VRX - Valeant Pharmaceuticals International Inc.

[giofranchi]

Alex Arfaei - BMO Capital Markets U.S.

Could you provide more details on how you achieved the cost savings with Bausch + Lomb? You mentioned you didn't [indiscernible] the sales force. So what did you cut? And, Howard, could you provide more details on the opportunity to improve the Bausch + Lomb manufacturing cost to achieve your goal of approaching 80% for gross margins?

 

J. Michael Pearson

Sure. So for B+L, the cuts came in, in a number of places. First, they had a corporate headquarters and we had a corporate headquarters, and we didn't need both. Second, they had regional offices. They had a large office in Switzerland, for example, and 3 regional offices in the U.S. for each of their 3 businesses, the vision care, the surgery and the pharmaceutical business. We didn't need any of those. And then they had a very decent -- they had a model, it was a centralized model, that in each country, for example, in the U.K., they had 3 general managers, 1 right in each of their different businesses. And that each of those general managers had a staff and a marketing department, and a finance department, et cetera, et cetera. So what we have done is combine those all into an eye health group in each of the different countries and in the U.S. So what we really -- most of the savings came through taking out management layers, and as we've mentioned, people that are not touching the customer. B+L had the exact same structure as Allergan has in terms of if you go to the countries in Europe, there'll be 3 general managers. And our European team is -- come back and we figured out the synergies bottoms up, and that's why we view the Bausch + Lomb acquisition pretty much as a blueprint to what we would do with Allergan, and why we're confident that we can maintain and perhaps even accelerate growth while taking these costs out.

--Q1 2014 Conference Call

 

Could someone explain to me what’s not rational about this? ;)

 

Gio

 

 

 

[giofranchi]

Valeant Pharmaceuticals Responds to Allergan's Rejection of Merger Proposal

 

http://ir.valeant.com:80/investor-relations/news-releases/news-release-details/2014/Valeant-Pharmaceuticals-Responds-to-Allergans-Rejection-of-Merger-Proposal/default.aspx

 

 

Gio

[vinod1]

Fat Pitch,

 

In my own estimates, I did try to factor for the fact that some of the amortization expense might be true economic depreciation due to obsolescence of existing products as competitors bring up newer products. IMO, this is much smaller than your estimates as only a small portion of Valeant's products are exposed to this risk - mostly pharmaceutical products and maybe some ointments.

 

I assumed that roughly 30% of products have this risk and that the life of the products would be about 30 years.  So economic depreciation in this case is about 1% of sales or about $80 million.

 

Gio,

 

There is only one reason why amortization of goodwill might be a true cost: Mr. Pearson has paid too much for the businesses VRX has acquired.

 

Most of the products that Valeant buys do indeed have consumer goods type product lives but some of the pharma and ointments do indeed become obsolete over time. That does not mean Valeant has overpaid. They would have made good money on the products before they expire.

 

Except for a few exceptional drugs, most would be replaced by others as other companies (mostly irrationally and wastefully spend on R&D) come up with new drugs. How many drugs are the same from say 1970s or 1980s? Valeant, thankfully, does not waste money on long shot R&D but it does mean that some of its products would expire at some point of time. This is economic depreciation that needs to be accounted for. It might be too small to worry about but I do not think it is something one can completely ignore.

 

As I mentioned above, my own guesstimate is about $80 million - Valeant probably increases its earning power by this much in a quarter or with one small acquisition - so one can rationally argue that it is nothing to worry about.

 

Vinod

 

 

[giofranchi]

Most of the products that Valeant buys do indeed have consumer goods type product lives but some of the pharma and ointments do indeed become obsolete over time. That does not mean Valeant has overpaid. They would have made good money on the products before they expire.

 

Except for a few exceptional drugs, most would be replaced by others as other companies (mostly irrationally and wastefully spend on R&D) come up with new drugs. How many drugs are the same from say 1970s or 1980s? Valeant, thankfully, does not waste money on long shot R&D but it does mean that some of its products would expire at some point of time. This is economic depreciation that needs to be accounted for. It might be too small to worry about but I do not think it is something one can completely ignore.

 

Well, but goodwill is not what you paid for a drug… Goodwill is what you paid for a company! (In excess of BV, of course!)

What truly matters is: does the value of that company, even if some patents of its inevitably expire, increase over time? Or does its value decrease?

If it keeps increasing, don’t worry about goodwill.

 

Gio

 

[vinod1]

Gio,

 

To me, Adjusted cash earnings are a good way to assess the performance of the management but it is not the same as owner's earnings which is what we should be thinking about as owners.

 

There are three items that need adjustment IMO to get to owner's earnings

 

1. Litigation expenses. In the health care field, litigation is to be expected and these are real expenses that would be incurred every year. So some sort of normalized litigation expenses should be deducted from cash EPS.

 

2. As I mentioned obsolescence of existing products would need to be accounted for as some of Valeant's products do indeed become obsolete.

 

3. Restructuring costs are indeed an investment but that only means they need to be capitalized and depreciated.

 

Vinod

 

 

 

[vinod1]

Most of the products that Valeant buys do indeed have consumer goods type product lives but some of the pharma and ointments do indeed become obsolete over time. That does not mean Valeant has overpaid. They would have made good money on the products before they expire.

 

Except for a few exceptional drugs, most would be replaced by others as other companies (mostly irrationally and wastefully spend on R&D) come up with new drugs. How many drugs are the same from say 1970s or 1980s? Valeant, thankfully, does not waste money on long shot R&D but it does mean that some of its products would expire at some point of time. This is economic depreciation that needs to be accounted for. It might be too small to worry about but I do not think it is something one can completely ignore.

 

Well, but goodwill is not what you paid for a drug… Goodwill is what you paid for a company! (In excess of BV, of course!)

What truly matters is: does the value of that company, even if some patents of its inevitably expire, increase over time? Or does its value decrease?

If it keeps increasing, don’t worry about goodwill.

 

Gio

 

I understand that. Let me explain in a different way to see if it makes sense.

 

Valeant buys companies as part of its normal course of business. If you take a step down, it is buying rights the to manufacture and sell products. Some of the products expire or they do not turn out to be as successful as expected and they need to take an impairment charge. In both these cases there is a real expense that had been incurred and owner's earnings would need to be decreased to account for this. I am not worried about how much goodwill is on the books, I am talking about economic depreciation.

 

A bank writes 100 loans and it expects to say write off 1-2 loans completely. For these loans they make a credit loss provision and then write it off as an expense. Valeant to me is doing the same thing buying products. To me it would not make sense to say well the bank made money overall so let us not count the 2 loans on which we lost money.

 

Vinod

[giofranchi]

Gio,

 

To me, Adjusted cash earnings are a good way to assess the performance of the management but it is not the same as owner's earnings which is what we should be thinking about as owners.

 

There are three items that need adjustment IMO to get to owner's earnings

 

1. Litigation expenses. In the health care field, litigation is to be expected and these are real expenses that would be incurred every year. So some sort of normalized litigation expenses should be deducted from cash EPS.

 

2. As I mentioned obsolescence of existing products would need to be accounted for as some of Valeant's products do indeed become obsolete.

 

3. Restructuring costs are indeed an investment but that only means they need to be capitalized and depreciated.

 

Vinod

 

Vinod,

 

1. Only legal expenses tied to acquisition and restructuring of purchased businesses are added back to GAAP earnings to calculate Cash EPS. Legal expenses tied to any other sort of litigation certainly are not.

 

2. I am not sure I understand what you mean: if cash flow increases over time, I don’t care where it comes from (if from old or new products).

 

3. Maybe this is right. But Cash EPS are supposed to represent the cash flow per share generated in a steady state. Steady state, therefore no restructuring, therefore no restructuring costs to be capitalized and depreciated.

 

Gio

 

[vinod1]

Gio,

 

To me, Adjusted cash earnings are a good way to assess the performance of the management but it is not the same as owner's earnings which is what we should be thinking about as owners.

 

There are three items that need adjustment IMO to get to owner's earnings

 

1. Litigation expenses. In the health care field, litigation is to be expected and these are real expenses that would be incurred every year. So some sort of normalized litigation expenses should be deducted from cash EPS.

 

2. As I mentioned obsolescence of existing products would need to be accounted for as some of Valeant's products do indeed become obsolete.

 

3. Restructuring costs are indeed an investment but that only means they need to be capitalized and depreciated.

 

Vinod

 

Vinod,

 

1. Only legal expenses tied to acquisition and restructuring of purchased businesses are added back to GAAP earnings to calculate Cash EPS. Legal expenses tied to any other sort of litigation certainly are not.

 

2. I am not sure I understand what you mean: if cash flow increases over time, I don’t care where it comes from (if from old or new products).

 

3. Maybe this is right. But Cash EPS are supposed to represent the cash flow per share generated in a steady state. Steady state, therefore no restructuring, therefore no restructuring costs to be capitalized and depreciated.

 

 

Gio

 

Gio,

 

1. Only legal expenses tied to acquisition and restructuring of purchased businesses are added back to GAAP earnings to calculate Cash EPS. Legal expenses tied to any other sort of litigation certainly are not.

 

I did not realize that. Then what you say makes sense.

 

2. I am not sure I understand what you mean: if cash flow increases over time, I don’t care where it comes from (if from old or new products).

 

Ok. I think I understand where we differ. I am assuming that given long enough time cash flows would decrease over time (very very slowly) as products expire and the remaining would not be able to make up for the lost revenue.

 

3. Maybe this is right. But Cash EPS are supposed to represent the cash flow per share generated in a steady state. Steady state, therefore no restructuring, therefore no restructuring costs to be capitalized and depreciated.

 

I would think restructuring would be an ongoing activity in a company like Valeant even if they stopped making acquisitions.

 

Thanks

 

Vinod

[Fat Pitch]

I guess the biggest question with Valeant is how long is the shelf life of their durable products? For example, if Valeant paid x amount for CeraVe will the value of CeraVe still be x 20years from now or will it be higher or lower? If it is higher then that will be a most outstanding outcome. The most likely result is it might be lower due to lower cash flows. This difference from the original purchase price to what it is worth in the future is a cost that needs to be accounted for and it seems no one here is taking that into account.

 

For the record I think Pearson is doing something magically here, but I’m just trying to understand the numbers. I am highly skeptical they are buying See’s Candies type products that they can sell with little formula adjustments 50 years from now. The purchase price of these products must be charged against free cash flow. Any prudent investor has to ponder this question since the purchase of these products is being financed by debt, and this money will need to get paid back in the future.

 

If these products turn out to be everlasting franchises with increasing mindshare in the emerging markets then we are witnessing another P&G in the making… but I like to handicap my odds ;)

 

[giofranchi]

Gio,

 

1. Only legal expenses tied to acquisition and restructuring of purchased businesses are added back to GAAP earnings to calculate Cash EPS. Legal expenses tied to any other sort of litigation certainly are not.

 

I did not realize that. Then what you say makes sense.

 

Actually, this should be checked out!

Basically I have always read statements like this one from Q1 2014:

expense related to a settlement of a preexisting relationship with respect to the acquisition of Solta Medical

It makes sense, but I cannot be sure how legal expenses are accounted for.

 

Gio

 

[giofranchi]

If these products turn out to be everlasting franchises with increasing mindshare in the emerging markets then we are witnessing another P&G in the making… but I like to handicap my odds ;)

 

They are constantly introducing new products into the market… Also in the last conference call this comes out very clearly... Old ones don’t need to be “everlasting franchises” in order for cash flow to keep growing. ;)

 

Gio

 

[giofranchi]

Legal Costs

Legal fees and other costs related to litigation and other legal proceedings are expensed as incurred and included in selling, general and administrative expenses. Legal costs expensed are reported net of expected insurance recoveries. A claim for insurance recovery is recognized when the claim becomes probable of realization.

--10-K 2013

 

For the three months ended March 31, 2014 other income/(expense) of $43.3 million primarily relates to the reversal of the AntiGrippin ® litigation reserve, $50.0 million, partially offset by $5.6 million expense related to a settlement of a preexisting relationship with respect to the acquisition of Solta Medical.

--8-K Q1 2014

 

It seems to me that legal expenses and related fees are expensed as incurred and included in selling, general and administrative expenses.

Then, expenses that are considered one time item (either related to acquisitions or not) are added back, or subtracted from, GAAP EPS to calculate Cash EPS. Actually, in Q1 2014 $48.8 million of a favorable development in legal expenses, evidently considered a one time item, were subtracted from GAAP EPS to get to Cash EPS.

 

Gio

 

 

 

[PJM]

Interesting to see that many value investors such as Lou Simpson, Wallace Weitz, Ruanne Cunniff etc has trimmed VRX position while hedge funds such as Paulson, Soros, Loeb etc have got on board VRX in Q1.

[giofranchi]

Interesting to see that many value investors such as Lou Simpson, Wallace Weitz, Ruanne Cunniff etc has trimmed VRX position while hedge funds such as Paulson, Soros, Loeb etc have got on board VRX in Q1.

 

Imo VRX today is a sort of “special event” investment: exactly the sort of thing which attracts people like Paulson and Loeb. Because, if it succeeds in buying Allergan, it will be worth a lot more.

Trimming a position, instead, might just be a portfolio management choice: VRX has performed very well until recently… no wonder it has grown into a disproportionately large position in many portfolios which owned it.

I myself was trimming my firm’s position in VRX, until it announced its intention of buying Allergan. Then I got back in for the potential handsome upside if the deal goes through.

 

Gio

 

[peter1234]

He who shall not be named is short...

 

We don't usually traffic in large-­‐cap shorts, and we don't usually disclose our shorts whilst they are still live. However we have spent considerable time trying to work out Valeant – a 50 billion dollar North American pharmaceutical roll-­‐up. We find their accounts difficult to comprehend – which is not to say that they are incorrectly stated, just complicated by many acquisitions. We have initiated a short position.

 

;)

[Guest wellmont]

Interesting to see that many value investors such as Lou Simpson, Wallace Weitz, Ruanne Cunniff etc has trimmed VRX position while hedge funds such as Paulson, Soros, Loeb etc have got on board VRX in Q1.

 

ruanne cunniff sold .26% of their shares.  ;) chris davis bought over 2m last quarter.

[wbr]

Interesting to see that many value investors such as Lou Simpson, Wallace Weitz, Ruanne Cunniff etc has trimmed VRX position while hedge funds such as Paulson, Soros, Loeb etc have got on board VRX in Q1.

 

ruanne cunniff sold .26% of their shares.  ;) chris davis bought over 2m last quarter.

 

The tiger cubs combined bought easily more than 5 million shares even though it was already one of the biggest positions for most of them. You rarely see a company with such a stellar past stock performance where the funds just keep adding on the way up, because the the stock price cant keep up with intrinsic value.

[bmichaud]

Risk-off market + AGN deal uncertainty + Chanos = Fantastic buying opportunity  8)

[wbr]

Risk-off market + AGN deal uncertainty + Chanos = Fantastic buying opportunity  8)

 

Indeed. Chanos' short thesis was a joke and was already debunked by Ackman's presentation, but people are going to follow him anyway, because he's famous and stuff...Does anybody actually know his track record? For the media he will always be the guy who was right on Enron no matter how his long term performance looks like.

[Fat Pitch]

Allergan is very skeptical about Valeant’s business model and thus using its stock as currency is going to be a tough sell. Too many people are attacking the "nonexistent" organic growth over at Valeant. Management needs to break out the sales of each of their product since acquisition to show their business model really works. It is really easy to show same store growth when you layer on new acquisitions that paper over declines in older products.

 

I wonder how much of Allergan’s shareholder base has turned over in the past few weeks? There must be a material amount of arbs and special events traders involved and will probably want a deal of some sort.

 

[Guest wellmont]

allergan is simply posturing. the business "model" they decry has increased shareholder value by 8x in a few years. allergan have no real defense. so they are attacking vrx. but the allergan shareholders will decide; not the entrenched management and bod. I think they are just trying to raise the price, which is what they should be doing. they will kiss and make up once they close the deal and negotiate their golden parachutes.

[Liberty]

Allergan is very skeptical about Valeant’s business model and thus using its stock as currency is going to be a tough sell. Too many people are attacking the "nonexistent" organic growth over at Valeant. Management needs to break out the sales of each of their product since acquisition to show their business model really works. It is really easy to show same store growth when you layer on new acquisitions that paper over declines in older products.

 

I wonder how much of Allergan’s shareholder base has turned over in the past few weeks? There must be a material amount of arbs and special events traders involved and will probably want a deal of some sort.

 

When the bid was announced, they said that VRX and AGN had an overlap of 50% in shareholders without counting Ackman's 10%. Using the stock as currency shouldn't be that hard a sell for the shareholders since so many of them already own it.

[fareastwarriors]

Short-Seller Chanos Turns Attention to Valeant

 

 

 

http://dealbook.nytimes.com/2014/05/16/short-seller-chanos-turns-attention-to-valeant/?module=BlogPost-Title&version=Blog Main&contentCollection=Hedge Funds&action=Click&pgtype=Blogs&region=Body

[loganc]

Allergan is very skeptical about Valeant’s business model and thus using its stock as currency is going to be a tough sell. Too many people are attacking the "nonexistent" organic growth over at Valeant. Management needs to break out the sales of each of their product since acquisition to show their business model really works. It is really easy to show same store growth when you layer on new acquisitions that paper over declines in older products.

 

Valeant does provide this information - check the 2Q13 and 3Q12 earnings slide decks.  I am sure they will provide similar disclosure this year in 2Q/3Q but likely earlier to facilitate the AGN deal. 

[giofranchi]

Ackman says Pyott has crippling conflict of interest in merger talks - 10:50 AM

•In a letter to Lead Director Michael R. Gallagher, Hedge fund honcho and owner of ~10% of Allergan (AGN +0.1%) Bill Ackman says Chairman and CEO David Pyott has a disabling conflict of interest standing in the way of progress in the merger negotiations. He asserts that Mr. Pyott cannot independently represent Allergan in considering Valeant's (VRX +0.1%) bid because he will lose his job if the deal goes through.

•He says the AGN board erred in not meeting with VRX management before rejecting its offer and designating Mr. Pyott as the only member of the BOD authorized to speak with shareholders. He accuses Mr. Pyott of acting improperly by criticizing both VRX and Pershing Square in meetings with institutional shareholders.

•Mr. Ackman believes that a majority of AGN shareholders favor the deal.

 

 

Gio