VRX - Valeant Pharmaceuticals International Inc.

[Liberty]

I'd have to look up if they added back the intangibles on Zovirax and such transactions, I don't know off the top of my head, but it's still a small part of their business so even if they have, we're talking about a few percents difference, as 80-85% isn't declining, and the real economics of those runoff transactions on a cash basis are still very attractive even if they were to distort cash EPS. The runoff part should be looked at on a DCF basis anyway, and only the rest of the business should be valued based on multiples.

 

The way Valeant looks at things, when they acquire an asset, they add up the cost of the asset + the cost of getting all the synergies, and if they can't get 20% on that at statutory tax rates without taking into account anything from the pipeline, they won't do the deal. And once it's done, they keep tracking it basically forever. And they probably have a different model for the declining assets that still aims for that 20% IRR. Management only optimizes for cashflow, not for GAAP EPS or adjusted cash EPS or whatever (I don't think cash EPS is perfect, just better than GAAP EPS in this case). That's all just to give you an idea of what the business could earn on a steady state, but it's not going to be steady, so that's kind of moot. Nobody said this was easy to value. The fact that they are on track or above their models on pretty much all of their deal models on a cash flow basis and that they have good growth on the durable part is good enough for me.

[biaggio]

Don t know what chances of merger are. Would want that as a free option.

 

I would have rather invested 6 years ago when revenue was  $843 million and total liability was $484 million.

 

versus today $6.6 billion and almost $23 b in total debt

 

At $6.6 billion in sales not earnings, and EV of almost $60b you are paying almost 10 x sales. That seems expensive too me not very cheap.

 

Hi biaggio!

Do you remember when we talked about SBUX at the FFH AM last April? You said SBUX probably has always been overvalued. I replied that, having gone from let’s say $5 billion in market cap to $100 billion in more or less 15 years, there must surely have been a lot of times when SBUX was actually very cheap!

The same imo is true for VRX… if, and only if, Mr. Pearson’s business model is so effective in eliminating wasteful R&D costs, as I believe it finally will prove to be.

There is simply no way to get around this thing: if Mr. Pearson is right, VRX is cheap; if Mr. Pearson is wrong, VRX is expensive.

 

Gio

 

I do remember our conversation re SBUX while waiting in that huge line up for coffee.

 

I have a problem paying up for quality---something I am working on and would like to change.

 

I am open to change my mind again.

 

I would feel better if VRX was a lot smaller and not so much debt.

 

Interesting that Professor Porter likes VRX business.

 

Will be interesting to see how things work out. Hope this thread continues as the story evolves.

[lu_hawk]

I'd have to look up if they added back the intangibles on Zovirax and such transactions, I don't know off the top of my head, but it's still a small part of their business so even if they have, we're talking about a few percents difference, as 80-85% isn't declining, and the real economics of those runoff transactions on a cash basis are still very attractive even if they were to distort cash EPS. The runoff part should be looked at on a DCF basis anyway, and only the rest of the business should be valued based on multiples.

 

The way Valeant looks at things, when they acquire an asset, they add up the cost of the asset + the cost of getting all the synergies, and if they can't get 20% on that at statutory tax rates without taking into account anything from the pipeline, they won't do the deal. And once it's done, they keep tracking it basically forever. And they probably have a different model for the declining assets that still aims for that 20% IRR. Management only optimizes for cashflow, not for GAAP EPS or adjusted cash EPS or whatever (I don't think cash EPS is perfect, just better than GAAP EPS in this case). That's all just to give you an idea of what the business could earn on a steady state, but it's not going to be steady, so that's kind of moot. Nobody said this was easy to value. The fact that they are on track or above their models on pretty much all of their deal models on a cash flow basis and that they have good growth on the durable part is good enough for me.

 

You don't have to look.  They add back all amortization of finite-lived intangibles when calculating "cash earnings."  It's the largest adjustment to get to cash earnings, on pace to exceed $1bn for this year.

 

Your second paragraph is just a story you are telling so you can accept something that is obviously absurd.

 

VRX is telling you that their profit is equal to the cash produced from an asset.  I.e., if I buy a stock for $10 and sell it for $8, then I am telling you that my PROFIT is $8, and you believe me.  No story will allow this to make sense.  You wouldn't believe that even if it were Buffett telling you, why believe it when Pearson says it is true?

 

At the very least, you'd have to deduct finite-lived intangibles for the result to be non-absurd.  If you do that then Q1 earnings were $130mm, a far cry from the $493mm cash earnings they reported.

 

The reason this is important: if I borrow $1 to buy an asset that produces a total of $1 in income then I haven't done anything.  I've only broken even.  When I settle things, I use the $1 in earnings to pay back the $1 of debt, and that is it because the asset has totally depleted.  My company isn't worth anything because it started at zero and the acquisition creates no value.

 

But VRX has convinced you that they are actually now worth $20, because the asset produced $1 in "cash earnings" and you are ascribing a 20x multiple to that.

 

 

 

[loganc]

I'd have to look up if they added back the intangibles on Zovirax and such transactions, I don't know off the top of my head, but it's still a small part of their business so even if they have, we're talking about a few percents difference, as 80-85% isn't declining, and the real economics of those runoff transactions on a cash basis are still very attractive even if they were to distort cash EPS. The runoff part should be looked at on a DCF basis anyway, and only the rest of the business should be valued based on multiples.

 

The way Valeant looks at things, when they acquire an asset, they add up the cost of the asset + the cost of getting all the synergies, and if they can't get 20% on that at statutory tax rates without taking into account anything from the pipeline, they won't do the deal. And once it's done, they keep tracking it basically forever. And they probably have a different model for the declining assets that still aims for that 20% IRR. Management only optimizes for cashflow, not for GAAP EPS or adjusted cash EPS or whatever (I don't think cash EPS is perfect, just better than GAAP EPS in this case). That's all just to give you an idea of what the business could earn on a steady state, but it's not going to be steady, so that's kind of moot. Nobody said this was easy to value. The fact that they are on track or above their models on pretty much all of their deal models on a cash flow basis and that they have good growth on the durable part is good enough for me.

 

You don't have to look.  They add back all amortization of finite-lived intangibles when calculating "cash earnings."  It's the largest adjustment to get to cash earnings, on pace to exceed $1bn for this year.

 

Your second paragraph is just a story you are telling so you can accept something that is obviously absurd.

 

VRX is telling you that their profit is equal to the cash produced from an asset.  I.e., if I buy a stock for $10 and sell it for $8, then I am telling you that my PROFIT is $8, and you believe me.  No story will allow this to make sense.  You wouldn't believe that even if it were Buffett telling you, why believe it when Pearson says it is true?

 

At the very least, you'd have to deduct finite-lived intangibles for the result to be non-absurd.  If you do that then Q1 earnings were $130mm, a far cry from the $493mm cash earnings they reported.

 

The reason this is important: if I borrow $1 to buy an asset that produces a total of $1 in income then I haven't done anything.  I've only broken even.  When I settle things, I use the $1 in earnings to pay back the $1 of debt, and that is it because the asset has totally depleted.  My company isn't worth anything because it started at zero and the acquisition creates no value.

 

But VRX has convinced you that they are actually now worth $20, because the asset produced $1 in "cash earnings" and you are ascribing a 20x multiple to that.

 

So..obviously, I disagree with how you think about valuing VRX.  So, how do you value a company that you are excited about?  Obviously, VRX is pure poison, where is the value you are finding?  And, if I may be so bold, what metrics do you use to determine actionable ideas? 

[radioheadok3]

I'd have to look up if they added back the intangibles on Zovirax and such transactions, I don't know off the top of my head, but it's still a small part of their business so even if they have, we're talking about a few percents difference, as 80-85% isn't declining, and the real economics of those runoff transactions on a cash basis are still very attractive even if they were to distort cash EPS. The runoff part should be looked at on a DCF basis anyway, and only the rest of the business should be valued based on multiples.

 

The way Valeant looks at things, when they acquire an asset, they add up the cost of the asset + the cost of getting all the synergies, and if they can't get 20% on that at statutory tax rates without taking into account anything from the pipeline, they won't do the deal. And once it's done, they keep tracking it basically forever. And they probably have a different model for the declining assets that still aims for that 20% IRR. Management only optimizes for cashflow, not for GAAP EPS or adjusted cash EPS or whatever (I don't think cash EPS is perfect, just better than GAAP EPS in this case). That's all just to give you an idea of what the business could earn on a steady state, but it's not going to be steady, so that's kind of moot. Nobody said this was easy to value. The fact that they are on track or above their models on pretty much all of their deal models on a cash flow basis and that they have good growth on the durable part is good enough for me.

 

You don't have to look.  They add back all amortization of finite-lived intangibles when calculating "cash earnings."  It's the largest adjustment to get to cash earnings, on pace to exceed $1bn for this year.

 

Your second paragraph is just a story you are telling so you can accept something that is obviously absurd.

 

VRX is telling you that their profit is equal to the cash produced from an asset.  I.e., if I buy a stock for $10 and sell it for $8, then I am telling you that my PROFIT is $8, and you believe me.  No story will allow this to make sense.  You wouldn't believe that even if it were Buffett telling you, why believe it when Pearson says it is true?

 

At the very least, you'd have to deduct finite-lived intangibles for the result to be non-absurd.  If you do that then Q1 earnings were $130mm, a far cry from the $493mm cash earnings they reported.

 

The reason this is important: if I borrow $1 to buy an asset that produces a total of $1 in income then I haven't done anything.  I've only broken even.  When I settle things, I use the $1 in earnings to pay back the $1 of debt, and that is it because the asset has totally depleted.  My company isn't worth anything because it started at zero and the acquisition creates no value.

 

But VRX has convinced you that they are actually now worth $20, because the asset produced $1 in "cash earnings" and you are ascribing a 20x multiple to that.

 

Buffett disagrees with you. Might consider that before being overly critical. I think it's draconian to not add back at least some portion of the finite-lived intangibles. It's an artifact of GAAP that doesn't reflect the true economics of the business. They could be straight up lying that they generate 20% unlevered returns even in run-off situations, but you haven't provided any evidence that what they say isn't true.

 

VRX isn't telling us that they are buying companies for $10 and generating $8 of cash. They're saying they are generating 20% compounded over the life of the asset. I don't think your example is even close to reality. Could it be somewhere in between, sure. But let's not pretend they're doing something they're not. We simply don't have enough data at this point to prove it one way or another. I think you have to ask yourself what ValueAct, Sequoia and Ackman are missing. These aren't your average investors and they have likely scrutinized the books in great detail, with far more transparency than we are afforded through public filings.

 

Full disclosure: Sold my VRX after Ackman's involvement. Mostly because, while likely legal, I didn't care for the mechanics.

[giofranchi]

I do remember our conversation re SBUX while waiting in that huge line up for coffee.

 

Ah! That one has been a great day! :)

 

I have a problem paying up for quality---something I am working on and would like to change.

 

I am not sure I would define this “quality”… Quality imo is JNJ, KO,… anything with a long history of sustaining high ROEs,… with some very durable competitive advantages.

Here I think we have something else… something more difficult to judge: a new way to do business in the pharma industry.

The fact is: someone is telling you he can achieve pharma’s profitability without incurring pharma’s wasteful costs. He is saying pharma’s profitability has caused complacency, and complacency has led to wasteful costs. And he is saying: no more, time to solve this business distortion. And he has embarked on a journey to show how this could be achieved. And he clearly explains the logic behind his thoughts and actions.

The question, therefore, is only one: do you believe he will be successful?

Personally, I believe he will be successful… until too many people finally recognize what he is doing, and competition becomes too fierce.

 

Gio

 

[vinod1]

I do remember our conversation re SBUX while waiting in that huge line up for coffee.

 

Ah! That one has been a great day! :)

 

I have a problem paying up for quality---something I am working on and would like to change.

 

The question, therefore, is only one: do you believe he will be successful?

 

Gio

 

Gio,

 

Even if one believes that he will be successful, as I do, the critical question is more of how long and what rate?

 

The approach makes so much business sense that barring an execution issue, I do not see how Valeant would not continue to be successful. What I have less confidence is for how long Valeant would be able to carry out this strategy and at what rate would it be able to deploy capital.

 

I might be misunderstanding you but why do you think these are not critically important? If you do not have some idea of what these would be how do you ensure you are not paying up more than fair price?

 

Thanks

 

Vinod

[giofranchi]

I might be misunderstanding you but why do you think these are not critically important? If you do not have some idea of what these would be how do you ensure you are not paying up more than fair price?

 

No, no! Far from me! Just read the last line of my last post! ;)

When will competition become too fierce? That’s preatty hard to say… but as to this day I can see still a lot of status quo thinking and therefore skepticism about VRX business model… if Mr. Pearson is right, still a lot of room to grow!

 

Someday that room will surely shrink down… and the right entrepreneurial judgment will be to recognize VRX will no longer be the right place to put your capital… imo, that moment is still far in the future… I don’t know when or even if it will come to pass… all I can do is to monitor how things evolve and make decisions accordingly.

 

Gio

 

[Liberty]

I think worries about the model being so replicated that it'll keep VRX from applying it successfully are premature. Pearson has been asked this question many times, in many forms ("what are the barriers to entry to your model?"), and he isn't worried for the next decade.

 

I think it's like value investing. There's no huge secret, it's simple, but it's hard to do, requires discipline, and compared to being safely with the herd, it's not fun for those who don't have that independent (dare I say outsider) streak. That's why there isn't a thousand Berkshire Hathaways making it impossible for the real Berkshire to acquire good assets at fair prices despite everybody seeing what Buffett's doing and Buffett himself explaining it very clearly.

 

Just look at how much flack VRX is getting for doing things differently from others, and that's after being a multi-bagger in a few years. Imagine if they were still waiting for success...

 

Changing a company's culture is very hard. I expect some other pharmas to do a few of the things, like tax inversions, cutting some R&D, but the discipline at the core of the model will be harder to adopt (only enter certain markets, walks away rather than overpay, zero-budget everything, don't be afraid to do big painful cuts on low ROI items, let local managers take most of the operational decisions, outsource lots of R&D so you don't have carrying costs, etc). It's like how every CEO knows in theory that lean operations are a good thing, but in practice, it takes people like 3G to really go against the institutional imperative and be the bad guys who say "no" to almost everything.

[giofranchi]

I think worries about the model being so replicated that it'll keep VRX from applying it successfully are premature. Pearson has been asked this question many times, in many forms ("what are the barriers to entry to your model?"), and he isn't worried for the next decade.

 

I think it's like value investing. There's no huge secret, it's simple, but it's hard to do, requires discipline, and compared to being safely with the herd, it's not fun for those who don't have that independent (dare I say outsider) streak. That's why there isn't a thousand Berkshire Hathaways making it impossible for the real Berkshire to acquire good assets at fair prices despite everybody seeing what Buffett's doing and Buffett himself explaining it very clearly.

 

Just look at how much flack VRX is getting for doing things differently from others, and that's after being a multi-bagger in a few years. Imagine if they were still waiting for success...

 

Changing a company's culture is very hard. I expect some other pharmas to do a few of the things, like tax inversions, cutting some R&D, but the discipline at the core of the model will be harder to adopt (only enter certain markets, walks away rather than overpay, zero-budget everything, don't be afraid to do big painful cuts on low ROI items, let local managers take most of the operational decisions, outsource lots of R&D so you don't have carrying costs, etc). It's like how every CEO knows in theory that lean operations are a good thing, but in practice, it takes people like 3G to really go against the institutional imperative and be the bad guys who say "no" to almost everything.

 

+1

I totally agree.

 

Gio

[constructive]

The question, therefore, is only one: do you believe he will be successful?

Personally, I believe he will be successful… until too many people finally recognize what he is doing, and competition becomes too fierce.

 

Let's remember the example of companies like Microsoft, Amazon, Coca Cola, Qualcomm and many other great companies that were caught in the tech bubble. Their businesses were stronger than ever, growing daily, yet their share prices were crushed.

 

In retrospect that is an extreme example, but Buffett made the mistake of holding KO and I respect him more than any of the large VRX holders (not a knock on them).

 

It can very easily be bad logic to assume that company growth will result in stock price growth, even though it often works. There is a foundation of value assumptions that you need to build, before you build a growth story on top of it.

[shalab]

Don't think anyone captured this, VRX advantages

 

    - (1) Doesnt pay tax or very little if any

    - (2) Cut R&D budget

 

Already people want to do (1) and and some may already do (2).

 

In addition, there are others like ENDP who are emulating VRX in both (1) and (2).

 

VRX is a momentum stock in my opinion and has done extremely well. They need to keep doing acquisitions to keep the momentum going. Once the momentum stops, they can reap further value by doing spin-offs.

 

[Liberty]

Allergan Inc rejects Valeant Pharmaceuticals International and Bill Ackman’s raised takeover offer

 

After thorough consideration, the Allergan Board has unanimously determined that your second revised proposal substantially undervalues Allergan, creates significant risks and uncertainties for the stockholders of Allergan, and is not in the best interests of Allergan and its stockholders. In addition, we do not believe your latest proposal offers sufficient or certain value to warrant discussions between Allergan and Valeant.

 

http://agn.client.shareholder.com/releasedetail.cfm?ReleaseID=853769

[vinod1]

I might be misunderstanding you but why do you think these are not critically important? If you do not have some idea of what these would be how do you ensure you are not paying up more than fair price?

 

No, no! Far from me! Just read the last line of my last post! ;)

When will competition become too fierce? That’s preatty hard to say… but as to this day I can see still a lot of status quo thinking and therefore skepticism about VRX business model… if Mr. Pearson is right, still a lot of room to grow!

 

Someday that room will surely shrink down… and the right entrepreneurial judgment will be to recognize VRX will no longer be the right place to put your capital… imo, that moment is still far in the future… I don’t know when or even if it will come to pass… all I can do is to monitor how things evolve and make decisions accordingly.

 

Gio

 

I agree with you that VRX still has some runaway before opportunities dry up. Question is how fast can they compound going forward?

 

I am referring to following comment that you made a couple of times earlier:

 

There is simply no way to get around this thing: if Mr. Pearson is right, VRX is cheap; if Mr. Pearson is wrong, VRX is expensive.

 

At the current price, they would need to grow cash EPS at 15% rate for a long time for us to get satisfactory returns.

 

The increase is likely be in a step function. If Allergan deal goes through it would likely get a 30% boost to IV.

 

So my question really is assuming VRX has the right strategy and that it still has a long runaway for growth, we need to figure out the growth rate. At the current price, without Allergan deal, it seems just a bit expensive for my taste.

 

Vinod

[giofranchi]

Let's remember the example of companies like Microsoft, Amazon, Coca Cola, Qualcomm and many other great companies that were caught in the tech bubble. Their businesses were stronger than ever, growing daily, yet their share prices were crushed.

 

In retrospect that is an extreme example, but Buffett made the mistake of holding KO and I respect him more than any of the large VRX holders (not a knock on them).

 

It can very easily be bad logic to assume that company growth will result in stock price growth, even though it often works. There is a foundation of value assumptions that you need to build, before you build a growth story on top of it.

 

First, I explained the difference between how I think about KO and about VRX in my last answer to biaggio.

Second, how would you compare KO selling at 35x EPS with VRX selling at 15x Cash EPS?

Third, in a meltdown everything get crushed. What you have to answer is: do I buy more?

 

Gio

 

[giofranchi]

So my question really is assuming VRX has the right strategy and that it still has a long runaway for growth, we need to figure out the growth rate. At the current price, without Allergan deal, it seems just a bit expensive for my taste.

 

Well, if Mr. Pearson is right, I think the 20% IRR he seeks from every acquisition will prove to be conservative. And I think this doesn’t depend on the Allergan deal at all.

 

Gio

 

[vinod1]

So my question really is assuming VRX has the right strategy and that it still has a long runaway for growth, we need to figure out the growth rate. At the current price, without Allergan deal, it seems just a bit expensive for my taste.

 

Well, if Mr. Pearson is right, I think the 20% IRR he seeks from every acquisition will prove to be conservative. And I think this doesn’t depend on the Allergan deal at all.

 

Gio

 

Thanks Gio!

[giofranchi]

Thanks Gio!

 

But... I have not told you if Mr. Pearson is right or wrong... which, unfortunately, is imo the thing that really matters! ;)

 

Gio

[saltybit]

Let's remember the example of companies like Microsoft, Amazon, Coca Cola, Qualcomm and many other great companies that were caught in the tech bubble. Their businesses were stronger than ever, growing daily, yet their share prices were crushed.

 

In retrospect that is an extreme example, but Buffett made the mistake of holding KO and I respect him more than any of the large VRX holders (not a knock on them).

 

It can very easily be bad logic to assume that company growth will result in stock price growth, even though it often works. There is a foundation of value assumptions that you need to build, before you build a growth story on top of it.

 

First, I explained the difference between how I think about KO and about VRX in my last answer to biaggio.

Second, how would you compare KO selling at 35x EPS with VRX selling at 15x Cash EPS?

Third, in a meltdown everything get crushed. What you have to answer is: do I buy more?

 

Gio

 

If the capital and debt markets close because of a downturn, can VRX continue to acquire companies? At this point, don't they need to issue equity and/or debt to continue doing acquisitions? (which means the cost of capital might be too costly during those times to make an accretive acquisition)

 

Since VRX has mentioned that there are only some areas where they will do acquisitions, how big is that remaining area/addressable market for them?

 

 

[giofranchi]

If the capital and debt markets close because of a downturn, can VRX continue to acquire companies? At this point, don't they need to issue equity and/or debt to continue doing acquisitions? (which means the cost of capital might be too costly during those times to make an accretive acquisition)

 

That would be a meltdown… and would certainly slow things down… but capital markets don’t stay close forever, right? Therefore, you will have to answer: do I buy more? ;)

 

Since VRX has mentioned that there are only some areas where they will do acquisitions, how big is that remaining area/addressable market for them?

 

I cannot put an exact number to that… but I am pretty sure about the order of magnitude: $trillions.

 

Gio

 

[Cunninghamew]

There isn't anything here yet other than John Hempton saying he will be posting his bear case for VRX... just thought I would pass on the link for those interested in reading as they come out

 

http://brontecapital.blogspot.com/

[Liberty]

If the capital and debt markets close because of a downturn, can VRX continue to acquire companies? At this point, don't they need to issue equity and/or debt to continue doing acquisitions? (which means the cost of capital might be too costly during those times to make an accretive acquisition)

 

The CFO recently said that he thinks VRX will be investment grade. This would help. But if they were not doing acquisitions, they would earn cash EPS relatively soon and could then use that to do buybacks, pay dividends, or spin off various assets that would be worth more on their own or in the hands of strategic buyers (they just got 5x sales for their dysport divestiture). They have many ways of creating value other than M&A.

 

Since VRX has mentioned that there are only some areas where they will do acquisitions, how big is that remaining area/addressable market for them?

 

The size of their fishing ponds is probably something like 10 trillion if you count both the public and private assets (there are many places around the world where almost everything is private), and the subset that would be of interest to them is probably at least in the hundreds of billions if not more. They don't even have to find whole companies that are a fit, they can buy just certain assets without buying the whole thing (that's how they got the Dow assets, and I think they bought some stuff from JNJ too). This was in the first 3-hour merger presentation (in the prepared remarks + in the Q&A at the end where they say they were very conservative with the numbers in the slides). And they see themselves as a healthcare company in general, so they can go outside of traditional pharma.

[lu_hawk]

Has anyone looked more deeply into the asset sale last month to Galderma?  It was most, but not all, of the drugs acquired in the Medicis acquisition.  Has enough information been released to do a real analysis of the deal? 

 

Has the company commented at all on their motive for selling those drugs?

[Liberty]

Has anyone looked more deeply into the asset sale last month to Galderma?  It was most, but not all, of the drugs acquired in the Medicis acquisition.  Has enough information been released to do a real analysis of the deal? 

 

Has the company commented at all on their motive for selling those drugs?

 

Yes, this was explained by management. They sold them because they expect the Allergan deal to go through and feel they had better bargaining power selling now rather than later (don't want to be a forced seller). They had to divest those assets because they are competing with Botox and they can't keep both for regulatory reasons.

[cayale]

Has anyone looked more deeply into the asset sale last month to Galderma?  It was most, but not all, of the drugs acquired in the Medicis acquisition.  Has enough information been released to do a real analysis of the deal? 

 

Has the company commented at all on their motive for selling those drugs?

 

They sold for 5.4 times revenues, I believe they disclosed.