...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.
