VRX - Valeant Pharmaceuticals International Inc.

[alpha asset strategies]

Keep It Simple Stupid.

 

FFH in June 2006 was simple.  They would not have lost money in 2005 (including KRW losses) were it not for runoff.  You had Prem in the 2005 Annual Report in your hand, saying he expected runoff to turn the corner in 2006.  You could believe him, or not.  He might be off by a little on the runoff turnaround timeline, but to be off enough to sink the company he would need to be an outright liar.  And the insurance business itself is pretty boring.

 

 

This is an excellent point.  At this stage, I'd say evaluating VRX is anything but simple. 

 

 

[Mephistopheles]

Keep It Simple Stupid.

 

 

The more experience I gain, the more I realize how true this is. Buffett and Munger talk about having the right temperament being an advantage over everyone else. Well I think those who are willing to look at matters simply, from a 10,000 ft view also have an advantage. It's not as easy to do because we all get gratification from tearing apart 30 years of financial statements and putting together 200 page ppt presentations, but then you miss the forest for the trees. Of course, you have to have the ability to look through the 10-k for any red flags, but if what you see is too complicated, that's when Buffett and Munger immediately discard to the "too hard" pile, while many of us get a thrill from the challenge. Carl Icahn and Dave Tepper are great at this sort of thinking as well.

 

Just my two cents.

[LongHaul]

In reality the pharma business is simple. They sell a product and there there are costs and the net result is profit.  R&D hits in the future are another issue.  VRX was purposely made very complex so it was nearly impossible to figure out - you just had to trust mgmt.  There is no value in complexity. 

 

Good points about the headache annuals.  I remember trying to read Enron's annual a few times from 99-01 and I just couldn't figure out what they did or how the made money.       

[Oreo]

Every day Im reminded how treacherous this investing business is.......its not easy folks.

That is such bullshit. This wasn't hard. It had tons of signs of a bad ending: A torrent of M&A, lots of debt, lots of rumors of unethical behavior, very aggressive management, incentives for management to pump the stock price, lots of adjusted non gaap numbers, and every time you try to read a 10-k you get a splitting headache. If you see these things, it's easy to figure out the right thing to do as an investor - you stay away.

 

The people that got burnt on this didn't do investing. They joined a cult in which common sense is suspended driven by a combination of greed and hero worship. All you have to do is go back a couple of hundred pages on this thread to see it in all its glory. If anyone would say anything negative about VRX then you would have a chorus of people basically:

1. Keep repeating: Well Value Act and Sequoia are is so it must be great!

2. Parroting numbers from the management presentation without any reasonable analysis

3. Declaring: You don't get it man, Pearson is an outsider.

 

There are some things that are hard. This one wasn't!

 

What I find inexcusable is how everyone (*everyone*) ignored the cash flow statement. Quarter after quarter, cash flow failed to present itself. In the most recent conference call, Joseph Papa guided to $1.7b of free cash flow this year (miles below that most people expected). Anyone who was paying attention to the cash flow statement over the past few quarters (and basically ignoring the non-GAAP EPS guidance) would have seen this guidance coming from a mile away.

 

Similarly, anyone who properly weighted the significance of VRX coming up with chess-themed names for the specialty pharmacy entities would have known to stay out of a long position.

 

Even though there's a decent chance VRX is a zero, I would not go short here. Pharma is not a very rational space nowadays and there are players who can overpay for certain assets if VRX decided to sell those. And the implied vol on the put options is too expensive. Shorting Pershing Square (PSH) could be interesting, though.

[rb]

But if they stopped doing acquisitions their cash flow was supposed to go through the roof. ;)

[Oreo]

But if they stopped doing acquisitions their cash flow was supposed to go through the roof. ;)

 

Well, they kinda have stopped though. And yet FCF isn't there. At least not to the level that the bulls were forecasting even a short while ago.

[Oreo]

My records show VRX has not made a substantial M&A-linked payment ever since Oct-2015.

[rb]

Of course it didn't. It was a sarcastic comment, hence the little face. You're new here. Sorry don't mean to haze  8)

[valueinvestor82]

That's cute, Oreo. So $1.7 billion FCF is roughly a 20% yield on the current market cap. I see you've said positive things about AMZN, trading at 50x trailing 12 mo FCF. TELL ME MORE.

[Oreo]

And what about the debt? Which of the two businesses is more likely to refinance its debt (when it comes due) at a reasonable yield?

 

The 'leverage-effects value build to the equity-stub' generally works better in businesses where the market has a good & uncontroversial handle on what the total business's unlevered FCF yield (or multiple) should be like. In situations where that yield rises (or the market reprices the multiples down), the equity value build is non-existent or ephemeral.

 

And I don't get how you've come to interpret my AMZN post as an unequivocally positive opinion on that business.

[Picasso]

Sentiment on this thread is so bad that it makes me want to go long. It's such the polar opposite of the CoBF sentiment at $250+.

[petec]

Sentiment on this thread is so bad that it makes me want to go long. It's such the polar opposite of the CoBF sentiment at $250+.

 

Me too!

[blainehodder]

Sentiment on this thread is so bad that it makes me want to go long. It's such the polar opposite of the CoBF sentiment at $250+.

 

I went long again at 24. Last yr VRX was my biggest winner and I was on the long side. I'm taking the Citron approach though. This is a name I trade when sentiment is extremely negative, and as it rebounds I bring up the stops. "Value" investing isn't the only way to make money.

[Guest roark33]

There is also the craps table in Vegas....

[randomep]

<--------------------- look at my avatar

[Liberty]

http://www.reuters.com/article/us-valeant-lawsuit-whistleblower-idUSKCN0YV2F1

[Graham Osborn]

Sentiment on this thread is so bad that it makes me want to go long. It's such the polar opposite of the CoBF sentiment at $250+.

 

Even the best of us fall victim to this logic from time to time.  Look at Left (not saying he's the best of us but he certainly gives at least some weight to fundamentals) buying VRX before earnings though the fundamentalist in him knows the common might be worth zero.  If you are a technical trader (as so many sometime value investors now seem to be) go for it.  But if you are wrong, you will suffer the double indignity of being wrong both technically and fundamentally.  It hurts twice as much when you knew better ;)

[Graham Osborn]

Every day Im reminded how treacherous this investing business is.......its not easy folks.

That is such bullshit. This wasn't hard. It had tons of signs of a bad ending: A torrent of M&A, lots of debt, lots of rumors of unethical behavior, very aggressive management, incentives for management to pump the stock price, lots of adjusted non gaap numbers, and every time you try to read a 10-k you get a splitting headache. If you see these things, it's easy to figure out the right thing to do as an investor - you stay away.

 

The people that got burnt on this didn't do investing. They joined a cult in which common sense is suspended driven by a combination of greed and hero worship. All you have to do is go back a couple of hundred pages on this thread to see it in all its glory. If anyone would say anything negative about VRX then you would have a chorus of people basically:

1. Keep repeating: Well Value Act and Sequoia are is so it must be great!

2. Parroting numbers from the management presentation without any reasonable analysis

3. Declaring: You don't get it man, Pearson is an outsider.

 

There are some things that are hard. This one wasn't!

 

What I find inexcusable is how everyone (*everyone*) ignored the cash flow statement. Quarter after quarter, cash flow failed to present itself. In the most recent conference call, Joseph Papa guided to $1.7b of free cash flow this year (miles below that most people expected). Anyone who was paying attention to the cash flow statement over the past few quarters (and basically ignoring the non-GAAP EPS guidance) would have seen this guidance coming from a mile away.

 

Similarly, anyone who properly weighted the significance of VRX coming up with chess-themed names for the specialty pharmacy entities would have known to stay out of a long position.

 

Even though there's a decent chance VRX is a zero, I would not go short here. Pharma is not a very rational space nowadays and there are players who can overpay for certain assets if VRX decided to sell those. And the implied vol on the put options is too expensive. Shorting Pershing Square (PSH) could be interesting, though.

 

This Oreo dude is one smart cookie :) Oreo, what's your opinion on AGN?  If your opinion doesn't start with "if the Teva deal goes through" you will have earned my respect

[Picasso]

Sentiment on this thread is so bad that it makes me want to go long. It's such the polar opposite of the CoBF sentiment at $250+.

 

Even the best of us fall victim to this logic from time to time.  Look at Left (not saying he's the best of us but he certainly gives at least some weight to fundamentals) buying VRX before earnings though the fundamentalist in him knows the common might be worth zero.  If you are a technical trader (as so many sometime value investors now seem to be) go for it.  But if you are wrong, you will suffer the double indignity of being wrong both technically and fundamentally.  It hurts twice as much when you knew better ;)

 

I'd have to go back and find it, but I had a similar response when I said I wanted to short VRX because of the sentiment on the thread.  The stock was 10x higher than it is today.

 

In some ways there's a pretty compelling case to go long the stock here.  I'll list some of them.

 

1) The auditors have given their blessings and they're filing on time again

2) The debt, while a lot, is already in place and you're getting a levered equity stub at 4x FCF. 

3) That debt is still trading at low to mid 80's.  The bonds stopped going down, unlike the equity.  And there aren't any big debt walls coming up for a couple years.

4) There are several ways to do some financial engineering. 

5) If a manager owns the stock, it's like giving the rest of their portfolio full blown AIDS.  You just can't own it.  The only guy willing to say he's buying it is the same guy (Bill Miller) who gets away with owning Bitcoin or Intrexon or airline stocks.  You can count the guys who are able to own this stock at the end of a quarter on one hand.

6) They seem to have the most reoccurring one-time items that I've ever seen, but it does seem like you're getting most of them over with in 2016.  You could very likely see some big FCF growth in 2017 versus 2016.  Sure, it can start declining after 2017 again from all the amortization costs that start becoming real, but how would the stock react to 50% YoY increases in FCF?  It'd probably go up a lot.

7) Negative news seems to be having less impact on the share price.  A lot of this stuff is getting baked in.

 

Not that I'm long or plan to buy, but it does seem like it's probably a bit oversold and those reasons give it a good setup to buy into 2017.  The rest of the bear case to short at $25 will probably take a few years to play out.  This won't go down to $10 or $0 immediately (famous last words). 

 

What exactly is the bear case at $25 and how quickly is the stock supposed to go down on that?  Is anyone shorting hoping it goes to 2x FCF and then FCF ends up dropping a ton, they breach covenants again, etc?  I only ask because it seems like 99% of all the crazy bearish things already played out.  We know Pearson is a liar, Philidor did all this rampant insurance fraud, they jacked up prices, you name it.  What else is the market supposed to figure out that hasn't already been priced in over the next few years?

[Graham Osborn]

By the way, I made an error when I said FCF after acquisitions and purchase of intangibles/ IPR&D was the best way to assess cash flow for AGN/ VRX/ ENDP.  If you really want to understand what gave Pearson and Saunders grey hair, you need to calculate "levered" FCF after acquisitions and intangibles/ IPR&D.  That means you need to deduct the cost of debt service as well since you hold the equity.  This is a business that literally chews up capital..

[Guest roark33]

Check out this interview from Pearson right after the Walgreens deal was done: http://www.cnbc.com/2015/12/15/valeant-strikes-distribution-deal-with-walgreens.html

 

The lies here are quite epic.  The funny thing is the short thesis regarding Walgreens was immediately evident, written up on VIC right after the deal was signed. 

[Guest roark33]

Not that I think it's a good short, but to make the "not a long" case, I think the best case is that the most profitable drugs are at risk of continued decline in the very near future. 

 

Isuprel and Nitropress both lose patents this year, Glumetza fell from #3 on revenue list to off the Top 30.  Isuprel and Nitropress alone make up about 15% of their Ebita number, so you can see why they have yet to give those 30% discounts.  When those profits go away, they trip the ebitda covenants on the debt in 2017-ish or sooner.  They would have already tripped them this year, hence the delay in the 10-K as a cover to amended the interest coverage covenants. 

 

 

[Graham Osborn]

I'd have to go back and find it, but I had a similar response when I said I wanted to short VRX because of the sentiment on the thread.  The stock was 10x higher than it is today.

 

What exactly is the bear case at $25 and how quickly is the stock supposed to go down on that?  Is anyone shorting hoping it goes to 2x FCF and then FCF ends up dropping a ton, they breach covenants again, etc?  I only ask because it seems like 99% of all the crazy bearish things already played out.  We know Pearson is a liar, Philidor did all this rampant insurance fraud, they jacked up prices, you name it.  What else is the market supposed to figure out that hasn't already been priced in over the next few years?

 

There are 3 major classes of contrarians:

 

Class III) do the opposite of what everyone else is doing - loses money by definiton

Class I) do what everyone else will be doing in the future, but currently is not doing - loses or makes money depending on accuracy of prediction

Class II) do what everyone else used to be doing but is no longer doing on the premise herd behavior will revert to the mean - tends to make money for long periods with intermittent, huge losses

 

Your proposal falls in Class II based on my assessment of your depth of analysis.  My recommendation is to do an analysis of levered FCF after acquisitions etc if you want to understand the liquidity problems with the business model.  If you want to know how bad things can get, look at Worldcom.  Why wasn't Worldcom able to rescue itself through asset sales?  Because the market was bear and there was no liquidity.  Funny how that tends to happen at the worst possible moment.  Welcome to the next few years.

[Oreo]

Many ways to make (and lose) money in the markets. I guess the question boils down to: when is it okay to put on a position that runs against your long-term fundamental view of the business (or even of the specific security in the capital structure)?

[Guest roark33]

Ackman pushed his options out until 2019 (they were previously set to expire in Jan 2017).  The thesis creep is strong here.  I think the initial reaction was that Citron was blowing smoke and when the smoke cleared, the valuation gap would close.  Now, the thesis is that there is some value (there was a fire), but Ackman thinks he can put the fire out and unlock the value over time, i.e. before 2019. 

 

https://www.sec.gov/Archives/edgar/data/885590/000119312516619164/d196271dsc13da.htm

 

I honestly think the biggest lesson from this is that you need to know your thesis going in and if it "breaks", you need to sell.  Admit you were wrong and take your losses.