VRX - Valeant Pharmaceuticals International Inc.

[Picasso]

Maybe the best way to monetize the neuro/other is through a rights offering.  Give all shareholders the right to buy the asset directly from Valeant so that investors who want to participate have the ability to keep the asset.  At the same time you can load some debt on that company and send additional cash back to Valeant. 

 

I'm not sure how that would affect the performance grants for Pearson.

[original mungerville]

Thanks Liberty. My impression was that they were giving the green light to most of Salix's pipeline before this PR episode. Is that a fair statement? (And they also put money to work on R&D at B&L as you say...)

 

But is this some big shift given the PR environment or has this shift been happening already in the last year or so?

 

I believe its the latter - is that correct in your view?

[original mungerville]

Maybe the best way to monetize the neuro/other is through a rights offering.  Give all shareholders the right to buy the asset directly from Valeant so that investors who want to participate have the ability to keep the asset.  At the same time you can load some debt on that company and send additional cash back to Valeant. 

 

I'm not sure how that would affect the performance grants for Pearson.

 

I can't imagine the big investors (eg, Ackman, Sequoia, Value Act) wanting a spin-off and all the negative publicity that might come with that.  It will be interesting how they sell it. I think its probably a good move by the way - just get rid of it totally. I love the decision making lately.

[Picasso]

OM, what decisions are you liking?  They've done a complete 180 in such a short period of time.  Valeant bought Marathon in February of this year and it's caused the entire capital structure for the company to get destroyed.  For $386 million or so, it's probably the most expensive acquisition they're ever going to make.  Who knows what large deal they're losing out on as a result of the hit to the stock price.

 

Also strange response from Pearson when asked about Philidor.  Basically fumbled around and didn't answer anything regarding Philidor but rather specialty fulfillment in general:

 

Sure. It's really primarily our dermatology brands and then some of our specialty products like Ruconest, Arestin and some of the products that some of the other orphan drugs. For certain products it is quite larger, for Jublia it is probably 50%, for a lot of other dermatology it is much, much less. David, I am sorry I can't-- it's significant but I don't know the precise number but it is certainly of our US portfolio, so 10%, 20% maybe, maybe Tanya's nodding probably closer to 10%.

 

Weird considering there's stuff like this floating around:  http://sirf-online.org/2015/10/19/hidden-in-plain-sight-valeants-big-crazy-sort-of-secret-story/

 

I guess it's nice they're being pragmatic, but they're clearly making serious mistakes leading up to these new pragmatic decisions. 

[giofranchi]

They've done a complete 180 in such a short period of time.

 

Well, I guess when public sentiment goes so much against a certain kind of business, it could really change it from a good business some months ago into a bad business today… Probably, they didn’t expect it, but it has occurred… What’s wrong in changing your mind?! ???

 

Cheers,

 

Gio

 

[giofranchi]

So now VRX doesn’t only disclose organic growth on a quarterly basis, but it has also started disclosing how that organic growth is achieved: 8.2% volume + 4.4% price = 13% organic growth.

Even if you think price increases are completely unsustainable, we still get a very healthy 8% organic growth. No meaningful divestiture to take into consideration, therefore I guess organic growth due to volume alone is quite reliable. But let’s say VRX has the habit of presenting too rosy a scenario, and that organic growth is around 6% instead.

A 6% organic growth imo means that their overall “finite-lived intangible assets” are worth more than before, not less. They have declared $912 million in total adjustments, of which $683 million (75% of total adjustments) were amortization of intangible assets. Could someone explain why cash eps are not a good metric to value a pharma company which is able to grow organically?

 

Thank you,

 

Gio

 

[giofranchi]

Drug Makers Sidestep Barriers on Pricing

 

http://www.nytimes.com/2015/10/20/business/drug-makers-sidestep-barriers-on-pricing.html?ref=health&_r=1

 

Cheers,

 

Gio

[original mungerville]

OM, what decisions are you liking?  They've done a complete 180 in such a short period of time.  Valeant bought Marathon in February of this year and it's caused the entire capital structure for the company to get destroyed.  For $386 million or so, it's probably the most expensive acquisition they're ever going to make.  Who knows what large deal they're losing out on as a result of the hit to the stock price.

 

Also strange response from Pearson when asked about Philidor.  Basically fumbled around and didn't answer anything regarding Philidor but rather specialty fulfillment in general:

 

Sure. It's really primarily our dermatology brands and then some of our specialty products like Ruconest, Arestin and some of the products that some of the other orphan drugs. For certain products it is quite larger, for Jublia it is probably 50%, for a lot of other dermatology it is much, much less. David, I am sorry I can't-- it's significant but I don't know the precise number but it is certainly of our US portfolio, so 10%, 20% maybe, maybe Tanya's nodding probably closer to 10%.

 

Weird considering there's stuff like this floating around:  http://sirf-online.org/2015/10/19/hidden-in-plain-sight-valeants-big-crazy-sort-of-secret-story/

 

I guess it's nice they're being pragmatic, but they're clearly making serious mistakes leading up to these new pragmatic decisions.

 

I don't see a 180 turn in the context of the overall business at all. Sure they are doing a 180 on part of the business, but my feeling is that the other changes (eg, increased R&D spend) were already well underway. I mean, their organic growth trajectory has changed dramatically for the better on the other 90% of the business over the last 12 months - ie since the Allergan drama. The addition of Salix is going to contribute a lot to organic growth. And investing in some R&D there seems to make a lot of sense. So I don't see a 180 for the overall business and strategy - just a progression. Also the Sprout acquisition has the potential to be a home-run.

 

Basically, excluding that 10% of the business, could you not argue that they are firing on all the major cylinders?

[giofranchi]

I mean, their organic growth trajectory has changed dramatically for the better on the other 90% of the business over the last 12 months - ie since the Allergan drama. The addition of Salix is going to contribute a lot to organic growth.

 

I agree.

And I would add that generally I am pleased seeing organic growth 2-3 percentage points above the rate of growth for the general economy... I suspect we are going to see organic growth at VRX much higher than that!

This being said, the market clearly disagrees right now... We will see.

 

Cheers,

 

Gio

[original mungerville]

Sure Marathon was a bad move - impacts P/E multiple, debt interest expense on overall company BUT look at Salix - they are expecting revenues for Q4 to accelerate to something like $600M versus $1.3 billion for all of 2015 (that is with the inventory still being worked off and so they emphasized that their projections are s conservative). Looks like the $14 billion spent is likely to turn out quite well as growth at Salix is very significant. I would think that Salix revenues for 2016 and 2017 are going to be through the roof.

[Guest Schwab711]

Cash taxes through 3Q15 are ~$90m vs. $10m in book taxes (against $80m GAAP net income). I think they will continue to repay DTLs considering how terribly EMs are doing (-15% QTD; -12% YTD).

 

Does anyone else find it frustrating that VRX doesn't release the BS and CFS on earnings release? $4.2b IPR&D is going to transfer to intangibles (IBS-D) so amortization charges are about to increase significantly. I believe nearly 100% of the growth in "Cash EPS" in 2016 is driven by the increase in amortization related to this balance transfer.

 

Edit: changed to intangibles

[flesh]

Starting to get interested at this price!

 

One thing I don't understand is why all of the long term holders here didn't sell at 230 plus?

 

Is it really possible to create such massive value is such a short period of time or did you think it

was simply ridiculously cheap at the beginning of the year?

 

Has anyone done any fcf estimates for 2016? Working on this now.

[ScottHall]

Starting to get interested at this price!

 

One thing I don't understand is why all of the long term holders here didn't sell at 230 plus?

 

Is it really possible to create such massive value is such a short period of time or did you think it

was simply ridiculously cheap at the beginning of the year?

 

I'm not as long term as most but I basically don't sell much these days. A company that is shrewd at making deals actually becomes more valuable at higher valuations and less valuable at lower ones; the market price isn't irrelevant in such circumstances.

 

As such, Valeant is worth less today based on its future expected cash flows than it was at $230. I'm still holding, may add more, but that is the reality. Value investors probably give too little credit to market pricing... it can be a very substantial component of value, in certain circumstances.

 

Taking the concept of Mr. Market too seriously can be as damaging as not taking it seriously enough.

[APG12]

Starting to get interested at this price!

 

One thing I don't understand is why all of the long term holders here didn't sell at 230 plus?

 

Is it really possible to create such massive value is such a short period of time or did you think it

was simply ridiculously cheap at the beginning of the year?

 

I'm not as long term as most but I basically don't sell much these days. A company that is shrewd at making deals actually becomes more valuable at higher valuations and less valuable at lower ones; the market price isn't irrelevant in such circumstances.

 

As such, Valeant is worth less today based on its future expected cash flows than it was at $230. I'm still holding, may add more, but that is the reality. Value investors probably give too little credit to market pricing... it can be a very substantial component of value, in certain circumstances.

 

Taking the concept of Mr. Market too seriously can be as damaging as not taking it seriously enough.

 

While I see what you're saying, there now exists the opportunity to repurchase shares.

[KCLarkin]

$4.2b IPR&D is going to transfer to intangibles (IBS-D) so amortization charges are about to increase significantly. I believe nearly 100% of the growth in "Cash EPS" in 2016 is driven by the increase in amortization related to this balance transfer.

 

I don't understand this logic. Cash EPS excludes amortization by definition.

[jay21]

Starting to get interested at this price!

 

One thing I don't understand is why all of the long term holders here didn't sell at 230 plus?

 

Is it really possible to create such massive value is such a short period of time or did you think it

was simply ridiculously cheap at the beginning of the year?

 

I'm not as long term as most but I basically don't sell much these days. A company that is shrewd at making deals actually becomes more valuable at higher valuations and less valuable at lower ones; the market price isn't irrelevant in such circumstances.

 

As such, Valeant is worth less today based on its future expected cash flows than it was at $230. I'm still holding, may add more, but that is the reality. Value investors probably give too little credit to market pricing... it can be a very substantial component of value, in certain circumstances.

 

Taking the concept of Mr. Market too seriously can be as damaging as not taking it seriously enough.

 

It's funny that some "platforms" are roll up machines b/c of an inflated stock price relative to comps rather than having a true business platform (e.g. distribution channel, scalable software, intellectual property, etc).

[Liberty]

It's funny that some "platforms" are roll up machines b/c of an inflated stock price relative to comps rather than having a true business platform (e.g. distribution channel, scalable software, intellectual property, etc).

 

That's true. But if you compare Valeant's revenue growth and share count increase over the years, you'll see that they are not one of those. And in their areas of focus (eye health, derm, GI), they definitely have advantages in scale/distribution (this is part of what makes the tuck-ins attractive -- you plug them in the larger system), on top of the tax and low SGA advantages.

 

What the low stock price prevents them from doing is big deals that they can't do with just FCF and debt, but they just did Salix less than a year ago, so it's not too bad to take a breather. In the meantime, they have other levers to pull. Organic growth and Salix inventory normalization should make them delever under 4x by the end of next year, and on top of that they'll have a few billions in FCF because most restructuring charges are gone, so they can use those for tuck-ins and/or buybacks and/or debt paydown. So double-digit organic growth plus a few percents from M&A and a lower share count should provide satisfactory returns even without a big deal (or if they pay down the debt, FCF will go up from lower interests). And at some point when things look better, a big deal will come.

 

If they get rid of the neuro & other portfolio, what they are left with are high quality assets with good growth and little controversy.

[Guest Schwab711]

$4.2b IPR&D is going to transfer to intangibles (IBS-D) so amortization charges are about to increase significantly. I believe nearly 100% of the growth in "Cash EPS" in 2016 is driven by the increase in amortization related to this balance transfer.

 

I don't understand this logic. Cash EPS excludes amortization by definition.

 

IPR&D is not amortized until it is converted to intangible assets. Cash EPS absolutely includes amortization...

 

https://www.sec.gov/Archives/edgar/data/885590/000119312515346156/d29357dex991.htm

[KCLarkin]

IPR&D is not amortized until it is converted to intangible assets. Cash EPS absolutely includes amortization...

 

By "includes" you mean that amortization is added back to GAAP EPS to get Cash EPS?

[Guest Schwab711]

IPR&D is not amortized until it is converted to intangible assets. Cash EPS absolutely includes amortization...

 

By "includes" you mean that amortization is added back to GAAP EPS to get Cash EPS?

 

Yes. In this instance I am using the phrase "Cash EPS" as Valeant defines it.

[Guest Schwab711]

Has anyone done any fcf estimates for 2016? Working on this now.

 

You should subtract average debt repayment from FCF given the industry. If it turns out that there is no competition for IBS-D in 2029 (as an example) then great, but it's not very conservative to assume so.

[Picasso]

Or just add back interest payments to 2016 free cash flow (should have been around $4 billion including interest payments) and compare it to the enterprise value.  Adding debt repayment is going to understate earnings.

[Guest Schwab711]

Or just add back interest payments to 2016 free cash flow (should have been around $4 billion including interest payments) and compare it to the enterprise value.  Adding debt repayment is going to understate earnings.

 

In theory, why would adding back debt repayment undervalue earnings for VRX? For VRX, the debt is equivalent to internal R&D for other major pharmas, which would be subtracted before you arrive at GAAP EPS.

[Picasso]

The debt isn't really equivalent to internal R&D, the debt was issued in exchange for a large amount of intangible assets producing a lot of cash flow.  For Valeant, they don't care how much it cost to develop something.  It could have cost $1 or $10 billion dollars.  All they care about is the cash flow coming from the acquisition price.  Now, the cost of servicing that debt will decrease your cash flow as the equity holder.  Because we're dealing with intangible assets you're looking at goodwill but that's not R&D.  R&D could have been a lot more or a lot less, who knows. 

 

If you take out debt repayment from earnings, well that's weird because if the earnings are durable what will earnings look like after they pay back all the debt?  In ten years you'll have a business generating a ridiculous amount of cash.  Now you have to discount that cash back to today and you can start to see why that's going to understate earnings.  Either way you end up with the same amounts of real cash flows (they could always relever and pay out a special dividend as an example), the difference is the timing of receiving them.  I don't think I've seen anyone try to value a stock by taking out debt repayments from earnings unless we're looking at a runoff situation.

 

What you can do is increase the cost of capital on the debt and see how earnings look if they issue debt at 8% instead of 6%.  But not all of the $30 billion will immediately cost 8%.  It's a rolling refinancing that will slowly increase their cost of capital.

 

Which is why I say it's easier to just add back in interest expense to free cash flow and compare it to the total enterprise value.  Right now I'm getting around a 7-8% yield on the levered equity (depending on the neuro/other spin), and 6-6.5% unlevered. 

 

But they can only take debt down so much without increasing their tax burden.  I've been wrong on some aspects of this calculation in the past so take what I say with a grain of salt. 

[flesh]

Okay, that's close to what I was getting. I'm looking to buy at 15x ntm fcf/ev....... it needs to come down another 10-15% from here.