VRX - Valeant Pharmaceuticals International Inc.

[original mungerville]

Maybe Salix earnings are depressed and they think they will boost even the normalized number a lot with their operating model. It seems very unlikely to me that Pearson has become undisciplined just after walking away from the Allergan deal. That's what I like about investing with great management, you can give them the benefit of the doubt.

 

That's what it is. Salix's EBITDA is very depressed in 2014 compared to the real earning power. Once they work through the inventory issue, that should normalize. That's why they expect to be able to go from 5.6x to less than 4x in little more than a year.

 

So you figure Salix revenues are very depressed? That must be it because I don't see any other explanation. What are the mechanics of these inventory or other issues depressing current sales? How does working through these renormalize Salix sales?

[giofranchi]

They are opportunistic. They won't let pass a chance to deploy this much capital just to give the market a few more clean quarters. But if you're looking for evidence, I think you got it. They rapidly went down to 3.5x, organic growth is super strong and would look even better without FX headwinds, GAAP was closing the gap (ha!) with adjusted, they brought to market new products (Jublia looks like a big hit), etc.

 

Gio, your reasoning for not investing is still not working as Pearson has said he will disclose the Salix and Dendreon acquisitions as separate US business unit so people with your view can understand the underlying growth of the rest of the company well.

 

Good results indeed!... But unfortunately I need more than a quarter… I want to see debt going down and staying low for at least a year… I want to see convincing organic growth for at least a year… I want to see GAAP earnings closing the gap with adjusted for at least a year… Then, I would feel safe saying I truly understand the business.

 

Unfortunately, though we might now monitor how the Salix and Dendreon acquisitions perform, because their results might be separately disclosed, debt will go up again, and the gap between adjusted and GAAP earnings will widen again…

 

But I understand they are opportunistic, and I think they will do very well going forward… I simply guess in this environment of high debts everywhere I must regretfully admit that such an outstanding compounding machine is out of my circle of competence.

 

Gio

 

[Liberty]

They are opportunistic. They won't let pass a chance to deploy this much capital just to give the market a few more clean quarters. But if you're looking for evidence, I think you got it. They rapidly went down to 3.5x, organic growth is super strong and would look even better without FX headwinds, GAAP was closing the gap (ha!) with adjusted, they brought to market new products (Jublia looks like a big hit), etc.

 

Gio, your reasoning for not investing is still not working as Pearson has said he will disclose the Salix and Dendreon acquisitions as separate US business unit so people with your view can understand the underlying growth of the rest of the company well.

 

Good results indeed!... But unfortunately I need more than a quarter… I want to see debt going down and staying low for at least a year… I want to see convincing organic growth for at least a year… I want to see GAAP earnings closing the gap with adjusted for at least a year… Then, I would feel safe saying I truly understand the business.

 

Unfortunately, though we might now monitor how the Salix and Dendreon acquisitions perform, because their results might be separately disclosed, debt will go up again, and the gap between adjusted and GAAP earnings will widen again…

 

But I understand they are opportunistic, and I think they will do very well going forward… I simply guess in this environment of high debts everywhere I must regretfully admit that such an outstanding compounding machine is out of my circle of competence.

 

Gio

 

Ok, then you'll never invest in Valeant because that's not their model, which is fine, we can't be comfortable with everything. That's like asking Malone to stop using leverage for a while to prove that he can. The opportunity cost of doing that is too high. He buys businesses that can support the leverage and is careful about how it's structured, just like Valeant (they're not depending on a couple big blockbusters that are going off patent soon...).

 

I don't know why you say that you need more than a quarter, though. Their last big acquisition prior to this was B&L in 2013.

[giofranchi]

I don’t really the environment we find ourselves investing in: I see both high debts and high asset prices… Therefore, I look for the exact opposite: companies with very little or no debt, and the performance of which is as uncorrelated to what the stock market does as possible.

Unfortunately, I simply cannot get convinced that VRX qualifies.

 

Gio

[giofranchi]

Ok, then you'll never invest in Valeant because that's not their model, which is fine, we can't be comfortable with everything. That's like asking Malone to stop using leverage for a while to prove that he can. The opportunity cost of doing that is too high. He buys businesses that can support the leverage and is careful about how it's structured, just like Valeant (they're not depending on a couple big blockbusters that are going off patent soon...).

 

Yes, unfortunately I guess you are right… I think in the present environment I might never get comfortable because of debt…

 

Anyway, I think shareholders will go on doing very fine! :)

 

Gio

 

 

[Liberty]

I don’t really the environment we find ourselves investing in: I see both high debts and high asset prices… Therefore, I look for the exact opposite: companies with very little or no debt, and the performance of which is as uncorrelated to what the stock market does as possible.

Unfortunately, I simply cannot get convinced that VRX qualifies.

 

Gio

 

What happened to your oft-repeated mantra that talented capital allocators will find a way to create value in all kinds of environments? It's not like the investing heroes of the past only succeeded because the coast was clear; they still created value through high inflation, high interest rates, wars, price controls, oil embargoes, high taxes, booms, busts, etc.

 

If I was buying an index fund, maybe I'd be worried more about the macro. But for a single business, I go bottoms up, and I think Valeant could benefit from some dislocation, actually. People aren't going to stop buying their products if Greece leaves the Euro or whatever, and if debt becomes more expensive, maybe they'll have less competition for M&A and their IRRs are still way higher than even a much higher cost of debt (but they keep their maturities pretty far out anyway). And they've shown that even if they couldn't make acquisitions for a while, all it would do it allow them to delever and keep growing organically; they aren't on some treadmill of debt and M&A like some other low-quality, undisciplined rollups that constantly print shares to buy crap.

[giofranchi]

If I was buying an index fund, maybe I'd be worried more about the macro. But for a single business, I go bottoms up, and I think Valeant could benefit from some dislocation, actually. People aren't going to stop buying their products if Greece leaves the Euro or whatever, and if debt becomes more expensive, maybe they'll have less competition for M&A and their IRRs are still way higher than even a much higher cost of debt (but they keep their maturities pretty far out anyway). And they've shown that even if they couldn't make acquisitions for a while, all it would do it allow them to delever and keep growing organically; they aren't on some treadmill of debt and M&A like some other low-quality, undisciplined rollups that constantly print shares to buy crap.

 

Liberty,

I don’t argue with what you have just said, because I agree 100%.

But right now I am looking for companies which have positioned themselves to grow earnings and BV during a possible market dislocation caused by widespread debt defaults, not after.

If during a market dislocation VRX’s stock price gets halved, I will then probably start buying aggressively, because I agree 100% they will behave opportunistically and make some wonderful investments! And I would invest aggressively using as a currency the stocks of those businesses that might perform better during a market dislocation, those businesses I am looking for now.

 

Think about LMCA in 2008: its stock price got badly clobbered… But Malone made the Sirius investment that later paid-off in spades! To have a hard currency to invest in LMCA in 2008 would have been very useful! Right?

 

Gio

 

[Liberty]

If I was buying an index fund, maybe I'd be worried more about the macro. But for a single business, I go bottoms up, and I think Valeant could benefit from some dislocation, actually. People aren't going to stop buying their products if Greece leaves the Euro or whatever, and if debt becomes more expensive, maybe they'll have less competition for M&A and their IRRs are still way higher than even a much higher cost of debt (but they keep their maturities pretty far out anyway). And they've shown that even if they couldn't make acquisitions for a while, all it would do it allow them to delever and keep growing organically; they aren't on some treadmill of debt and M&A like some other low-quality, undisciplined rollups that constantly print shares to buy crap.

 

Liberty,

I don’t argue with what you have just said, because I agree 100%.

But right now I am looking for companies which have positioned themselves to grow earnings and BV during a possible market dislocation caused by widespread debt defaults, not after.

If during a market dislocation VRX’s stock price gets halved, I will then probably start buying aggressively, because I agree 100% they will behave opportunistically and make some wonderful investments! And I would invest aggressively using as a currency the stocks of those businesses that might perform better during a market dislocation, those businesses I am looking for now.

 

Think about LMCA in 2008: its stock price got badly clobbered… But Malone made the Sirius investment that later paid-off in spades! To have a hard currency to invest in LMCA in 2008 would have been very useful! Right?

 

Gio

 

That's a nice scenario, but it assumes that things happen like you're planning. Very smart people were saying the same thing pretty much every year since 2009, we're due for a big correction, an apocalypse, any day now. I know we'll go through some tough times at some point, but I don't try to time it, I just buy attractive businesses, and I think Valeant will do fine in that environment anyway, as will my other investments. The share price of many of them might go down a lot, but they have solid businesses, great capital allocators at the helm with track records of deploying capital opportunistically, and buyback programs... They'll come out stronger on the other side. Not sure why that's something you want to avoid like the plague.

 

Also, references to 2008 are probably not useful. Generals keep fighting the last war. These types of events don't happen often. I think too many investors are trying to position themselves for the repeat of 2008, and that's misguided, just like those who expected another great depression after the 30s missing on a lot of things. Doesn't mean we'll have some infinite bull market, but it also doesn't mean that everything - without regard to quality - will go on sale by 50%+ every few years.

 

Also, you could have bought VRX for almost 50% of the current price less than a year ago.

[Liberty]

One thing I'm excited about is that Valeant now has two new platforms (GI, oncology).

 

The value there is that they can make smaller bolt-on acquisitions and integrate them in the existing infrastructure. They've shown they can create a lot of value that way by finding small private or PE-owned businesses. Before, it would have been a lot harder to buy a small thing in those fields without a platform to integrate it into (you don't want to just have a small thing hanging out on its own), and they also gain expertise in those fields to help do the search and DD on deals, so it actually opens up many new avenues of opportunities for the company.

[giofranchi]

That's a nice scenario, but it assumes that things happen like you're planning. Very smart people were saying the same thing pretty much every year since 2009, we're due for a big correction, an apocalypse, any day now. I know we'll go through some tough times at some point, but I don't try to time it, I just buy attractive businesses, and I think Valeant will do fine in that environment anyway, as will my other investments. The share price of many of them might go down a lot, but they have solid businesses, great capital allocators at the helm with track records of deploying capital opportunistically, and buyback programs... They'll come out stronger on the other side.

 

But it is not like I am not doing business… I am just looking for what I judge to be a more conservative kind of businesses… Businesses I am more comfortable with in this environment… I know VRX might be wonderful, and might be among the best performers out there… I have always said I think shareholders might continue doing very well!... But I am positive I will do well enough concentrating on businesses that better fit what I am looking for today… So I don’t really feel the need to do something I am not comfortable with.

 

Cheers,

 

Gio

 

 

 

[Liberty]

That's a nice scenario, but it assumes that things happen like you're planning. Very smart people were saying the same thing pretty much every year since 2009, we're due for a big correction, an apocalypse, any day now. I know we'll go through some tough times at some point, but I don't try to time it, I just buy attractive businesses, and I think Valeant will do fine in that environment anyway, as will my other investments. The share price of many of them might go down a lot, but they have solid businesses, great capital allocators at the helm with track records of deploying capital opportunistically, and buyback programs... They'll come out stronger on the other side.

 

But it is not like I am not doing business… I am just looking for what I judge to be a more conservative kind of businesses… Businesses I am more comfortable with in this environment… I know VRX might be wonderful, and might be among the best performers out there… I have always said I think shareholders might continue doing very well!... But I am positive I will do well enough concentrating on businesses that better fit what I am looking for today… So I don’t really feel the need to do something I am not comfortable with.

 

That's fine, I'm not trying to push you to do something you don't want to. I'm just examining your stated reasons for doing what you do. You are the final arbiter of what happens to your capital, of course.

[giofranchi]

I'm just examining your stated reasons for doing what you do.

 

Well, I think my reasoning is quite simple after all. Buffett never used debt, and grew shareholder capital intelligently deploying free cash flow. Though in a less levered overall environment I would feel comfortable also with a more aggressive business model, in the present environment I prefer to stick to Buffett’s model.

 

Gio

 

[rpadebet]

I agree this is a "one of a kind" company. I think of it more like a durable consumer products company (like parts of P&G, JNJ etc) rather than a healthcare company.

 

I like the debt and leverage here (maybe because I think this time the low rates are here to stay for much longer). I was lucky to have invested last year in August, pretty close to the 52 week low. Given the run since then, it has already become my largest position (around 10-11%) and don't see myself trimming,  as their runway seems pretty huge.

 

I think in general companies are under levered for the future in this environment (except for some sub sectors). This is why I like capital allocators who aren't scared of debt  in this cycle. If we have a Japan like scenario for next decade or so with minimal organic growth and alternating between modest inflation/deflation, not trying to maximize returns on equity now by levering up a stable underlying business wont seem like a smart decision in 2025.

 

[Liberty]

I'm just examining your stated reasons for doing what you do.

 

Well, I think my reasoning is quite simple after all. Buffett never used debt, and grew shareholder capital intelligently deploying free cash flow. Though in a less levered overall environment I would feel comfortable also with a more aggressive business model, in the present environment I prefer to stick to Buffett’s model.

 

Gio

 

Isn't Liberty Media one of your biggest investments?

[jawn619]

I think it's so interesting when people say that buffet never used leverage. Buffet was leveraged almost his whole career at Berkshire through insurance float. Just because he got it at a really cheaply and some years for free(or even negative cost) doesn't mean it wasn't leverage.

[rpadebet]

I think it's so interesting when people say that buffet never used leverage. Buffet was leveraged almost his whole career at Berkshire through insurance float. Just because he got it at a really cheaply and some years for free(or even negative cost) doesn't mean it wasn't leverage.

 

Exactly. He used and continues to use leverage in form of insurance float, tax deferring etc. Getting to his 15% BV growth without these leverages in a 8-9% cost of capital environment is pretty tough even for him.

[giofranchi]

I think in general companies are under levered for the future in this environment (except for some sub sectors). This is why I like capital allocators who aren't scared of debt  in this cycle. If we have a Japan like scenario for next decade or so with minimal organic growth and alternating between modest inflation/deflation, not trying to maximize returns on equity now by levering up a stable underlying business wont seem like a smart decision in 2025.

 

Well, this is another possible view… As you say companies which make extensive use of debt might never run into trouble and might even prosper more than companies which don’t… A judgment outside my circle of competence! ;)

 

Gio

 

[giofranchi]

I think it's so interesting when people say that buffet never used leverage. Buffet was leveraged almost his whole career at Berkshire through insurance float. Just because he got it at a really cheaply and some years for free(or even negative cost) doesn't mean it wasn't leverage.

 

Exactly. He used and continues to use leverage in form of insurance float, tax deferring etc. Getting to his 15% BV growth without these leverages in a 8-9% cost of capital environment is pretty tough even for him.

 

This completely misses my point!

 

Gio

[giofranchi]

Isn't Liberty Media one of your biggest investments?

 

Not anymore. LMCA is not quite leveraged right now, but I think Sirius is and it is too much tied to the auto industry, which I don’t like going forward… I have greatly trimmed my investment in LMCA. Another thing I might come to regret… But, whenever I cannot get comfortable with the downside, I’d better be safe than sorry…

 

Gio

 

[Liberty]

Isn't Liberty Media one of your biggest investments?

 

Not anymore. LMCA is not quite leveraged right now, but I think Sirius is and it is too much tied to the auto industry, which I don’t like going forward… I have greatly trimmed my investment in LMCA.

 

Gio

 

Really interesting to watch this transformation in your style unfold. I'd say that a year or two ago we were quite close in our approaches, but not so much anymore.

 

So if I'm keeping track, you're basically in OAK, FFH, GLRE, and BH, correct?

[giofranchi]

So if I'm keeping track, you're basically in OAK, FFH, GLRE, and BH, correct?

 

I have no investment in GLRE, and a small one in Lancashire, which will grow as my company gives me free cash. I also have a large investment in PSH.

 

I still like both LMCA and VRX very much! I have not changed that much! :) Under the present circumstances, though, I simply prefer the wait and see approach. If everything goes fine and we go on experiencing a so called “good deleveraging”, my companies probably will create some value, but less than LMCA and VRX. If, on the other hand, something goes wrong, I believe the vice versa might be true.

 

Gio

 

[Liberty]

Mike Pearson on CNBC:

http://video.cnbc.com/gallery/?video=3000356706&play=1

http://video.cnbc.com/gallery/?video=3000356688&play=1

[original mungerville]

So if I'm keeping track, you're basically in OAK, FFH, GLRE, and BH, correct?

 

I have no investment in GLRE, and a small one in Lancashire, which will grow as my company gives me free cash. I also have a large investment in PSH.

 

I still like both LMCA and VRX very much! I have not changed that much! :) Under the present circumstances, though, I simply prefer the wait and see approach. If everything goes fine and we go on experiencing a so called “good deleveraging”, my companies probably will create some value, but less than LMCA and VRX. If, on the other hand, something goes wrong, I believe the vice versa might be true.

 

Gio

 

Gio, I am of a similar view on the macro picture.

[original mungerville]

Some smart guy at the 35 minute mark of the conf call asked how they are going to get their target IRR out of this. The answer: We have consistently said our IRR is 20% pre tax synergies, we have obtained this on small/medium acquisitions along with a max cash payback period of 6 years; however, for larger acquisitions like B&L, we expect numbers lower than this with a payback period in higher single digits, we expect something in line with the B&L acquisition.

 

Pretty fuckin' vague if you ask me (relative to Allergan, relative to Dendreon deals, etc).

 

Don't expect as much detail as for Allergan in most deals. From memory, you didn't get it for B&L either, and it turned out fantastic.

 

With Allergan, it was a public relations battle and they had to convince Allergan shareholders and arbs. Here, the deal was sealed without all that, so they don't have to reveal their models and do quite as much handholding.

 

Makes sense.

[original mungerville]

Maybe Salix earnings are depressed and they think they will boost even the normalized number a lot with their operating model. It seems very unlikely to me that Pearson has become undisciplined just after walking away from the Allergan deal. That's what I like about investing with great management, you can give them the benefit of the doubt.

 

That's what it is. Salix's EBITDA is very depressed in 2014 compared to the real earning power. Once they work through the inventory issue, that should normalize. That's why they expect to be able to go from 5.6x to less than 4x in little more than a year.

 

So you figure Salix revenues are very depressed? That must be it because I don't see any other explanation. What are the mechanics of these inventory or other issues depressing current sales? How does working through these renormalize Salix sales?

 

Guys, my triangulating of various facts today have lead me to the following rough estimates:

 

1. The thing I was missing - which got me pretty negative - is that Salix's 2016 revenues are thought to be around $2.2 billion (according to BMO Capital Markets); 2015 revenues are harder to determine because of the inventory work through; 2013 revenues were around $1 billion (this is what really made me wonder how this acquisition made any sense). In any case, once 2015 is over, 2016 revenues should jump for Salix. On that number, under Valeant, $1-1.5 should be owner earnings.

 

2. Valeant's other businesses will probably do $3.5 to 4 billion of owner earnings by 2016.

 

3. Grand total: somewhere in the $5 billion range +/-

 

4. Enterprise value: $90 billion (60 billion market cap and 30 billion debt); interest expense of $30 billion times say 6% or 1.8 billion; 90 / 6.8 billion = about 13x multiple.

 

5. Forward P/E estimate: In terms of owner earnings per share, Pearson had stated 2016 of $12 per share; but more growth and other recent acquisitions (excluding Salix) that will be higher - I'll guess $13 per share. Salix is projected to add 20% to that. So $15.60 per share for 2016. Current stock price is $200 per share. $200/15.6 is a p/e = 13x as well.

 

6. Both 4 and 5 lead me to a 2016 forward multiple of 13x times both from an equity and enterprise value perspective.

 

7. Furthermore, as Salix's earnings will grow faster (15%?) than Valeant's existing organic biz growth (say 8%?), and Salix earnings will be 20 to 25% of total Valeant earnings, the owner earnings going forward after 2016 should grow organically a little faster now, maybe a little over 1% faster overall. So if you thought Valeant earnings were growing 10% organically, you should now expect 11% growth post 2016 with the Salix acquisition; if you thought 8%, it may now be 9 or 9.5%.

 

8. Post 2016, taking a very conservative view, and we assume organic earnings growth of only 5-10%, then Valeant reinvests those annual already growing earnings into acquisitions at a conservative IRR of 15% with tax benefit getting them to 20%, I still see overall earnings growing 25-30% (ie 5-10% plus 20%) annually.

 

In conclusion, a 13x multiple based on 2016 owner earnings which earnings can quadruple (ie 25-30% growth is a double every 3 years) by 2022 may STILL not be too high a price to pay now. You really have to be a believer in Pearson to make these projections - which I am.

 

Certainly it is clear the stock in the low 100s last year was a steal - after all Lou Simpson bought in, Value Act added, and Sequoia kept their Valeant stake at in excess of 20% of their entire fund. While we were buying, several investment greats were as well.

 

What I keep debating is not whether to buy (I did) but how big to make this stake.

 

"The most extreme mistakes in Berkshire’s history have been mistakes of omission. We saw it, but didn’t act on it. They’re huge mistakes — we’ve lost billions. And we keep doing it. We’re getting better at it. We never get over it. There are two types of mistakes: 1) doing nothing; what Warren calls "sucking my thumb" and 2) buying with an eyedropper things we should be buying a lot of." -Charlie Munger

 

found at http://www.valueinvestingworld.com/

 

 

 

 

 

 

 

Not crazy expensive