VRX - Valeant Pharmaceuticals International Inc.

[Liberty]

That said - I think you guys are crazy to be so confident in this idea. Its just an industrial roll-up ported over to Pharma that you paying a very rich multiple of CF for right now.  There's no magic here.  If the roll-up works you'll get paid until it stops working, and once it stops working. Look out below.

 

The problem with most rollups is that they don't realize real synergies, either don't integrate businesses or try to centralize everything, and they overpay, ideally (for them) with high-priced stock.

 

I don't think it's the case for any of these things here.

 

What we have is a superior operating model (like 3G) combined with superior capital allocation (only going in products and markets that have certain desirable characteristics and staying disciplined on price).

[topofeaturellc]

that all makes sense, except there isn't really any evidence its a superior operating model. Nor is it really evident they are realizing any cost synergies other than R&D. Perhaps sales force productivity is up but I don't know.

 

The thing is this could still work as an idea if you were paying a reasonable multiple for it. But Valeant's own projections for '15 as a standalone are for 2.9Bil iin Adjusted CFO on an EV of 50.  If it turns out you are remotely wrong, you are going to lose a lot of money.

 

I remember paying 5x EV/EBITDA for Jarden in '07 when there was this much controversy surrounding the story.  Obviously the underlying businesses here are better, but still.

[KCLarkin]

Nor is it really evident they are realizing any cost synergies other than R&D.

 

Actual # of Medicis employees at the time of acquisition was 831

 

Total headcount reduction of 764 includes 636 Medicis employees and 128

Valeant employees

 

[cayale]

It's not clear to me that this "roll-up" is any different than BUD, PCP or TDG (Teledyne, back in the day), all successful "roll-ups".  Some of them do work, using precisely the tools that VRX claims it uses; cost-cutting, focus and durable product selection.

[topofeaturellc]

at some point those roll-ups will stop working. In the case of PCP and TDG we are also now now in year 11 of an upcycle.  The tide may or may not go out for those guys once the first 737NG hits the desert, but neither you nor I can underwrite that.

 

BUD - is based around Interbrew - which was a broken rollup BTW. The 3G guys may or may not be geniuses. Again - neither you nor I can really underwrite that.  For all we know they've been generating profits from buying a broken roll-up cheaply and fixing it.  Which is great, and they're smart guys. But once that's over - who knows?

 

It all comes down to that the only thing you can underwrite is cheapness on historic earnings and return on capital (sometimes for the latter).  These prospective stories only make sense from a risk/reward if the risk of being wrong is small.  17x Non-Gaap CFO is not that.

[topofeaturellc]

Nor is it really evident they are realizing any cost synergies other than R&D.

 

Actual # of Medicis employees at the time of acquisition was 831

 

Total headcount reduction of 764 includes 636 Medicis employees and 128

Valeant employees

so then where's the cashflow? Returns on capital are still punk.

[Liberty]

http://www.reuters.com/article/2014/08/13/us-hedgefunds-ackman-idUSKBN0GD1JC20140813

 

Ackman says he remains committed to Valeant's bid for Allergan

 

Here's Ackman's Q2 letter (the part of Allergan management is worth reading):

 

http://www.scribd.com/doc/236712968/Pershing-Sqr-1Q-2Q-2014-Investor-Letter-1-1

 

Looks like he wants to take Pershing public with an IPO too.

[rpadebet]

2014 EBITDA is expected to be 3.8b as per Factset @ 46% EBITDA margin implying an EV/EBITDA for VRX of  14X. It looks rich, but if you look at the high margins, low tax rates and 6% sustainable organic growth assuming no more inorganic acquisition led growth, it isn't that rich.

 

The crux of the bear argument, which I find most credible is to do with, whether the 6% organic revenue growth is "sustainable" with R&D at  3% of revenues or not. All other companies seem to suggest 20% of revenues towards R&D is necessary to get 6% revenue growth. VRX says 1$ of revenue growth can be bought at 50 cents and bears say, nope, it costs 3$ at least. If bear argument is correct, then margins have to compress to sustain growth and so EV/EBITDA multiple should be lower.

 

I don't know the answer to this. I don't think anyone on the outside can know or predict R&D efficiency , unless you are industry insider historically and have seen the metrics on the R&D payoff. Mike Pearson seems to have based his VRX operating model mainly on this, given his industry experience as a strategic consultant.

 

So it again boils down to, whether you trust him and assume he knows what he is doing or not.

[topofeaturellc]

 

 

So it again boils down to, whether you trust him and assume he knows what he is doing or not.

Which is why Hempton's attack is essentially an ad hom towards Pearson.

 

If you read his tweets and what not, you really see that he just thinks its the typical industrial roll-up at an untenable valuation.  He's not really making a case its an out and out 0 fraud.  Tho I think he thinks he can freak the bankers out if goes far enough.

 

I took those CFO numbers straight from a VRX presentation.  Course its CFO not Unlevered CF.

[Liberty]

at some point those roll-ups will stop working. In the case of PCP and TDG we are also now now in year 11 of an upcycle.  The tide may or may not go out for those guys once the first 737NG hits the desert, but neither you nor I can underwrite that.

 

I can't speak for PCP, but I don't think you understand TDG. They've been at this since the early 90s, they went through wars, 9/11, the GFC and everything else just fine (most were barely a blip in the overall revenue-passenger-mile numbers, which is what matters most to them). As long as planes and helicopters fly, they need replacement parts, and for most of the stuff TDG sells, there's only 1 supplier, them. In this incredibly fragmented industry, they have a zillion acquisition targets left, most in private equity or family owners' hands. They have a very impressive track record of reducing their purchase multiple by cutting costs, raising prices, and getting more products on new airframes, giving them EBITDA margins higher than most people's gross margins. By constantly shrinking the equity and focusing on per-share value, they don't even have to grow that big in absolute size to provide great returns to investors.

 

So why do you see them failing any time soon? I agree most rollups, like most companies in general, aren't very good. But painting everyone with the same brush without understanding how they might be different doesn't seem like the right approach...

[topofeaturellc]

at some point those roll-ups will stop working. In the case of PCP and TDG we are also now now in year 11 of an upcycle.  The tide may or may not go out for those guys once the first 737NG hits the desert, but neither you nor I can underwrite that.

 

I can't speak for PCP, but I don't think you understand TDG. They've been at this since the early 90s, they went through wars, 9/11, the GFC and everything else just fine (most were barely a blip in the overall revenue-passenger-mile numbers, which is what matters most to them). As long as planes and helicopters fly, they need replacement parts, and for most of the stuff TDG sells, there's only 1 supplier, them. In this incredibly fragmented industry, they have a zillion acquisition targets left, most in private equity or family owners' hands. They have a very impressive track record of reducing their purchase multiple by cutting costs, raising prices, and getting more products on new airframes, giving them EBITDA margins higher than most people's gross margins. By constantly shrinking the equity and focusing on per-share value, they don't even have to grow that big in absolute size to provide great returns to investors.

 

So why do you see them failing any time soon? I agree most rollups, like most companies in general, aren't very good. But painting everyone with the same brush without understanding how they might be different doesn't seem like the right approach...

 

I'm not saying I see them failing soon. I'm saying you can't underwrite if their model continues to scale - and the shares are not being priced at a level that allows the future to not look as good as the past.  I'm not saying it can't. I'd love to buy transdigm at the right price.

 

The reality is that in 2002 TDG had 200 mil in sales and 50 mil in EBIT. Today it has  its a 2 Bil company today with 750 mil in EBIT. And it did all of that when it was a pretty good time to be running an aviation MRO biz. Yeah, its not an OEM biz. But look at what happened to other MRO bizzes during the last real aviation downturn we had  in '01-'02.

 

Its much easier to growth through the bumps when you are a 150 mil top line biz then it is when you are >2bil. And even then don't forget that TDG's base biz was down DD in '02. The biz was up 48 mil that year, but that's because they acquired 60 mil in revs and had a win related to 9/11 of 10 mil. Biz was down 12% Do you want to own a levered equity on a high=ish EV/EBITDA multiple with a down top line?

 

 

But the issue with all of these is the same.  If the story breaks, they are overvalued. 

 

[rpadebet]

 

 

So it again boils down to, whether you trust him and assume he knows what he is doing or not.

Which is why Hempton's attack is essentially an ad hom towards Pearson.

 

If you read his tweets and what not, you really see that he just thinks its the typical industrial roll-up at an untenable valuation.  He's not really making a case its an out and out 0 fraud.  Tho I think he thinks he can freak the bankers out if goes far enough.

 

I took those CFO numbers straight from a VRX presentation.  Course its CFO not Unlevered CF.

 

The risk is clearly whether that 6% organic growth promised is sustainable at that level of R&D. If they were promising 15% or so organic growth, even I would be a little skeptical. But 6% is not a huge number. General medical product inflation, unit volume growth due to population dynamics get you most of the way and you don't need incremental R&D for either of those. Yes R&D is required to replace lost organic growth due to competition etc and 3% towards incremental innovation seems reasonable.

 

The second most important factor for sustainability is the kind of products they are buying. 1 durable product (like Botox in Allergan) is more risky than 3-4 durable products. So even if you face new innovation and competition eating away at one products' share, you don't lose as quickly. You have time to replace it with other purchases.

 

At current prices, the way I see it, I am getting the potential "inorganic growth" for free (including the Allergan acquisition). Because I am greedy, I would also like to get the tax rate for free, but that could happen at prices 20% lower. So waiting to add and hoping Hempton is successful at scaring a few folks.  ;)

 

[Liberty]

I'm not saying I see them failing soon. I'm saying you can't underwrite if their model continues to scale - and the shares are not being priced at a level that allows the future to not look as good as the past.  I'm not saying it can't. I'd love to buy transdigm at the right price.

 

The reality is that in 2002 TDG had 200 mil in sales and 50 mil in EBIT. Today it has  its a 2 Bil company today with 750 mil in EBIT. And it did all of that when it was a pretty good time to be running an aviation MRO biz. Yeah, its not an OEM biz. But look at what happened to other MRO bizzes during the last real aviation downturn we had  in '01-'02.

 

Its much easier to growth through the bumps when you are a 150 mil top line biz then it is when you are >2bil. And even then don't forget that TDG's base biz was down DD in '02. The biz was up 48 mil that year, but that's because they acquired 60 mil in revs and had a win related to 9/11 of 10 mil. Biz was down 12% Do you want to own a levered equity on a high=ish EV/EBITDA multiple with a down top line?

 

But the issue with all of these is the same.  If the story breaks, they are overvalued.

 

I guess we're just not looking at it the same way. A lot of value is created in down markets, when good businesses can be bought cheaply. I don't care about short-term volatility. Fact is, they have great management and one of the largest moats I've seen (and it has been tested often in the past 25 years). People aren't about to stop flying (except maybe in a huge world war, in which case their defense business would probably boom) and airframes stick around for decades, providing annuity-like streams of cash. And the company's still small compared to their opportunity size (and they return excess capital as special dividend, billions of it so far, so no growth for growth's sake here, only profitable growth).

 

I wish they were cheaper (like everything I like), but it's one of those businesses that is actually worth a higher multiple, IMO.

 

Anyway, this is off-topic...

[Liberty]

The risk is clearly whether that 6% organic growth promised is sustainable at that level of R&D. If they were promising 15% or so organic growth, even I would be a little skeptical. But 6% is not a huge number. General medical product inflation, unit volume growth due to population dynamics get you most of the way and you don't need incremental R&D for either of those. Yes R&D is required to replace lost organic growth due to competition etc and 3% towards incremental innovation seems reasonable.

 

R&D isn't the only factor. Remember that they pick their markets very carefully (product wise and geographically -- they have shown matrices that show this). So, for example, by staying out of Western Europe and focusing more on fast-growing emerging markets, their baseline organic growth is higher than most other pharmas that are truly global and play everywhere.

[topofeaturellc]

I'm not saying I see them failing soon. I'm saying you can't underwrite if their model continues to scale - and the shares are not being priced at a level that allows the future to not look as good as the past.  I'm not saying it can't. I'd love to buy transdigm at the right price.

 

The reality is that in 2002 TDG had 200 mil in sales and 50 mil in EBIT. Today it has  its a 2 Bil company today with 750 mil in EBIT. And it did all of that when it was a pretty good time to be running an aviation MRO biz. Yeah, its not an OEM biz. But look at what happened to other MRO bizzes during the last real aviation downturn we had  in '01-'02.

 

Its much easier to growth through the bumps when you are a 150 mil top line biz then it is when you are >2bil. And even then don't forget that TDG's base biz was down DD in '02. The biz was up 48 mil that year, but that's because they acquired 60 mil in revs and had a win related to 9/11 of 10 mil. Biz was down 12% Do you want to own a levered equity on a high=ish EV/EBITDA multiple with a down top line?

 

But the issue with all of these is the same.  If the story breaks, they are overvalued.

 

I guess we're just not looking at it the same way. A lot of value is created in down markets, when good businesses can be bought cheaply. I don't care about short-term volatility. Fact is, they have great management and one of the largest moats I've seen (and it has been tested often in the past 25 years). People aren't about to stop flying (except maybe in a huge world war, in which case their defense business would probably boom) and airframes stick around for decades, providing annuity-like streams of cash. And the company's still small compared to their opportunity size (and they return excess capital as special dividend, billions of it so far, so no growth for growth's sake here, only profitable growth).

 

I wish they were cheaper (like everything I like), but it's one of those businesses that is actually worth a higher multiple, IMO.

 

Anyway, this is off-topic...

very very few roll-ups accelerate deals in a downturn. Mostly because the credit markets are tight, equity multiples are low, and selling management teams are generally not willing to sell at a time of distress.  About the only assets you can buy at the bottom are levered ones, so you need to be able to pay cash or stock for them, not debt so much.

[Liberty]

very very few roll-ups accelerate deals in a downturn. Mostly because the credit markets are tight, equity multiples are low, and selling management teams are generally not willing to sell at a time of distress.  About the only assets you can buy at the bottom are levered ones, so you need to be able to pay cash or stock for them, not debt so much.

 

I think we're talking passed each other. I'm not talking about an end-of-the-world downturn, or catching the very bottom, I'm just saying that over the cycle sometimes multiples are higher and sometimes they're lower. They tend to be lower in downturns, hence the ability to create value. They've shown they can create M&A value even at higher multiples, but they'd do even better with lower multiples and fewer buyers competing with them. Even growing at the rate they've been growing at, they generate more cash than they can use, hence the big special dividends. It's not like capital is tight. They could delever quickly if they felt conditions change..

 

What matters is the risk of permanent loss, and I don't see it with TDG in almost any realistic scenario. Their debt is managed well, they gush cash, their customers can't go anywhere else, competitors can't realistically take business from them. Even without M&A they would still be able to create nice value with organic growth + buybacks, though not as much as with M&A.

 

Anway, as I said, this is off-topic...

[topofeaturellc]

no really we're not talking past one another.  For every "wonderful" business that is actually doing what they say they do there are ten "wonderful" businesses that turn out to just be riding a cycle or telling a story.

 

My point is that you can't actually tell if VRX is one of those, or if TDG is one of those. That's why its a suckers bet at a high valuation.  Even if you are right when you consider what would have happened had you been wrong, its a bad risk/reward. 

 

Imagine you were a POST shareholder. HTF does a Cereal company miss earnings and decline 20%? Well it was trading on a crazy EBITDA value because he's doing a P/E Arb roll-up.  Once that story is shot its nothing but "He's an outsider" guys left holding the bag.

 

[Liberty]

To each their own. If you don't think you can identify good businesses and good management, you certainly shouldn't put value on those attributes, I agree. Personally, I think I can sometimes tell (a lot goes in the "too hard" pile). I may be right or I may be wrong, but for better or worse, the past few years have convinced me that business and management quality paramount if I want to hold for the long term and sleep well at night. It's just my style, and I'm sure you're doing very well with yours.

 

You keep talking about temporary drops in price. Berkshire has been down more than 50% a bunch of times. So what?

 

I really don't care if TDG or VRX slows down once in a while and Mr. Market becomes really depressive because they missed analyst targets. They aren't serial stock emitters needing a high share price to do what they do. They aren't in capital-intensive cyclical businesses. Competitors aren't breathing down their necks, compressing their margins. All that volatility will have meant nothing in 5 years as long as the fundamentals stay strong and capital is allocated well, which I have every reason to believe they will.

 

And I never liked POST. It's not like I'm just buying a random basket of acquisitive companies. I specifically like a few because of their specific businesses, models and managers.

[KCLarkin]

Imagine you were a POST shareholder. HTF does a Cereal company miss earnings and decline 20%? Well it was trading on a crazy EBITDA value because he's doing a P/E Arb roll-up.  Once that story is shot its nothing but "He's an outsider" guys left holding the bag.

 

POST is trading at 21 EV/EBITDA AFTER dropping more than a third. VRX is trading at 15x. 15x is not a crazy multiple. Fairly valued sure. But not crazy.

[Liberty]

There are rumors that AGN might be about to buy either SLXP or JAZZ.

 

http://online.wsj.com/articles/allergan-has-approached-salix-pharmaceuticals-about-acquisition-1408467996

 

Buried in the article: "Meantime, Valeant is getting close to securing the support of 25% of Allergan shareholders needed to call a special meeting, according to a person familiar with the matter."

[original mungerville]

So it looks like if there is no deal with Allergan, VRX is going to go up. And if there is somehow a deal, VRX will also go up?

 

Smells like a bargain. Of course, if they didn't have $18 billion in debt, it would be a complete no brainer. I am invested, but its the $18 Billion in debt that is stopping me from going really big on this one - its just hard to neglect that in the valuation.

 

 

[giofranchi]

no really we're not talking past one another.  For every "wonderful" business that is actually doing what they say they do there are ten "wonderful" businesses that turn out to just be riding a cycle or telling a story.

 

My point is that you can't actually tell if VRX is one of those, or if TDG is one of those. That's why its a suckers bet at a high valuation.  Even if you are right when you consider what would have happened had you been wrong, its a bad risk/reward. 

 

Topofeaturellc,

I think it is obvious it cannot work that way.

 

Entrepreneurs are people who know how to judge the "future prospects" of a business. Successful entrepreneurs are people who judge successfully the future prospects of a business. Period.

 

If you don't feel to be one of them, probably you'd much better find a safe job, save, and buy an index fund.

 

Ah! Of course, I am very skeptical about all those statistical strategies to play the stock market... Successfully...

 

Even the valuation of a business is bound to be terribly wrong (and therefore what you call a risk/reward scenario is bound to be terribly wrong), if you make huge mistakes in assessing a business future prospects.

 

Liberty thinks he can judge VRX's future prospects successfully. And he has done a great job trying to understand the company!

 

I sold my investment, because I admitted I wasn't able to muster enough confidence in VRX's future prospects (mostly because of all its debt...).

 

But I don't judge Liberty's chioce... And I don't pretend if I can't understand something very well, therefore nobody can...

 

I still think chances are Liberty will be proven right on VRX in the end.

 

Gio

 

 

 

[topofeaturellc]

LOL - not only is it obvious that it works that way but there is a lot of literature that shows that it works that way.

 

Entrepreneurs know very little. Managements/Entrepreneurs are hysterically wrong at predicting their businesses.  There is a wealth of data on this as well.

 

Yes - its very hard to judge the future prospects of a business.  Your best bet is to find mean reversion scenarios at massive discounts to IV.

 

Trying to do anything else just isn't the sort of value investing that the academic research suggests might work.

[coc]

LOL - not only is it obvious that it works that way but there is a lot of literature that shows that it works that way.

 

Entrepreneurs know very little. Managements/Entrepreneurs are hysterically wrong at predicting their businesses.  There is a wealth of data on this as well.

 

Yes - its very hard to judge the future prospects of a business.  Your best bet is to find mean reversion scenarios at massive discounts to IV.

 

Trying to do anything else just isn't the sort of value investing that the academic research suggests might work.

 

So putting all of your money in Berkshire 20 or 30 years ago and sitting there, under your definition, "doesn't work"?

 

(For the record, I own none of the stocks mentioned here - VRX, POST, TDGM, etc.)

[topofeaturellc]

LOL - not only is it obvious that it works that way but there is a lot of literature that shows that it works that way.

 

Entrepreneurs know very little. Managements/Entrepreneurs are hysterically wrong at predicting their businesses.  There is a wealth of data on this as well.

 

Yes - its very hard to judge the future prospects of a business.  Your best bet is to find mean reversion scenarios at massive discounts to IV.

 

Trying to do anything else just isn't the sort of value investing that the academic research suggests might work.

 

So putting all of your money in Berkshire 20 or 30 years ago and sitting there, under your definition, "doesn't work"?

 

(For the record, I own none of the stocks mentioned here - VRX, POST, TDGM, etc.)

there is an exception to every rule. That doesn't mean the rule is wrong. Besides 45 years ago you would have been buying one of the Nifty 50 because they are "wonderful" businesses - and you'd be underwater on a non-trivial number of those.  Someone who wants to own VRX would have looked at dying Textile business and a bunch of weird retail/consumer assets and laughed at you.

 

Its only ex-post that it seems so obvious that BRK was what you should own. What's the great stat about BRK meeting attendance? thirty years ago there were 250 people at his annual meeting - and that was already after anyone paying attention knew he was a genius.

 

My point is that we have a very very limited ability to find something like BRK, and we are way way way more likely to find a false-BRK than we are find BRK Mark II.  To think otherwise is to go against the odds.

 

Let me ask you this another way  - for every lucky Omahan who invested in BRK  in '65 because they personally knew WEB, how many people do you think thought they found someone who was "really really smart" and maybe even had some good numbers doing something along the way and totally flamed out? I've gotta think its 500-1.