Glossary of Hostile Takeover Terms with Discussion

After the dust settles, i don't believe Brexit will do much in either direction. However, it could be used as an excuse to do what various parties were thinking, planning, or contemplating but didn't quite know how to time.

In our instance, the biggest issue is if Teva will pull out. I was concerned after the Pfizer deal broke (Pfexit ), and then felt the concern dissipating as deal mechanics (such as divestments) were affected. In light of Brexit, I'm slightly concerned again. If Teva wants to pull out or negotiate the price down without looking like an untrustworthy deal-breakers, now they have the perfect "material adverse event beyond our control" excuse.

Dan

 

Yup.

For a while, there were news stories circulating and sum-of-parts valuations throwing around noon numbers like $15-20B for B&L. I don't know the details of the inner workings of B&L, or any VRX company (or, really, any company anywhere); but I do believe in the "no magic" principal: you can't buy a car for $X, strip it out, drive it like crazy, ignore all the maintenance red lights on the dashboard, and, years later, hope to sell it for more than $X. Same with a company. If you don't maintain it, through ongoing investments, it drops value faster than a car leaving the dealership lot.

Wall Street is acting surprised, now that Wells blew the fantasy that B&L is somehow worth more than paid for; but they shouldn't, it would've required some serious magic for it to be otherwise.

Id expect the same to be true for every single VRX asset (although some of that may be obfuscated by mixing and matching pieces from different acquisitions)

Dan.

 

Hi everyone:

With the Wall Street Journal coming out after the market closed yesterday with an explosive revelation that Valeant is under Federal criminal investigation for Insurance Fraud relating to the undisclosed (at the time) Philidor relationship, I can't help but crow -- You've seen it here first!

As far as I can tell, this blog was the first time anyone anywhere put the dots together and realized that this is a story of massive insurance fraud. Post #526, on October 26, 2015 (a small portion of which is quoted above), detailed my finding after some fairly intensive digging. At the time, John Hempton (Bronto Capital) has already documented some systematic claim-level abuses at Philidor and Andrew Left (Citron) alleged that the relationship between Valeant, Philidor, and the "network pharmacies" was for the purpose of accounting fraud (we now know that there was a bit of accounting fraud in that relationship, but that was not the main event). However; neither pinned down that the entire network's undisclosed existence (not merely individual practices) was for the purpose of committing massive insurance fraud -- which is exactly what the Feds, according to the WSJ, are pursuing!

Dan.

 

Hey everyone:

I guess we got some development in both AGN and VRX -- nothing that should surprise readers of this thread, but Wall Street, as evidenced by the sharp valuation changes, still seems to be surprised with some regularity.

First AGN:
We had a few acquisitions, some at eye-popping premiums, some criticism, some share price drop, then a big miss on Q3 earnings and an even bigger drop in guidance, more share price drops, and then a shares buyback announcement. So what's my read?

My basic read is that after going some extra miles giving Saunders the benefit of the doubt, this is the 3rd strike in the year-and-a-half he's been at the helm.

The first strike was the Pfizer deal (I still insist, with no value creation other than the tax benefit mirage, what were they thinking???). Demoralized (and lost) some good people, created a lot of distraction, spent a lot of 'benefit-of-the-doubt' good will currency, and got nothing.

The second strike was the spree of over-paid acquisitions. I have no way of telling how much the companies he bought are worth; but some of them were publicly traded -- meaning that some very smart buyers and sellers have established a fair market value for them already. A 20-50% control premium (meaning how much above the market price the buyer is willing to pay the seller to relinquish control of the company) is normal. Once in a rare while, the synergy between the buyer and seller is so compelling that even a 100% premium is conceivable. But 500%? Really? That means that either all the people who were trading that stock beforehand were completely unaware of how valuable their asset is or the buyer (AGN) seriously overpaid. Looked another way: I am usually opposed to hostile take over -- I think the value destroyed during the battle makes for a smaller pie to divide between the participants and stakeholders. However, if the seller's board won't sell for less than a 500% premium, and the buyer honestly thinks the company is worth that much, then the buyer should just make a, say, 200% premium tender offer directly to the shareholders. I can't imagine that they won't get at least half the shareholders to sell at a 200% premium. What could have possibly convinced Saunders that the companies he was buying are worth 5 times what their current buyers and sellers think; and that he can't acquire them for any less than such a price?

The 3rd strike is missing the numbers. Of course. There was no natural disaster, governmental regulation, lawsuit, judgement, or other unanticipated event. Sometimes things don't go well; that's a normal part of life, but the first job of a CEO -- before they may have the luxury of occupying themselves with strategic transactions -- is to know where the numbers are headed before they get there and to guide the market before the fact. Not surprise them afterward. If your numbers are a big miss and you didn't know about it well beforehand (absent an unanticipated externality, such as those listed above), then you are not doing your job.

Often, 3 strike and no scores, for a new CEO, would mean they are out. However, Saunders, here, is not entirely scoreless. He did have one well-executed move: Selling the generic business to Teva, getting a great price, and bringing the deal home even as the overall M&A climate got quite choppy. Readers of this thread know that even though I always considered the deal as likely to close (which it did), I was also worried that Teva would find an excuse to walk away or renegotiate (because the price they agreed to was when the Pharma sector was riding high; they could have played for a re-negotiation to a lower price. The fact that they didn't is to Saunders credit, even if he didn't do anything in particular about this issue).

My feeling: I think Saunders can survive this 3rd strike, but I'm not so sure about the next one (unless he scores again somewhere). I also think his decision to affect a significant share buyback is an acknowledgement of this situation. I am neither a fan nor an opponent of share buybacks. On the one hand, if you use your cash to buy back shares, you are basically admitting that you don't have any good idea how to make investments that generate good returns -- so why are the shareholders paying you the big bucks to be a CEO? On the other hand, if a ton of cash is burning such a hole in your pocket that you start doing stupid things (like pay 500% premium), then it is better, far better, that you just give the cash back to the shareholders to do with as they please. With this buyback, Saunders is, in my opinion, both admitting that he has no good investment ideas and implying that he is no longer inclined to make big acquisitions. That latter implication should put nervous investors at ease that he is not going to continue spending the Teva cash wildly.

To be continued shortly...

 

...Continued

Now VRX:

A few important news pieces moved the stock wildly in both directions over the last few days. As noted by others on this thread earlier, the feds, in due course, are moving closer to filing criminal charges against the former top leadership of Valeant. It would be completely fair to say that no long-time reader of this thread is even minimally surprised. The list of criminal transgressions, well detailed over many posts here, is so compelling that it would have been shocking if somehow charges were not brought up. That Wall Street saw fit to push Valeant down 12% (and a new low) on this non-news news, show that those gurus are still not seeing the big picture.

The next day, Valeant jumped over 30% on leak that they are close to selling Salix for $8.5-10B. They paid for it, about a year ago, over $11B. Actually, if you count assumed debt (over $2B), restructuring costs, integration costs, and various other transactional loads, the price tag gets to around $15-16B (and maybe knock that down by, say, $0.5B for the gross profits made by Salix during the year Valeant owned it). So, far from creating value during the short period of stewardship, Valeant will be lucky to get back 2/3 of what they paid. Only in the upsidedown-economics world of Valeant this is good news. So why is the market cheering? My guess is that a sale of Salix would be a definitive repudiation of the "we are not selling 'core' assets" mantra that management has been uttering and that investors loath. While no one ever defined which assets are core and which aren't, it has been generally assumed that B&L and Salix (and maybe a few other lines) are 'core,' whereas everything else is not. To me, however, this climbdown highlights a dark reality: After months of trying to sell those "non-core" assets and not getting even one deal through the door, it is fair to surmise that the non-core assets are just not worth much.

This brings me to my main observation regarding Valeant. If I may coin a term, I will call it "stealth bankruptcy." When a company is in a liquidation bankruptcy, a committee of creditors, or a judge, or some appointed caretaker, auctions off the assets trying to balance the desire for rapid liquidation with the competing goal of maximizing the liquidation value and avoiding value destruction through non-orderly liquidation. Whatever value is extracted from selling off the assets is then handed over to the creditors (in a pecking orders that follows precise legal standards of the seniority of the various debtholders), and if anything is left afterwards, to the shareholders. When a company is solvent (i.e., not in bankruptcy), the shareholders are the exclusive owners of all values it generate. Valeant is, technically, for now, solvent -- it is still paying all its debtholders on time, and whatever debt covenants it has, or would have, violated, have now been cured through multiple revised debt deals. However, that solvency is not sustainable. Even if it can continue making interest payments, as their various notes reach maturities, they will need to pay down their principals too. There is no way Valeant can do so just from operating cash. So they are ultimately insolvent unless they can sell off assets faster than the maturities arrive. In other words, the only course of action available to them is to liquidate assets fast enough to beat the tsunami of arriving maturity dates, while still trying to get as good a price as they can; and hand over all cash obtained directly to the debt holders (hoping some will be left over at the end for the shareholders). So, they are doing exactly what they would have been doing if they were formally in bankruptcy, but without calling it a bankruptcy. Hence my term: Stealth Bankruptcy.

Right now, Valeant has an Enterprise Value (Equity + Debt - Cash) of about $38B (about $31B debt and $7B equity). Their EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization -- this is effectively the cash profit they make from operations) is about $4.5B. So, the key question in each divestiture, is how much they are getting and how much EBITDA will go away. If they are getting a lot of cash and not much EBITDA is going away, then it's a good deal ("accretive" in Wall Street Speak), because they push the debt down by more than the reduction in ability to pay for it. The whole thing with selling 'non-core' assets has been this notion that products that aren't making much money in Valeant's tainted hands might be worth a lot more to some buyer out there who would be willing to pay handsomely for such (but, as we are seeing, this is a fantasy; no one is prepared to write a king ransom check for the odds and ends of the Valeant hodge-podge portfolio; only a crown jewel asset, like Salix, can get buyers' interest, and even that at a very sizable loss). The opposite of "accretive" is "dilutive." It means that a divestiture is taking with it a lot of EBITDA, and not bringing in enough cash. A dilutive deal reduces the equity of the company. If it reduces it to below zero, the shareholders are wiped out. So how does the Salix deal measure up? It's just at the borderline between accretive and dilutive. The deal will bring in enough cash to account for about a quarter of the Enterprise Value, while also wiping out about a quarter of the EBITDA. In other words, it will buy Valeant a little time -- the next few maturity events will be covered -- but not make any progress whatsoever in digging the company out of the hole. After the transaction Valeant will have a smaller debt, but also less operating cash to service it. If the rest of their divestitures will also have a similar borderline accretive/dilutive profile, then it's not horrible (not great either); it means that when they are done divesting enough to pay off all the debts there will be just enough left to pay the equity holders roughly what the stock is worth now. They won't be making any profits in consideration of all the harrowing they had to endure, but they won't be wiped out either. Unfortunately, for Valeant shareholders, this scenario is, in my opinion, unrealistically optimistic. Salix, as a largely intact recent acquisition with a still growing (although showing some premature signs of stalling) book of business, is probably their best crown jewel. B&L may be second best -- not recent or growing, but a well-established brand with strong market presence. However, beside those two, the rest of the Valeant portfolio -- the 'non-core' assets is not looking very shiny. It probably can't fetch much of a valuation. Some product lines (such as Jublia) are vaporizing, now that there is less room for Valeant shenanigans.

And this brings us back to a recurring theme in this thread: The excruciatingly slow, yet entirely intractable, Valeant death spiral: They are forced to liquidate assets to stay ahead of the debt maturity calendar. If they unload assets -- even the crappy 'non-core' ones -- at fire sale prices, they will have 'dilutive' deals and risk have their equity drop below zero and wipe all shareholders out. But no one will give them enough cash for the non-core assets to make those deals 'accretive.' So, they are forced to sell 'core' assets instead -- where, at least, they can get enough cash to get to the borderline between dilutive and accretive. But there are really only two such assets (Salix and B&L) and, between them, not enough to pay the debt off. so, they are stuck: Sell Salix, buys time; later, sell B&L, buy more time; after that, a rapid disintegration as either the non-core assets are sold at fire-sale prices and wipe the shareholders out through negative equity; or they are not sold and wipe the shareholders out through insolvency. either way, the shareholders will, after a long and torturous path, be wiped out.

But, before I close with Valeant; one need to remember the flood of lawsuits and investigations that are hitting them. If there are several billions worth of not-reserved-for liabilities; those go directly against the already meager equity. If any of the large ones turns into a judgement, it will likely break debt covenants yet again and this time there isn't enough cash left to pay the debtholders into continuing the Stealth Bankruptcy charade; the debtors will simply put the company into receivership and liquidate it themselves.

While just about all the lawsuits have solid merits; one that was filed today doesn't, in my opinion. It is the one by Sprout shareholders who sold Abbyi (the so-called female Viagra) to Valeant for about $1B this year. Valeant, for all practical purposes, botched the launch and the product is no longer actively marketed -- losing the Sprout shareholders milestone and royalties payments. However, in my view, the Sprout people should kiss the billion dollars they got very hard and keep their mouth shut. The drug is effectively worthless and the manner they pressured the FDA to approve it (by pretending it was a women rights issue) is despicable and set a horrible precedent. By going to court, they risk having enough adversarial scrutiny shining a spotlight on their actions to end up turning the tables on themselves (by having the drug somehow un-approved, or by having the fact of it lack of effectiveness become more widely known and internalized). If actions are taken, at some future point, to claw back some of that $1B, they will only have their own litigious big mouth to blame.

That's all for tonight. Hope everyone is doing great!

Dan.