VRX - Valeant Pharmaceuticals International Inc.

[ScottHall]

I love it.

[original mungerville]

I think I mentioned a securities lawsuit was probably next in my prior posts. They have now arrived!

 

Its game on for Valeant - either they are a fraud and engage in broad illegal activity OR they are not, get a little fine, and the longs will make a lot of money from here on.

 

One impact is that they are probably going to be focusing more on debt reduction than they otherwise would have with all these pressures now as it should be more expensive for them to issue debt now.

 

[original mungerville]

McCaskill responds:

 

https://pbs.twimg.com/media/CRYbEjxUkAALK9T.jpg:large

 

Is it just me or does it seem like a bit of a juvenile response? I mean I read the Valeant letter, there seemed to be some data in there (maybe not as much as the Senator wanted but some) - at a minimum they must have partially answered some of her questions? Or am I misreading this?

[original mungerville]

Seems these investigations are pretty widespread in the industry:

 

http://www.wsj.com/articles/valeant-probe-reprises-federal-focus-on-drug-pricing-1444952138?mod=yahoo_hs

 

Valeant is a different animal (low tax rate, raises debt, acquires, slashes R&D and middle-management, and repeats), and nobody likes different.

[Liberty]

McCaskill responds:

 

https://pbs.twimg.com/media/CRYbEjxUkAALK9T.jpg:large

 

Is it just me or does it seem like a bit of a juvenile response? I mean I read the Valeant letter, there seemed to be some data in there (maybe not as much as the Senator wanted but some) - at a minimum they must have partially answered some of his questions? Or am I misreading this?

 

I'm not sure she could be expected to say anything else, really.. Do you think Valeant could have written anything that would have made her go "Ok, great, thank you, that's all I wanted." I'm sure she's genuinely concerned about this issue, though I'm not sure how much time a senator has to devote to learning about a company (I'm sure staffers have given her a folder full of NYT and WSJ pages with highlighted lines about 'raising drug prices at a 48% CAGR for 8 years'), but it's also in very large part politics. That's why Pearson had to point out american jobs and other stuff irrelevant to the matter at hand.

[Picasso]

I'm not sure I completely agree with "how else could she have responded?"  Well, she could have not publicly responded at all and just continued her investigation.  It's somewhat telling that the response struck the wrong nerve.

 

Also Pearson probably made a mistake by focusing on the jobs created in Rochester.  The last thing a democrat wants to hear is the "job creation" when you strip out earnings with interest, move around IP, pay little to no tax, fire other people, and generally focus on maximizing shareholder value.  That's all fine for shareholders, but you can't try and point out some positives, these politicians have been used to hearing that their whole careers and it probably ticks them off.  They're not so stupid to think that makes up for what they're really after, and they probably don't believe that maximizing shareholder value is the best thing for the economy.  And especially in healthcare related activities.  These are the people, after all, who ridicule the bush tax cuts.

 

If that was the only information Pearson sent, then I can see how she wants to make a point that this isn't a way to smooth over the situation.  Maybe some of that was for shareholders more than the subpoena response.

 

At the end of the day, who knows.  This just introduces extra risk into a super levered and tense situation.  I'm having trouble handicapping any of the odds here, other than Pearson stands to lose the most from letting this turn into a Ocwen-like outcome.  His net worth will almost completely evaporate in that kind of situation.  So I think he's going to comply the best that he can and maybe take a couple steps back.

 

One risk I thought about today was something the last short VIC article highlighted on VRX.  I thought Valeant would do another large deal when the stock was trading over 20x cash EPS, but we might see Valeant trade at 10x cash EPS (or lower) for a while and at the same time see a recovery in other large targets.  If that happens, Valeant is going to have its hands tied from issuing debt or stock and you'll start to see the real free cash flow coming from the existing asset base.  If it doesn't converge with $4 billion of FCF in 2016 this could cause a problem for the stock.  This drama just makes it a lot harder for Valeant to paper over any hiccups in the business.

[original mungerville]

In a worst case scenario, with Valeant having grown so fast, how large can any past annual illegal activity be? If you look at their current portfolio of businesses including Salix which was just purchased, B&L, etc... all of this price increase activity, investigations, etc. would only seem to relate to a small part of their business. So just how large can the potential settlement be on that in a worst case scenario?

 

A few hundred million?

 

Can it get worse than that? The Ocwen stuff I imagine/guessing was firm-wide or a large amount of assets relative to equity capital.

 

At most, this seems to be a portion of the business which was exposed.

[ScottHall]

One thing to consider is that Ocwen is perpetually in run-off unless it can source new MSRs, etc. because the loans go away over time. So it's a melting ice cube. If you believe VRX's products really are durable... well, I'm not so sure it's an apt comparison.

[Picasso]

I should probably spend more time making my thoughts more clear.

 

When I say Pearson has a lot to lose in a Ocwen like situation, if you read his latest employment agreement he basically loses all his unvested stock if he's kicked out for reasons like fraud. Now we have no indication of that, but the deal struck with Erbey basically forced him out. Pearson needs to resolve this in the cleanest way possible and maybe legislators know that's a weakness of his.

 

I don't know why they didn't properly address this during the first inquiry.

[Larry]

Im thinking about the worst outcome aswell. Not really familiar with lawsuits in US corporate world. But if I understood correctly, this subpoena touches only price hikes of some of the Marathon drugs? So when people are talking of Ocwen kind of situation, Im not sure if the whole company is going down with this.

 

I might add a bit. Though it was before any of the subpoena news, if I remember correctly Valueact was adding when this was trading in 140's or near that level (and I think this was before they closed several deals like Salix and Amoun).

[Liberty]

Q3:

 

2015 Third Quarter Results

 

Total Revenues of $2.8 billion; an increase of 36% over the prior year despite negative foreign exchange impact of $172 million

Same store sales organic growth of 13%; 5th consecutive quarter of > 10% organic growth, driven by:

Continued outperformance of U.S. businesses, particularly dermatology and contact lens

Strong results in China (23%), South Korea (15%) and Mexico (10%)

Total company growth was 8.2% volume and 4.4% price

U.S. branded pharmaceuticals growth was 18.8% volume and 15.2% price

Excluding the impact from genericization of Targretin Capsules during the quarter, same store sales organic growth would have been 14%

Impact from generic Xenazine expected fully in fourth quarter

Salix revenue was $461 million

Strong Xifaxan script uptake following IBS-D approval

Salix wholesaler inventory levels reduced from 3-3.5 months to 2-2.5 months

GAAP EPS $0.14; Cash EPS $2.74, an increase of 30% over prior year despite the negative foreign exchange impact of $0.13 versus the prior year

GAAP Operating Cash Flow $737 million, an increase of  19% over prior year; excluding the impact of foreign exchange, the increase was 26%

Adjusted Operating Cash Flow $865 million, an increase of  12% over prior year; excluding the impact of foreign exchange, the increase was 18%

Deals recently closed include Sprout, brodalumab, Synergetics and Amoun, which is expected to close later today

 

Fourth Quarter 2015 Guidance

 

Total Revenue increased to $3.25 - $3.45 billion from $3.2 - $3.4 billion

Cash EPS increased to $4.00 - $4.20 from $3.98 - $4.18

 

Full Year 2015 Guidance

 

Total Revenue increased to $11.0 - $11.2 billion from $10.7 - $11.1 billion,

Salix revenue expected to be ~$1.35 billion

Cash EPS increased to  $11.67 - $11.87 from $11.50 - $11.80

Adjusted Cash Flow from Operations of greater than $3.35 billion

Same Store Sales Organic Growth of >10% for Q4 and FY 2015     

 

http://ir.valeant.com/investor-relations/news-releases/news-release-details/2015/Valeant-Pharmaceuticals-Reports-Third-Quarter-2015-Financial-Results/default.aspx

 

Call about to begin.

 

http://ir.valeant.com/files/doc_presentations/2015/q3/Q3-2015-Earnings-Deck-10-11-2015-Final.pdf

[giofranchi]

To Reduce the Cost of Drugs, Look to Europe

 

http://www.nytimes.com/2015/10/20/upshot/to-reduce-the-cost-of-drugs-look-to-europe.html?partner=socialflow&smid=tw-nytimesbusiness&smtyp=cur

 

Cheers,

 

Gio

[giofranchi]

CEO of the Year 2015: Mike Pearson, Valeant

 

http://www.canadianbusiness.com/leadership/ceo-of-the-year/top-ceo-mike-pearson-valeant/

 

Cheers,

 

Gio

[Picasso]

So we have some confirmation of Pearson comments from an interview that they are probably not going to do anymore mispriced Marathon type deals. They also might sell or spin off that part of the business which can be interesting.  Probably hard to sell with the attention it's receiving so maybe it'll just be a spinoff that no one will want to own.

 

No commitment yet to a beefed up repurchase program. I'm a bit surprised by that, but they seem to get much better returns in their business that I can understand that decision.

 

And they used a weighted average for some of their disclosures. Sort of funny to see weighted in there, I'm sure they know that people are looking for any reason to discredit their numbers.

[KCLarkin]

I assume current debt levels and covenants preclude repurchases, even if stock is underpriced?

[jay21]

I assume current debt levels and covenants preclude repurchases, even if stock is underpriced?

 

I would have to look at the stack but covenants are more prevalent in loans rather than bonds and aren't usually linked to market value of equity. Typical ones are Debt/EBITDA, interest coverage, debt ratings etc.

 

 

[Liberty]

So we have some confirmation of Pearson comments from an interview that they are probably not going to do anymore mispriced Marathon type deals. They also might sell or spin off that part of the business which can be interesting.  Probably hard to sell with the attention it's receiving so maybe it'll just be a spinoff that no one will want to own.

 

I like the flexibility. The way the media has been covering things without much context, I'm sure some people think that all that Valeant does is buy drugs and raise the price. But in fact, it was a relatively small portion of their business, a declining one, and they've always said that they want to go for durable products with growth and that this stuff isn't core, so this would be more of a tweak to the business model rather than a big change of direction. As Pearson said, out of the 150+ deals that they've made, only about a handful had to do with these "mispriced drugs".

 

I thought it sounded like they were more interested in spinning it off than selling it outright, but we'll see. They said it was likely something would happen in the next 12 months.

 

No commitment yet to a beefed up repurchase program. I'm a bit surprised by that, but they seem to get much better returns in their business that I can understand that decision.

 

They already have a $2bn buyback program approved, and to my ears, they were strongly hinting that they would do buybacks when the restricted period was over (if prices stay low). I think they phrased it the way they did because they weren't sure if today's Q would make the price jump up and reduce the buyback opportunity. Apparently not.

 

I assume current debt levels and covenants preclude repurchases, even if stock is underpriced?

 

It definitely sounded like they are not prevented from doing buybacks. They said that they are committed to bringing leverage to under 4x by the end of 2016, and that they wouldn't issue new debt, but that there would be capacity left over for M&A and/or buybacks.

 

If anyone wants the audio of the call: https://www.dropbox.com/s/m3i6cby4n8nn90m/2015-Q3-cc-VRX.m4a?dl=0

[Picasso]

In reality they don't have a lot of cash on the balance sheet to buyback significant amounts of stock.  They also want to bring down the debt burden but if the business is really durable, I don't understand why they want to retire debt yielding less than their current cost of new debt issuance.  They locked in low rates when the capital markets didn't care about all these new problems.  How much can they really pay down without losing the tax advantages of stripping out US earnings, etc?  Maybe I'm missing something here but I have a theory....

 

Sequoia had mentioned in one of their annual Q&A's that Valeant at 4x leverage was the very high end of what they would be comfortable investing in.  In talking with their investors, maybe Valeant was nudged a bit to keep leverage lower or risk losing their largest investor.  Hard to say, but I think the recent share volatility could have put pressure on Sequoia to put some pressure on Valeant.

 

Let's say they announce a new $5 billion repurchase agreement.  That's 5x more than what they have in cash, more than FCF in a year, and at the same time they're trying to retire some debt.  Even if they could pull it off, it's less than a 10% reduction of shares outstanding at the current price.  Not only are the largest shareholders pretty much unable to buy more shares, but Valeant can't buy much either.  And there isn't a ton of short interest for short sellers to buy in.  And if they're focused on repaying debt, then they aren't able to lever up and repurchase shares either.

 

But they don't need to repurchase shares.  I'm only curious about that comment since they were able to announce a repurchase during the Allergan fight and on a valuation comparison, the stock is less expensive now. 

 

Maybe Liberty is right about trying to time a buyback after the restriction period.  It's also probably better to see the market reaction to new disclosures and figure out how you want to approach any kind of major capital allocation decision.

[Liberty]

A lot of the leverage reduction will come from growth in EBITDA. Salix inventory will be mostly normalized next year and is growing fast, add to that the strong organic growth which seems to be mostly on rail from a lot of new products ramping up (Xifaxan, Ultra, biotrue, Jublia), and they don't have to retire much debt to get under 4x. When they mention the $7.5bn guidance now, they almost always mention that it's conservative and that they expect to exceed it. If they do 8bn or more of EBITDA, that brings down leverage to around 3.75x if debt stays the same.

 

I don't expect them to retire a gigantic amount of shares, but if they see it as the best ways to deploy capital, then they should do it. And if the stock stays at a low price for a while, maybe selling the neuro & other portfolio could raise cash to be redeployed to buyback at a larger scale (tender offer?)..

[rogermunibond]

So was the $286 million spent on Marathon worth it?  Neuroscience and Other unit is now a hot potato.

 

http://www.ft.com/intl/cms/s/0/afc6351e-766f-11e5-a95a-27d368e1ddf7.html

[Picasso]

Growth in EBITA seems to already be a big part of the reduction in leverage.  They also mentioned in their presentation an attempt to accelerate debt retirement.  $30 billion of debt with $7.5 billion of 2016 EBITA is 4x as it is.  If you strip out the 10% they might sell/spin then you might be looking at $6.8 billion of EBITA or 4.4x.  Add 10% growth and you're back at 4x.  I just don't see how the neuro/other gets sold at a high value to issue a tender or anything like that.  Valeant has all but said it's a toxic wastepool they no longer want to participate in and it brings down the multiple on the rest of their business.  By that virtue the multiple on a sale/spin should be very low.  I have a feeling that could be a fantastic investment if it's as hated if/when they get around to spinning it off.

 

Using their guidance leaves around $4 billion of free cash flow.  Unlevered free cash flow might be around $5.2 billion (net of adding back interest costs and taking out tax deductions of that interest stripping) which is say 6% on the enterprise value.  Either they have to issue stock (they state as undervalued) to do deals and delever but that's hard at these values, or they have a long slow slog ahead of them while they wait for their stock to give them a better currency.  In the meantime I would imagine you're giving the green light to hedge funds to continue shorting the stock because a big stock/debt deal becomes less likely.

 

I could see analysts nervous about the shift in business model.  Suddenly they are signaling more R&D spend without quantifying previous/future returns on their R&D.  Then they're moving away from Marathon type deals.  Plus they are unable to say much because of the government investigation.  And there's no floor on the stock from a repurchase program or a reason why this all might be clear to investors in the next year.  It's become a "show me" story and we know how much Wall St hates show me stories.  Just my guess but I'd expect some downgrades over the coming days, especially given the tone of analysts on the call.

[original mungerville]

I increased my position by 50% today.

[original mungerville]

I did not have time to listen to the conference call yet. But my guess regarding R&D spending increase is that that was happening anyway on account of buying Salix and Pearson is certainly not going to balloon R&D for no reason. So when he says increase R&D, be less reliant on price increases - (other than for the part of the biz they will sell) its already happening. So its good PR to say it, but if you are keeping your head, it doesn't change the overall biz strategy.

 

Do others agree with the above?

[Picasso]

He basically said on the call that the returns from R&D were vey good, so they're doing more. But they wouldn't quantify that. On a current run rate that might be $400-500 million a year.  It will still be a lot less than other pharma's as a percent of sales.

 

I was surprised that they cut off the analyst who started asking about the impact to EBITDA from the spinoff. They sure seemed eager to change the subject but maybe they were tight on time?  This is the only time to really address those key questions so that's a bit off putting for me.

[Liberty]

I did not have time to listen to the conference call yet. But my guess regarding R&D spending increase is that that was happening anyway on account of buying Salix and Pearson is certainly not going to balloon R&D for no reason. So when he says increase R&D, be less reliant on price increases - (other than for the part of the biz they will sell) its already happening. So its good PR to say it, but if you are keeping your head, it doesn't change the overall biz strategy.

 

Do others agree with the above?

 

For what it's worth, on the call they said that they had now proven to themselves that they could get good returns on their R&D approach (which is partly about using spare capacity at other labs rather than carrying the fixed costs themselves), which seems to have made them more comfortable in investing more. I think a few years ago, they probably weren't as sure and didn't have the capabilities they do now. A lot of good stuff has come out of Dow and B&L, and they are greenlighting pretty much everything Salix had in the pipeline. I don't think legacy Valeant, Biovail and Medicis were quite as effective as a R&D foundation, at the time... And of course, the optics of announcing more R&D are also appealing, but I don't think they would do it just for that reason if the ROI wasn't attractive.

 

I was surprised that they cut off the analyst who started asking about the impact to EBITDA from the spinoff. They sure seemed eager to change the subject but maybe they were tight on time?  This is the only time to really address those key questions so that's a bit off putting for me.

 

From memory, that was the second guy in a row to be asking 4 questions when they were close to the hour-and-a-half mark with other people left in the queue.. To me it just seemed like they wanted to give everybody a chance, but maybe you're right.

 

I wonder how much debt they could put on that spin-off... Probably not a ton, but at least some.