% EBITDA margin as per Ackman's slides).

 

Salix had depressed revenues because of a channel stuffing scandal (which allowed VRX to buy them at a reduced price). Inventories should be back to normal around Q4-early 2016. In 2014 they mostly drew down existing inventories.. Management has guided to 600m of Salix revenues for Q4, which should be a more business-as-usual run-rate.

 

From the Q2 call:

 

Glenn Greenberg - Brave Warrior Advisors

Quick question. On Salix you said the revenues this year would be about a billion two and it looks like they were 300 million in the last quarter and will be 300 million again in the third quarter. So, does that imply that the fourth quarter revenues would be 600 million and that we could maybe annualize that a little better as we look into its contribution to revenues next year?

 

Mike Pearson - Chairman and CEO

Yes, we are projecting 600 for the fourth quarter, the one to in the end may prove a little conservative, it depends it just start to know all the inventory to be out there. But, the business is also accelerating, the growth continues to be very strong and certainly by first quarter of next year we should be selling to full demand. So, if you incorporate maybe a slight bit of inventory still in the channel fourth quarter we don’t know that’s what we’re assuming and then you continue to model and the growth that we have experienced across the brands that should give you a pretty good feel for what this thing will look like for next year.

[Picasso]

Here's a link to that slide deck detailing some of their bigger deals like B+L and Salix.

 

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

Just click the PDF under related files.

[Picasso]

Holy crap, check out page 76 under the Salix forecasts.  They took a ruler out to 2024 saying they would earn around $10 billion of revenue and $44 of adjusted EPS.

 

I don't know how I missed that the last time I reviewed that information.  Management was certainly bullish but why the hell would they sell then?  Scandal and everything set aside.

[rishig]

Salix, their last acquisition had $1.1B in revenue in 2014 and even at Valeant's cost structure, no more than $650M in EBITDA (50% EBITDA margin as per Ackman's slides).

 

Salix had depressed revenues because of a channel stuffing scandal (which allowed VRX to buy them at a reduced price). Inventories should be back to normal around Q4-early 2016. In 2014 they mostly drew down existing inventories.. Management has guided to 600m of Salix revenues for Q4, which should be a more business-as-usual run-rate.

 

From the Q2 call:

 

Glenn Greenberg - Brave Warrior Advisors

Quick question. On Salix you said the revenues this year would be about a billion two and it looks like they were 300 million in the last quarter and will be 300 million again in the third quarter. So, does that imply that the fourth quarter revenues would be 600 million and that we could maybe annualize that a little better as we look into its contribution to revenues next year?

 

Mike Pearson - Chairman and CEO

Yes, we are projecting 600 for the fourth quarter, the one to in the end may prove a little conservative, it depends it just start to know all the inventory to be out there. But, the business is also accelerating, the growth continues to be very strong and certainly by first quarter of next year we should be selling to full demand. So, if you incorporate maybe a slight bit of inventory still in the channel fourth quarter we don’t know that’s what we’re assuming and then you continue to model and the growth that we have experienced across the brands that should give you a pretty good feel for what this thing will look like for next year.

 

From Salix' 2014 10K

Revenue:

2014: $1,133,542

2013:    $913,781

2012:    $735,444

 

http://www.sec.gov/Archives/edgar/data/1009356/000156459015001199/slxp-10k_20141231.htm

 

Revenue in 3 years from 2012-2014 was 15% CAGR. What we saying is that 2016E Revenue is $2,2B to get a EBITDA of $1.1B. That is a revenue growth of CAGR of 41%.

 

So going back to my original question, why are assets acquired by Valeant worth significantly more than 1.5x what they paid for it?

 

 

[rishig]

Holy crap, check out page 76 under the Salix forecasts.  They took a ruler out to 2024 saying they would earn around $10 billion of revenue and $44 of adjusted EPS.

 

I don't know how I missed that the last time I reviewed that information.  Management was certainly bullish but why the hell would they sell then?  Scandal and everything set aside.

 

I never said scandal anywhere ever in my post in any of the threads. I hope we can continue the discussions with an emotional detachment.

[Picasso]

By scandal I meant Salix essentially forced a sale due to their channel stuffing issues.  If they really thought they would be earning $5 billion+ of EBITDA in ten years then why sell even with those issues?

[jay21]

Salix, their last acquisition had $1.1B in revenue in 2014 and even at Valeant's cost structure, no more than $650M in EBITDA (50% EBITDA margin as per Ackman's slides).

 

Salix had depressed revenues because of a channel stuffing scandal (which allowed VRX to buy them at a reduced price). Inventories should be back to normal around Q4-early 2016. In 2014 they mostly drew down existing inventories.. Management has guided to 600m of Salix revenues for Q4, which should be a more business-as-usual run-rate.

 

From the Q2 call:

 

Glenn Greenberg - Brave Warrior Advisors

Quick question. On Salix you said the revenues this year would be about a billion two and it looks like they were 300 million in the last quarter and will be 300 million again in the third quarter. So, does that imply that the fourth quarter revenues would be 600 million and that we could maybe annualize that a little better as we look into its contribution to revenues next year?

 

Mike Pearson - Chairman and CEO

Yes, we are projecting 600 for the fourth quarter, the one to in the end may prove a little conservative, it depends it just start to know all the inventory to be out there. But, the business is also accelerating, the growth continues to be very strong and certainly by first quarter of next year we should be selling to full demand. So, if you incorporate maybe a slight bit of inventory still in the channel fourth quarter we don’t know that’s what we’re assuming and then you continue to model and the growth that we have experienced across the brands that should give you a pretty good feel for what this thing will look like for next year.

 

From Salix' 2014 10K

Revenue:

2014: $1,133,542

2013:    $913,781

2012:    $735,444

 

http://www.sec.gov/Archives/edgar/data/1009356/000156459015001199/slxp-10k_20141231.htm

 

Revenue in 3 years from 2012-2014 was 15% CAGR. What we saying is that 2016E Revenue is $2,2B to get a EBITDA of $1.1B. That is a revenue growth of CAGR of 41%.

 

So going back to my original question, why are assets acquired by Valeant worth significantly more than 1.5x what they paid for it?

 

Here's the general model the try to follow:

 

You are missing his point bout earnings growth from taxes. They are doubling the EBIT of the company through synergies and then getting a better tax rate.

 

Unlevered Company pre VRX:

 

Revenue: 100

EBIT: 25

Taxes at 40%:10

Earnings: 15

 

Unlevered Company post VRX:

 

Revenue: 100

EBIT: 50

Taxes at 10%:5

Earnings: 45

 

A triple in earnings on a double in EBIT. unlevered.

 

Most of the EBIT expansion is from cutting 20% of revenue in R&D.

[rishig]

Salix, their last acquisition had $1.1B in revenue in 2014 and even at Valeant's cost structure, no more than $650M in EBITDA (50% EBITDA margin as per Ackman's slides).

 

Salix had depressed revenues because of a channel stuffing scandal (which allowed VRX to buy them at a reduced price). Inventories should be back to normal around Q4-early 2016. In 2014 they mostly drew down existing inventories.. Management has guided to 600m of Salix revenues for Q4, which should be a more business-as-usual run-rate.

 

From the Q2 call:

 

Glenn Greenberg - Brave Warrior Advisors

Quick question. On Salix you said the revenues this year would be about a billion two and it looks like they were 300 million in the last quarter and will be 300 million again in the third quarter. So, does that imply that the fourth quarter revenues would be 600 million and that we could maybe annualize that a little better as we look into its contribution to revenues next year?

 

Mike Pearson - Chairman and CEO

Yes, we are projecting 600 for the fourth quarter, the one to in the end may prove a little conservative, it depends it just start to know all the inventory to be out there. But, the business is also accelerating, the growth continues to be very strong and certainly by first quarter of next year we should be selling to full demand. So, if you incorporate maybe a slight bit of inventory still in the channel fourth quarter we don’t know that’s what we’re assuming and then you continue to model and the growth that we have experienced across the brands that should give you a pretty good feel for what this thing will look like for next year.

 

From Salix' 2014 10K

Revenue:

2014: $1,133,542

2013:    $913,781

2012:    $735,444

 

http://www.sec.gov/Archives/edgar/data/1009356/000156459015001199/slxp-10k_20141231.htm

 

Revenue in 3 years from 2012-2014 was 15% CAGR. What we saying is that 2016E Revenue is $2,2B to get a EBITDA of $1.1B. That is a revenue growth of CAGR of 41%.

 

So going back to my original question, why are assets acquired by Valeant worth significantly more than 1.5x what they paid for it?

 

Here's the general model the try to follow:

 

You are missing his point bout earnings growth from taxes. They are doubling the EBIT of the company through synergies and then getting a better tax rate.

 

Unlevered Company pre VRX:

 

Revenue: 100

EBIT: 25

Taxes at 40%:10

Earnings: 15

 

Unlevered Company post VRX:

 

Revenue: 100

EBIT: 50

Taxes at 10%:5

Earnings: 45

 

A triple in earnings on a double in EBIT. unlevered.

 

Most of the EBIT expansion is from cutting 20% of revenue in R&D.

 

That doesn't answer my question. Repeating again:

 

2016E EBITDA of $1.1B as per picasso in thread #4516. As per your model, you need revenue of $2.2B in 2016, right, to get an EBITDA of $1.1B? From 2014, 10K revenue for 2014 was $1.1B. That requires growth of 41% in revenue CAGR for 2014-2016 under Valeant umbrella. Pre-acquisition, revenue, for Salix grew at 15% from 2012 - 2014. How do you take a company that has been growing revenue at 15% and grow at 41%

[jay21]

Youre question was: "So going back to my original question, why are assets acquired by Valeant worth significantly more than 1.5x what they paid for it?"

 

That example explains why they can make the assets worth 1.5x.

[rishig]

Youre question was: "So going back to my original question, why are assets acquired by Valeant worth significantly more than 1.5x what they paid for it?"

 

That example explains why they can make the assets worth 1.5x.

 

What example? Specifically, let's address Salix.

[Guest Schwab711]

That doesn't answer my question. Repeating again:

 

2016E EBITDA of $1.1B as per picasso in thread #4516. As per your model, you need revenue of $2.2B in 2016, right, to get an EBITDA of $1.1B? From 2014, 10K revenue for 2014 was $1.1B. That requires growth of 41% in revenue CAGR for 2014-2016 under Valeant umbrella. Pre-acquisition, revenue, for Salix grew at 15% from 2012 - 2014. How do you take a company that has been growing revenue at 15% and grow at 41%

 

New indication of Xifaxan was approved on MAY-27-2015. Peak sales proj to be ~$2b. SLXP has nothing else in the pipeline so you have to be Pollyanna to proj peak sales >$4b or to proj peak sales sustaining for more than a couple years. Xifaxan loses exclusivity for all indications by 2018 and competing novel compounds have already been approved. After 2018, competitors can fully compete.

 

Xifaxan (IBS-D) is nothing more than a glorified Imodium tablet.

 

http://www.fda.gov/NewsEvents/Newsroom/PressAnnouncements/ucm448328.htm

 

VRX purposefully did not advertise Xifaxan (IBS-D) DTC in 2015 so that they could show large "organic growth" in 2H16.

[arcube]

I have an open mind and I am willing to change my mind, if someone can tell me with a high degree of confidence why he or she understands the underlying assets are definitely worth significantly more than the current enterprise value of $60B, i.e. 1.5x the sum of all acquisition prices of $40B. This can be supported using anything other than because "Mr. Pearson is a great allocator of capital and their deal model says they only do acquisitions at 20% IRR and that's why".

 

Salix, their last acquisition had $1.1B in revenue in 2014 and even at Valeant's cost structure, no more than $650M in EBITDA (50% EBITDA margin as per Ackman's slides). And for sake of argument, let's say that *all* of that converts into free cash flow (how about 0 taxes, 0 interest). That is a payback period of 23 years! You need some massive organic growth to match their "deal model" of 20% IRR. We all know that they have fewer levers to pull, no one can say exactly which ones. But like Ben Graham said "You don't have to know a man's exact weight to know that he's fat"

 

Rishig,

I might be missing something here. How did you get $650mm in EBITDA at 50% margin? Do you mean $550m?

[ERICOPOLY]

If true this doesn't sound good:

http://pdfsr.com/pdf/the-missing-piece

 

I can forgive anyone for ignoring that and ignoring what he had to say, but this is bizarre:

 

Matching Grants for Share Purchases. In connection with such share ownership, you shall also be eligible to

receive matching share units under the Company’s matching share unit program in accordance with its terms as

applied for similarly situated executives of the Company.

 

The executive is given matching shares when he buys stock with his own shares. 

 

So do I understand that correctly?  Like if you see an insider buy stock at $200, he is really only investing $100 of his own money?  That kind of shit (when insiders buy) makes a lot of people feel confident about the stock price.  Are they trying to pump up the stock or something?  Weird.

[Guest Schwab711]

Youre question was: "So going back to my original question, why are assets acquired by Valeant worth significantly more than 1.5x what they paid for it?"

 

That example explains why they can make the assets worth 1.5x.

 

Your example depends on a low tax rate that does not match actual results and cannot be explained.

 

So how are the assets worth >1.5x purchase price?

[arcube]

If true this doesn't sound good:

http://pdfsr.com/pdf/the-missing-piece

 

I can forgive anyone for ignoring that and ignoring what he had to say, but this is bizarre:

 

 

"Matching Grants for Share Purchases."

 

The executive is given matching shares when he buys stock with his own shares. 

 

So do I understand that correctly?  Like if you see an insider buy stock at $200, he is really only investing $100 of his own money?  That kind of shit (when insiders buy) makes a lot of people feel confident about the stock price.  Are they trying to pump up the stock or something?  Weird.

 

Not sure if it will be shown as an Open Market Purchase. That would be different than grant or matching grant?