VRX - Valeant Pharmaceuticals International Inc.

[Liberty]

Yes, the quote may be out of context.

 

But I wasn't talking about growth for growth's sake.  More that, compared to the baseline CEO, a CEO that would make that kind of statement is about 100x more likely to be fudging the numbers or doing something else nefarious.  Maybe it is out of context and doesn't mean anything, but that line popped out at me more than anything else I read in Grant's.  Maybe he is the Buffett of biotech, but Buffett wouldn't say something like that.

 

It's clear that if this is the only thing you know about management, it's a red flag. And I agree to some level, it's not my favorite thing that he's said. But what matters is meaning. I think that in this case, the words look worse than the meaning, because most people who would say this are empire builders, but he's clearly not like that. They put that on a slide of aspirational goals and everybody jumped on it. They had a similar aspirational goal a few years ago (which they reached profitably), but I don't think it made waves back then because nobody thought they could do it.

 

If having these kinds of ballpark goals motivates him and his team without resulting in bad behavior, I'm all for it. But if I start seeing bad behavior, then I'll be out.

 

The main difference between saying that and Buffett saying that he's always looking for big elephants is that he's quantified the size of what he's looking for a bit more, but as long as they both are disciplined about creating value, I don't think it's a problem. If you didn't know that Buffett had the right approach, saying that he is looking to do multi-billion-dollar acquisitions could be worrying too...

 

VRX has been saying for a while that they're interested in doing a merger of equals (iirc, they almost did one but walked away), and that this deal would probably be mostly equity to delever. If they almost double in size just from that, it wouldn't take that much more growth and smaller acquisitions to reach that ±150b size. But if they don't reach it, I don't think management will care that much... And if that merger of equals provides anything near the benefits that they brought to previous deals (getting a good price, cost cutting, benefits from lower tax, their more efficient approach to products and R&D, etc), that could be a lot of value creation per share.

 

Basically, VRX has a different model than most of the industry. If you believe that their model is superior at creating value and that the current management is good at executing it, then it follows that they should swallow other companies that are a good fit and integrate them into their model because these businesses are more valuable inside valeant than outside. But if that's incorrect, we should be seeing signs strain over time. I haven't seen them yet, but I'm certainly keeping my ear to the ground.

[wbr]

From that Grant's short piece, he quotes the CEO as saying that he wanted to make Valeant "one of the top-five most valuable pharmaceutical companies as measured by market cap by the end of 2016.  This equates to roughly $150 billion in market cap." 

 

I don't know, but do you ever want to see a CEO make a proclamation like this?

 

If that was the only thing he said, absolutely not.

 

But if you listen to all that he's saying and not just one thing out of context, you'll see that he's absolutely not an empire builder. He repeatedly talks about how their first criteria for anything is financial, and if a deal doesn't hit their return targets (and they are conservative with those, giving no value to future products, extra synergies, etc), they won't do it even if it's strategic, otherwise attractive, or if everyone else is doing it. They said that they're agnostic about markets and products and don't feel they have to be in anything, and that they only do deals when they are the only ones at the table, they don't participate in auctions or bidding wars. Management is compensated on long-term per-share metrics and gets not benefit from growing unprofitably.

 

Basically, growth for growth's sake is bad. But profitable growth is very good, so I'm glad that they have big ambitions while staying disciplined.

 

Yes, the quote may be out of context.

 

But I wasn't talking about growth for growth's sake.  More that, compared to the baseline CEO, a CEO that would make that kind of statement is about 100x more likely to be fudging the numbers or doing something else nefarious.  Maybe it is out of context and doesn't mean anything, but that line popped out at me more than anything else I read in Grant's.  Maybe he is the Buffett of biotech, but Buffett wouldn't say something like that.

 

Maybe I misunderstood you, but to me you are implying that a CEO who clearly communicates his goals/plans to the public has a much higher likelyhood of being a fraud than the average CEO who primarily minimizes his career risk but not saying anything that might get him fired down the road. It seems to me that it is exactly the other way around. A CEO who doesnt tell you anything more than the formal announcements of earnings etc..is much more likely to be imcompetent and maybe "nefarious".

 

Also I can assure you that Buffet is in favor of executives setting goals for themselves, because there has to be a way to measure performance. He didnt tell you how big he wanted Berkshire to be in year t. He just tells you his goal for bookvalue growth, which is actually the same! The goal is not fixed (but neither is Pearsons goal of being in the top 5 pharma market caps) since it is set relative to the S&P500, but when it is "S&P500 + 5%" and the realized return of the S&P over the last 10 years is 6% then you know that Buffet thereby wanted to grow BV by 184% over those 10 years which gives you an exact target for the size of the company.

 

[constructive]

Isn't it possible that VRX has acquired companies at good prices, yet VRX is overpriced?

 

Mr. Pearson answering if Valeant is going to use its stock as currency for future acquisition:

And as we’ve always said, we think that our stock is our most valuable asset. And we are going to be very, very careful using it because we think it’s extremely undervalued, given our growth prospects.

--Q4 2013 Earnings Call February 27, 2014

 

Gio

 

Yes, as others have pointed out it is a bit promotional to predict a $150B market cap and claim that your stock is extremely undervalued. Communicating business goals is good, but promoting the stock is bad.

 

And it doesn't make any sense to say that stock is their most valuable asset. That's only true if the stock is overpriced and they are willing to use it as currency. If the stock is underpriced, then patents and brands are their most valuable asset.

[Liberty]

And it doesn't make any sense to say that stock is their most valuable asset. That's only true if the stock is overpriced and they are willing to use it as currency. If the stock is underpriced, then patents and brands are their most valuable asset.

 

He obviously meant that they feel that by paying with stock, they risk giving away more value than they are getting, thus diluting shareholders. If the stock was overvalued, it would be less valuable to them because they would be giving away less value by growing the number of shares.

 

f.ex. If IV is 10 and share price is 5, it costs you a lot more value for a fixed nominal price paid in new shares than if the IV is 10 and the price is 20.

[Guest wellmont]

Isn't it possible that VRX has acquired companies at good prices, yet VRX is overpriced?

 

Mr. Pearson answering if Valeant is going to use its stock as currency for future acquisition:

And as we’ve always said, we think that our stock is our most valuable asset. And we are going to be very, very careful using it because we think it’s extremely undervalued, given our growth prospects.

--Q4 2013 Earnings Call February 27, 2014

 

Gio

 

Yes, as others have pointed out it is a bit promotional to predict a $150B market cap and claim that your stock is extremely undervalued. Communicating business goals is good, but promoting the stock is bad.

 

And it doesn't make any sense to say that stock is their most valuable asset. That's only true if the stock is overpriced and they are willing to use it as currency. If the stock is underpriced, then patents and brands are their most valuable asset.

 

when was the last time you saw VRX CEO "pumping" the stock on bubblevision? he did not "predict" a $150b valuation. He said he "wanted" a $150b valuation. that would mean he found an elephant that fits his criteria.  there is a distinction there. It's like buffett saying he wants to bag an elephant. If you can link to an interview of the CEO I would love to watch it. cuz I haven't seen him give any interviews. however, I have seen a lot of the ebix CEO on youtube. I think he has his own channel.

[giofranchi]

The stock price of this thing is coming down, and it is fast approaching the level I would buy more… and aggressively! But also LRE stock price right now is very low, I wouldn’t sell any of my FFH holdings, because they will be much more valuable in the future, nor I would sell any of my BH holdings, because they are cheap, and I wouldn’t sell any of my ALS holdings.

 

Thanks God I have a lot of cash! And yet, people continue to think that cash is nothing but a drag on performance… Really, I don’t understand… ::)

 

Gio

 

[Guest hellsten]

The stock price of this thing is coming down, and it is fast approaching the level I would buy more… and aggressively! But also LRE stock price right now is very low, I wouldn’t sell any of my FFH holdings, because they will be much more valuable in the future, nor I would sell any of my BH holdings, because they are cheap, and I wouldn’t sell any of my ALS holdings.

 

Thanks God I have a lot of cash! And yet, people continue to think that cash is nothing but a drag on performance… Really, I don’t understand… ::)

 

Gio

 

Because I hate money I eventually want to lose all I have. This year I have studied chart reading and technical analysis because I failed to achieve my goals with value investing. Can anyone explain this stock's performance from 2009 to today? Was VRX close to bankruptcy in 2009, or did Mr. Market figure out how good VRX and its management are?

 

This chart looks scary:

http://finance.yahoo.com/echarts?s=VRX+Interactive#symbol=VRX;range=my

 

I'm also wondering where the Adaptive Prize Zone (APZ) is.

 

Thank you in advance ;)

[giofranchi]

Because I hate money I eventually want to lose all I have. This year I have studied chart reading and technical analysis because I failed to achieve my goals with value investing. Can anyone explain this stock's performance from 2009 to today? Was VRX close to bankruptcy in 2009, or did Mr. Market figure out how good VRX and its management are?

 

This chart looks scary:

http://finance.yahoo.com/echarts?s=VRX+Interactive#symbol=VRX;range=my

 

I'm also wondering where the Adaptive Prize Zone (APZ) is.

 

Thank you in advance ;)

 

Well, VRX before 2008, before Mr. Pearson came in and changed everything, was a completely different company. It was, to make an easily understandable comparison, BRK before Mr. Buffett came in.

 

The new business model Mr. Pearson implemented has value investing at its core, with a flare of activist involvement, in an industry full of inefficiencies. The business model has been very often and very clearly explained by Mr. Pearson, and I don’t see any evident flaws. The stock price is justified by the results achieved thanks to that new business model.

 

Of course, if they are cooking the books and reporting Cash EPS that are not real but much inflated, then I have been deceived. If someone who speaks so plainly and openly about the goals and dynamics of his business, as Mr. Pearson does, is a fraud, then anyone might be deceiving and no one might be truly trusted. Unfortunately, without trust business itself becomes impossible. And without business chart reading and technical analysis would not exist… because, what would you be “reading” then? ;)

 

Gio

 

[Guest hellsten]

Of course, if they are cooking the books and reporting Cash EPS that are not real but much inflated, then I have been deceived. If someone who speaks so plainly and openly about the goals and dynamics of his business, as Mr. Pearson does, is a fraud, then anyone might be deceiving and no one might be truly trusted. Unfortunately, without trust business itself becomes impossible. And without business chart reading and technical analysis would not exist… because, what would you be “reading” then? ;)

 

Gio

 

Thank you. Sequoia Fund would also have been deceived, which is unlikely.

[frommi]

Of course, if they are cooking the books and reporting Cash EPS that are not real but much inflated, then I have been deceived.

 

I probably don`t know enough about accounting but an m-score of -1.98 says they do.

And a 2% free cashflow yield and doesn`t look very appealing at the moment.

I would never touch a stock when Chanos is on the short side, just to be safe. (and especially when it has gone up tenfold in three years)

 

But with Sequoia on the other side, i should just shut my mouth because what do i know?

[giofranchi]

Of course, if they are cooking the books and reporting Cash EPS that are not real but much inflated, then I have been deceived.

an m-score of -1.98 says they do.

 

Mr. Malone probably had an M score greater then –2 all his life! ;D

 

I don’t think it works that way. If you have a sound business model, you know very well you are going to make much more money being honest, than being dishonest.

 

And, as I have said, I don’t see any flaw in Mr. Pearson’s business model. If someone might point me out a weakness that has escaped my attention, I would gladly take notice and reevaluate my thesis about VRX.

 

An M score certainly is not enough! ;)

 

Gio

 

[giofranchi]

By the way, show me a company, which has made as many acquisitions as VRX in the last 5 years, that sports a better M score! ;)

 

Gio

[frommi]

By the way, show me a company, which has made as many acquisitions as VRX in the last 5 years, that sports a better M score! ;)

 

Gio

 

Can you explain to me why it has an effect on the m-score or point me to a website where it is explained?

 

[giofranchi]

Can you explain to me why it has an effect on the m-score or point me to a website where it is explained?

 

Well, just look at how the 8 different indices, which combined give the M score, are calculated, and I think it is clear that many distortions are inevitable when lots of acquisitions enter the equation…

In fact, they are ratios of year X to year X-1, and therefore they implicitly assume a steady business regime… Steadiness that instead gets shaken each time a new acquisition is made!

And this is the very same reason why Cash EPS are the true measure of VRX’s profitability, not FCF.

 

Gio

 

[no_free_lunch]

Mr. Pearson answering if Valeant is going to use its stock as currency for future acquisition:

 

    And as we’ve always said, we think that our stock is our most valuable asset. And we are going to be very, very careful using it because we think it’s extremely undervalued, given our growth prospects.

--Q4 2013 Earnings Call February 27, 2014

 

Gio

 

I am somewhat bullish on the company right now at these prices but the fact is that they have used stock for their most recent acquisition of Bausch and Lomb.  I think about 20% of the purchase price was raised by issuing shares.  Now this isn't to say that it wasn't a smart move, I mean look at the share price since that acquisition!  Just saying that he definitely will issue shares when need be.

 

One of the ratings agencies just put out a statement that if they buy a generic drug manufacturer they will likely rate the debt as junk.  So if anything the next acquisition will likely require an even larger share issuance.

 

Pearson knows this and is probably just trying to get the stock price up so he can minimize the dilution. 

 

The thing is though, as long as the deals are accretive who cares if he issues stock?

[no_free_lunch]

Frommi,

 

I think FCF is a good metric but it is just obscured right now by the acquisitions.  If they stopped making acquisitions, you should have a FCF yield of around 7-8% at these prices.

[cubsfan]

Because I hate money I eventually want to lose all I have. This year I have studied chart reading and technical analysis because I failed to achieve my goals with value investing. Can anyone explain this stock's performance from 2009 to today? Was VRX close to bankruptcy in 2009, or did Mr. Market figure out how good VRX and its management are?

 

This chart looks scary:

http://finance.yahoo.com/echarts?s=VRX+Interactive#symbol=VRX;range=my

 

I'm also wondering where the Adaptive Prize Zone (APZ) is.

 

Thank you in advance ;)

 

Well, VRX before 2008, before Mr. Pearson came in and changed everything, was a completely different company. It was, to make an easily understandable comparison, BRK before Mr. Buffett came in.

 

The new business model Mr. Pearson implemented has value investing at its core, with a flare of activist involvement, in an industry full of inefficiencies. The business model has been very often and very clearly explained by Mr. Pearson, and I don’t see any evident flaws. The stock price is justified by the results achieved thanks to that new business model.

 

Of course, if they are cooking the books and reporting Cash EPS that are not real but much inflated, then I have been deceived. If someone who speaks so plainly and openly about the goals and dynamics of his business, as Mr. Pearson does, is a fraud, then anyone might be deceiving and no one might be truly trusted. Unfortunately, without trust business itself becomes impossible. And without business chart reading and technical analysis would not exist… because, what would you be “reading” then? ;)

 

Gio

 

I can't imagine you are going to slip a shoddy business model past Jeffery Ubben at ValueAct.

[frommi]

Frommi,

 

I think FCF is a good metric but it is just obscured right now by the acquisitions.  If they stopped making acquisitions, you should have a FCF yield of around 7-8% at these prices.

 

Ok thanks for the explanations, i just wait until i see a clear picture in the numbers. For me this is a black box at the moment where i don`t know if i buy cheap or expensive.

[no_free_lunch]

Frommi,

 

I hear you.  The accounting is definitely a mess and I am somewhat suspicious how well any analyst really understands it.  However the cost cuts , the tax advantage and the growth rates are real so I think the room for suspicion on the numbers is small enough that I can buy into it.

 

The real issue for me is whether the hack and slash to R&D and other costs is overdone or not.  It is true that they don't have patent issues but they do have competition nevertheless.  With all the cost-cuts there is also the risk for a blow-up with one of their existing products.  It's very speculative of me but when you start cutting costs this aggressively existing staff quit and you can end up with second tier people who don't know what they are doing.  At least that has been my personal experience in my industry.  In my mind, the valeant story is still a little too early to tell if their cost-cutting makes sense from an operations perspective.

 

So I like the stock and think it will likely go up but I have enough suspicions that I always wrap it in options should it ever blow up.

[Liberty]

One of the ratings agencies just put out a statement that if they buy a generic drug manufacturer they will likely rate the debt as junk.  So if anything the next acquisition will likely require an even larger share issuance.

 

They've been pretty clear about that. One of their goals for the year is to reduce their leverage below 4x EBIDTA, and if they do a big merger of equals, it'll probably be done with stock to delever.

 

But based on their track record, if they can't get more value over the long-term than they have to give, they won't do it, so I'm not too worried  about them issuing stock.

[Guest wellmont]

Can you explain to me why it has an effect on the m-score or point me to a website where it is explained?

 

Well, just look at how the 8 different indices, which combined give the M score, are calculated, and I think it is clear that many distortions are inevitable when lots of acquisitions enter the equation…

In fact, they are ratios of year X to year X-1, and therefore they implicitly assume a steady business regime… Steadiness that instead gets shaken each time a new acquisition is made!

And this is the very same reason why Cash EPS are the true measure of VRX’s profitability, not FCF.

 

Gio

any meaningful acquisition, like a merger of equals, would produce a bad M score. I would not invest based on the m score.

[giofranchi]

The real issue for me is whether the hack and slash to R&D and other costs is overdone or not.  It is true that they don't have patent issues but they do have competition nevertheless.  With all the cost-cuts there is also the risk for a blow-up with one of their existing products.  It's very speculative of me but when you start cutting costs this aggressively existing staff quit and you can end up with second tier people who don't know what they are doing.  At least that has been my personal experience in my industry.  In my mind, the valeant story is still a little too early to tell if their cost-cutting makes sense from an operations perspective.

 

Yours undoubtedly is an entrepreneurial question. And the answer can only be another question: do you trust Mr. Pearson’s abilities as an entrepreneur, or do you trust them not? If you trust them, you believe he will cut non-strategic costs aggressively, while keeping strategic costs in place, or even increasing them. That’s what a great entrepreneur does.

How can you develop trust in an entrepreneur? By listening at what he says, and by looking at the results of what he does. And by judging if what you hear and see is worthy of your esteem.

 

Gio

 

[giofranchi]

I can't imagine you are going to slip a shoddy business model past Jeffery Ubben at ValueAct.

 

Sorry, I am not sure I understand what you mean... Can you elaborate a bit further?

 

Thanks!

 

Gio

[cubsfan]

I can't imagine you are going to slip a shoddy business model past Jeffery Ubben at ValueAct.

 

Sorry, I am not sure I understand what you mean... Can you elaborate a bit further?

 

Thanks!

 

Gio

 

Gio

 

ValueAct takes large concentrated positions in companies they understand well - and that they can get board seats in to effect change.

ValueAct was instrumental in replacing the Valeant CEO and recruiting Michael Pearson for the rollup strategy. They own around 7%

of company and have been buying up large amounts of stock for last few years. As a firm, they typically have around 10 holdings

and VRX is their 2nd largest holding. They establish a constructive dialog with other board members before effecting change.

They know their companies inside out and will not attempt to get a control position and board seats unless management/board are

willing to change. When they do become involved, they are active in CEO compensation and insist the correct financial metrics

are implemented - ROE and capital allocation in regards to M&A and growth.

 

Just look at the recent influence they have had on Microsoft (now their largest holding) since becoming involved. They are extremely

well respected and influential  in the institutional money management business - and are widely suspected of helping to force out Balmer.

 

They know VRX inside out and Michael Pearson is their handpicked CEO - they are not short timers looking for a quick flip.

They are hard core value investors that build longterm value.

 

http://www.marketwatch.com/story/ubbens-latest-move-another-acquisition-2011-03-30

 

 

[giofranchi]

Gio

 

ValueAct takes large concentrated positions in companies they understand well - and that they can get board seats in to effect change.

ValueAct was instrumental in replacing the Valeant CEO and recruiting Michael Pearson for the rollup strategy. They own around 7%

of company and have been buying up large amounts of stock for last few years. As a firm, they typically have around 10 holdings

and VRX is their 2nd largest holding. They establish a constructive dialog with other board members before effecting change.

They know their companies inside out and will not attempt to get a control position and board seats unless management/board are

willing to change. When they do become involved, they are active in CEO compensation and insist the correct financial metrics

are implemented - ROE and capital allocation in regards to M&A and growth.

 

Just look at the recent influence they have had on Microsoft (now their largest holding) since becoming involved. They are extremely

well respected and influential  in the institutional money management business - and are widely suspected of helping to force out Balmer.

 

They know VRX inside out and Michael Pearson is their handpicked CEO - they are not short timers looking for a quick flip.

They are hard core value investors that build longterm value.

 

http://www.marketwatch.com/story/ubbens-latest-move-another-acquisition-2011-03-30

 

Great! ;)

 

Thank you very much!

 

Gio