VRX - Valeant Pharmaceuticals International Inc.

[Guest Schwab711]

@roark: I really believe VRX could experience a "death spiral" if there's a run on their debt. Look at my previous posts for more detail, but they have >$26b (of their $30b) in debt maturing between 2018-2023. They set themselves up for a huge liquidity crunch each year during that period.

 

They were able to pay down $2B last year and have added cash generating assets since then so they shouldn't be too worried until 2020.

 

How did you arrive at 2020? Debt maturing in 2018 is larger than the estimated amortization charges, so they have to make GAAP profit between now and then to cover the difference (or rely on the ability to refi). I'm pretty sure they will need to refinance regardless (unless GAAP profit >$2b or so). I really think it's worth creating a treasury schedule for VRX to see this for yourself. They face many potential liquidity issues over at least the next 8 years. They will have <$0 FCF each year for at least the next 6 years, assuming double-digit growth (it's probably fair to say, at this moment, that price increases will be more difficult during this time). Liquidity is the by far the biggest problem for the next decade.

 

This is why Cash EPS is misleading. It doesn't really represent "earnings power" because they shouldn't add back any amortization that coincides with terminating revenue streams (which is all of their amortization charges). It is a real expense that is necessary to account for debt repayment and they have to repay nearly all of their debt before Salix IP expires in 2029 - which is not as far away as you'd think. I also think they should only add back a small portion of their interest paid, not the whole expense, for similar reasons.

 

FCF will never come close to projected Cash EPS for at least the next decade. All of this FCF has to repay debt anyway. The stock looks insanely overvalued with amortization and interest adjustments. It doesn't make any sense to use multiples to value VRX anyway (just like GILD), since durable products will make up a small and decreasing % of revenue after SLXP. Folks are valuing VRX like it is still on the JNJ path.

 

I really do like VRX's portfolio and Pearson. I just think they severely over-inflated expectations with Cash EPS.

[KCLarkin]

How did you arrive at 2020?

 

This is a highly levered stock. Saying they will have a liquidity crunch in 2018 if they can't refinance, don't have FCF, and don't have GAAP earnings is true, of course. Just depends on how strongly you believe in those 3 assumptions.

 

[ccplz]

A lot of tears from VRX longs.

 

I love it.

[Guest Schwab711]

How did you arrive at 2020?

 

This is a highly levered stock. Saying they will have a liquidity crunch in 2018 if they can't refinance, don't have FCF, and don't have GAAP earnings is true, of course. Just depends on how strongly you believe in those 3 assumptions.

 

But I did the exact opposite. I'm assuming everything is fine and growth continues and I'm still arriving at $0 FCF for a significant period and potential refi issues. That's why I think Cash EPS is so problematic.

[JoeDawg]

"Be Fearful When Others Are Greedy and Greedy When Others Are Fearful."

 

I am feeling a bit greedy today.. ;)

[Picasso]

I think most stable businesses will have a 2.5x EBITDA multiple of outstanding debt.  At 4.5-5x, you will definitely lack free cash if it all went to debt repayment.

 

But I think you tend to see a combination of debt repayment + refinance and it's fairly dynamic depending on the opportunity set.  So looking at it from "they earn nothing if you pay back debt" is true but doesn't usually happen in the corporate finance world. 

 

This is a public stock that is essentially a vintage 2008 private equity deal.  The stock fluctuates with the value coming back to the private equity partners (in this case shareholders).  The high leverage is why you often get so much volatility.  Leverage is definitely on the high side for any durable business.

 

In theory they could delever by purchasing a non-levered pharma using their stock as a currency.  AGN is too big for them now, but it has no net debt.  That's one way around the debt picture that I could see them doing one day.

 

Credit default swaps on VRX aren't that high yet.  350 bps from last Friday on 5Y (don't know where they trade today), but if you were going to bet against VRX it might be better to go through the CDS market.  If they'll always keep a high amount of leverage there isn't a lot of downside, but you get the upside if it gets ugly.

[S2S]

For those who insist on VRX's party line that only a small portion of its portfolio is subject to price increases: http://valeantpricing.com/

[Guest Schwab711]

I think most stable businesses will have a 2.5x EBITDA multiple of outstanding debt.  At 4.5-5x, you will definitely lack free cash if it all went to debt repayment.

 

But I think you tend to see a combination of debt repayment + refinance and it's fairly dynamic depending on the opportunity set.  So looking at it from "they earn nothing if you pay back debt" is true but doesn't usually happen in the corporate finance world. 

 

You are absolutely correct if we were talking about a debt-intensive company in just about any other industry. Your quote makes sense if the debt was used to create highly stable and predictable revenue streams backed by real assets that do not expire. If VRX were to refi all their debt between 2018-2023 to beyond 2030 then they would have no means to repay the debt since >~90% of the current revenue will have expired. That is the major difference between high pharmaceutical debt and debt for other industries. Every other major pharmaceutical company with expiring IP has a Net-Debt:EBITDA ratio of -1 to 1. VRX's is 7.0x.

 

The potential liquidity crunch is a very real issue and low stock/bond prices will only enhance the problem. I've mentioned this before, but VRX has net negative cumulative GAAP earnings since 1/1/2010. Also, >100% of cumulative Cash EPS since 2010 is from amortization + interest. A true view of "earnings power" would not add back either of these expenses solely due to the expiring IP.

 

 

For what it's worth, I had a recent issue with Fidelity. If I didn't, I would have bought Jan 16' puts about two weeks ago when shares were at $225. I really don't like the idea of betting on price deceases (or movement in general) but VRX was going to be the exception for me because I think the liquidity problems are so severe. I will finally be able to buy puts by the end of the week, but after today's drop I don't think it makes as much sense to do so anymore. I do think VRX is worth >$0 (assuming projected growth). I really wanted to back up my negative comments with real money.

[Picasso]

I think most stable businesses will have a 2.5x EBITDA multiple of outstanding debt.  At 4.5-5x, you will definitely lack free cash if it all went to debt repayment.

 

But I think you tend to see a combination of debt repayment + refinance and it's fairly dynamic depending on the opportunity set.  So looking at it from "they earn nothing if you pay back debt" is true but doesn't usually happen in the corporate finance world. 

 

You are absolutely correct if we were talking about a debt-intensive company in just about any other industry. Your quote makes sense if the debt was used to create highly stable and predictable revenue streams backed by real assets that do not expire. If VRX were to refi all their debt between 2018-2023 to beyond 2030 then they would have no means to repay the debt since >~90% of the current revenue will have expired. That is the major difference between high pharmaceutical debt and debt for other industries. Every other major pharmaceutical company with expiring IP has a Net-Debt:EBITDA ratio of -1 to 1. VRX's is 7.0x.

 

The potential liquidity crunch is a very real issue and low stock/bond prices will only enhance the problem. I've mentioned this before, but VRX has net negative cumulative GAAP earnings since 1/1/2010. Also, >100% of cumulative Cash EPS since 2010 is from amortization + interest. A true view of "earnings power" would not add back either of these expenses solely due to the expiring IP.

 

 

For what it's worth, I had a recent issue with Fidelity. If I didn't, I would have bought Jan 16' puts about two weeks ago when shares were at $225. I really don't like the idea of betting on price deceases (or movement in general) but VRX was going to be the exception for me because I think the liquidity problems are so severe. I will finally be able to buy puts by the end of the week, but after today's drop I don't think it makes as much sense to do so anymore. I do think VRX is worth >$0 (assuming projected growth). I really wanted to back up my negative comments with real money.

 

Guidance is for $7.5 billion of EBITDA (questionable whether they hit it or not), so it stands at 4x or so.  Cumulative GAAP earnings are probably not the best indicators of debt repayment ability when the company has large amortization expenses.  This would apply to any business which buys up a ton of goodwill and it depends on how durable you think the products are.  I think there will be extra expense from goodwill write downs at some point but that's a non-cash expense for several years.

 

The question is what the $30 billion of debt bought VRX.  If they do earn $7.5 billion of EBITDA then it probably bought them a lot.  And judging by the massive run up in the stock since 2008, issuing debt was a major part of that success.  Is 12x EBITDA an expensive price?  It sort of depends on their reinvestment rates, tax rates, interest expenses in the future, etc.

 

And for everyone showing % changes in drug prices, can we also see $'s? Percentage changes are not that helpful and are like shouting fire in a crowded theatre.

 

As for leverage ratios versus other pharmas, I took a look at a few while trying to figure out the R&D comparisons and they generally have very volatile businesses.  Look at how much cash flow Gilead produces but it comes from pretty much one expiring product.  Pfizer had several years of growing pains post Lipitor.  I don't know if they keep lower leverage ratios for this reason, but they are run very differently.

[Liberty]

For those who insist on VRX's party line that only a small portion of its portfolio is subject to price increases: http://valeantpricing.com/

 

Where do they say how much of the portfolio those repesent?

[Liberty]

since >~90% of the current revenue will have expired

 

Where do you get that from? Haven't we addressed this enough times already? Why do you write as if all Valeant products are patent-protected and facing generics competition?

 

You think their branded generics will become even more generic? That generics makers will start targeting tiny drugs in foreign countries, contact lenses, skin creams, and medical devices? That no product can get expanded protection from reformulation work and line extensions? That they aren't launching many new products (with patents) every year?

[Guest Schwab711]

since >~90% of the current revenue will have expired

 

Where do you get that from? Haven't we addressed this enough times already? Why do you write as if all Valeant products are patent-protected and facing generics competition?

 

You think their branded generics will become even more generic? That generics makers will start targeting tiny drugs in foreign countries, contact lenses, skin creams, and medical devices? That no product can get expanded protection from reformulation work and line extensions?

 

Actually your link has slides from the presentation I used to arrive at the number (along with other figures they have released). As you mention, I have already defended this assumption numerous times by saying that it is quite possible that a compound will not have competition after expiration. However, if we are going to estimate the value I'd rather be conservative and assume competition then not (since presumably they thought it was worth patenting). I really don't understand why this is so controversial since this is exactly how sell-side does their research for pharmaceutical companies.

 

If you follow your link, the 2nd slide states that durable revenue accounts for 26% of total 2014 revenue. In that same presentation, where they break out generics they show that organic growth for generics is 2-3% v. 8-12% for VRX as a whole. If you add in the rev from the SLXP acquisition (100% of rev is non-durable) + 2015 revenue growth of durables and non-durables, you will arrive at >90%.

 

I have also showed before that nearly all of the top 20 products, by revenue, rely on patent protection (I think 16 or 17 out of the 20 and it should be 18 or 19 by end of 2016). The claim that durable product revenues insulate them is misleading.

[Picasso]

I think the slide was saying 26% of revenue, coming from the rx revenue segment. So around 15-16% of total given rx is at 41% of the total.

 

Edit: Around 40% of rx is non durable according to management, so given rx is at 41% if total you have 16% non durable.

[Liberty]

If you follow your link, the 2nd slide states that durable revenue accounts for 26% of total 2014 revenue.

 

You are misreading it, I believe.

 

They mean that ±60% of rx revenues are durable, and that this 60% of rx represents ±26% of total. That's just the rx and durable, not the total durable.

[original mungerville]

So three things happened today to affect VRX's price:

 

1) biotech sells off,

2) potential subpeona on pricing for Valeant,

3) junk bonds sell off causing a continued sell off in "platform / roll-up" companies more generally

 

Stock is now selling at less than 10x expected 2016 cash earnings per share, although they have a big load of debt.

 

I had call LEAPS on Valeant at higher prices (the notional of which was fully hedged against the S&P) and given the 35% drop here in the price of VRX over the past week or two, I decided it was time to reload today and lower my strike price on the call LEAPS - effectively I increased my long position in relation to Valeant. Let's see how this works out. If it falls another 35% to around 6-7 times 2016 earnings, I'll do the same thing.

 

EBITDA is growing, they are expecting $7.5 billion next year. They have the option to slow acquisitions and focus on debt repayment while EBITDA grows. I am not sure I want to see share purchases of Valeant stock, I would rather see debt repayment and/or build cash up for future acquisitions.

 

I am maintaining puts on the S&P because I think it is going to get a lot uglier than this for the general market. No or very few stocks will be spared (ie that would include downward pressure on Valeant going forward) in my view.

 

[original mungerville]

BTW Ackman's portfolio must be getting hammered right now - I believe he was long a lot of platform companies. Possibly overly concentrated in this area. Hopefully he has some puts somewhere.

[Valueguy134]

I think for those looking to buy on the dip because"If there's blood in the street....." should step back and see if this is a fundamental problem going forward or just a blip. If you have the high potential for a regulator to come in and stamp out parts of the business model, I would have to think if the valuation is warranted. While the drugs with high multipliers are something like 10-15% of revenues, would it be unreasonable to think the regulatory body puts a cap across the board and we see price reductions on everything, bringing the US inline with the rest of the world, since they have pharma in their sights. Additionally, what happens to future deal making......I can't imagine it will be as easy going forward with every investor eyeing the targets like a hawk.

 

[KCLarkin]

http://www.bloomberg.com/news/articles/2015-09-28/bond-market-punishes-valeant-as-house-democrats-seek-subpoena

 

 

[KCLarkin]

If you have the high potential for a regulator to come in and stamp out parts of the business model

 

There is a massive difference between a regulator and a legislator. A regulator enforces EXISTING laws. A legislator creates NEW ones. Presumably, Clinton would need to pass legislation through a Republican House and Senate. Good luck...

 

Correct me if I am wrong. As a Canadian I admit my ignorance of the U.S. health system.

[Liberty]

I think for those looking to buy on the dip because"If there's blood in the street....." should step back and see if this is a fundamental problem going forward or just a blip. If you have the high potential for a regulator to come in and stamp out parts of the business model, I would have to think if the valuation is warranted. While the drugs with high multipliers are something like 10-15% of revenues, would it be unreasonable to think the regulatory body puts a cap across the board and we see price reductions on everything, bringing the US inline with the rest of the world, since they have pharma in their sights. Additionally, what happens to future deal making......I can't imagine it will be as easy going forward with every investor eyeing the targets like a hawk.

 

By design, most of valeant's sales don't have government reimbursement, they are cash pay, so they are not particularly vulnerable.

 

But if the government could somehow affect all prices across the board regardless of how products are paid for, then Valeant would be far from alone in having problems, the whole industry would be in upheaval. I'd guess those with fat SG&A, high R&D, smaller sales outside the US, and lower margins would be hit harder than Valeant, though...

[Picasso]

Yeah that would be one good way to really kill off R&D.  Everyone might be talking about Valeant, but the kind of proposal to hit the other 85% of their sales would make every other pharma lobby like crazy.  You'd pretty much kill off the pharma and biotech industry.

 

 

[Picasso]

The funny thing is, everyone got upset when Abbvie and Pfizer tried to do a tax inversion.  They backed off and no one is talking about that anymore.

 

Now people are focused on some kid who was trolling the system with some 70 year old drug as a reason to send the entire industry into the crapper.

 

You can't make this stuff up.

[original mungerville]

I think for those looking to buy on the dip because"If there's blood in the street....." should step back and see if this is a fundamental problem going forward or just a blip. If you have the high potential for a regulator to come in and stamp out parts of the business model, I would have to think if the valuation is warranted. While the drugs with high multipliers are something like 10-15% of revenues, would it be unreasonable to think the regulatory body puts a cap across the board and we see price reductions on everything, bringing the US inline with the rest of the world, since they have pharma in their sights. Additionally, what happens to future deal making......I can't imagine it will be as easy going forward with every investor eyeing the targets like a hawk.

 

With biotech getting hammered, that is a positive because prices of acquirees are coming down. Somewhat offsetting this is junk bond yields are rising and should rise further. All in all though, the drop in valuations outweighs the increase in junk yields in my view - and I am talking in the US. Emerging equity markets are getting even cheaper here.

[abitofvalue]

Isn't one of the issues for Valeant that once you get the attention of the legislatures, regulators, attorney generals etc.. bureaucrats start digging. In any organization you are going to have some wrong doing.  If that wrong-doing is discovered by the wrong regulator - you could be in a world of hurt. (see: OCN last year).  the attention on price gouging and dems willingness to subpeona VRX can't be a good thing.  Wonder why the company didn't cooperate when they were asked to provide information earlier this month.  Seems to me by not cooperating they raised the stakes, possibly for no reason.

 

Valeant will not make for a sympathetic figure if forced to testify. All the talk about not doing as much R&D, being more efficient at R&D, not paying taxes will be used against them. Increasing prices because it's healthcare so patients likely have little choice and Pearson wants to increase shareholder value will be an interesting defense. May still work out if politicians don't have the will but something tells me this could be an issue that dems and repubs could somehow get behind.

 

No position. 

 

Btw - seems to be some confusion as to how much price increases matter. I have seen investors saying VRX acheives returns 50% from price increase and others saying price increases aren't that big a deal. If price increases need to be subdued for a little while - even say 2 years - what does that do 10 yr 20% IRRs?

[original mungerville]

Isn't one of the issues for Valeant that once you get the attention of the legislatures, regulators, attorney generals etc.. bureaucrats start digging. In any organization you are going to have some wrong doing.  If that wrong-doing is discovered by the wrong regulator - you could be in a world of hurt. (see: OCN last year).  the attention on price gouging and dems willingness to subpeona VRX can't be a good thing.  Wonder why the company didn't cooperate when they were asked to provide information earlier this month.  Seems to me by not cooperating they raised the stakes, possibly for no reason.

 

Valeant will not make for a sympathetic figure if forced to testify. All the talk about not doing as much R&D, being more efficient at R&D, not paying taxes will be used against them. Increasing prices because it's healthcare so patients likely have little choice and Pearson wants to increase shareholder value will be an interesting defense. May still work out if politicians don't have the will but something tells me this could be an issue that dems and repubs could somehow get behind.

 

No position. 

 

Btw - seems to be some confusion as to how much price increases matter. I have seen investors saying VRX acheives returns 50% from price increase and others saying price increases aren't that big a deal. If price increases need to be subdued for a little while - even say 2 years - what does that do 10 yr 20% IRRs?

 

No question that if they go to Washington it could get ugly from a public relations perspective. Sure, all of that can be used against them - just like the little short articles which came out today. Shorts come out of hiding in bear markets - they've been waiting for Valeant here. It'll be a rough time - but if you are long you should be prepared for a rough time over the next quarters to 3 years: lots of debt, low tax rate, junk debt yields should rise, pricing on certain drugs, slash R&D, layoff people, etc, etc.

 

On the other hand, they should generate $20 billion in EBITDA over the next 3 years - so that will fill a few potholes here and there.