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Subject:  VRX - Some notes from recent news Date:  3/16/2016  6:41 PM
Author:  BenGrahamMan Number:  24022 of 26247

Looking for constructive discussion

March 16, 2016 ($33.63 intraday) Update

Thesis:

We have owned this at an average cost of around $102.60. We had a smallish position for us of just under 2.50% allocation. With deterioration, we are now at about a 1% position. I would consider owning Valeant at these prices for portfolios that can tolerate the very high risk. There is not enough data, nor management trust to believe the numbers, and the chance of implosion is quite real. Yet, the potential for reward is there, and Valeant should have revenues well in excess of $10B in Fiscal 2016. In any case, any position we had would be <3% (probably well less) of anyone’s portfolio. My gut tells me that we will just stay status quo, but as days and months go on, that could change.

Observations:

The risks to Valeant are numerous and material, yet we will continue to hold Valeant, perhaps to its death star. Of course I see some type of possible positive outcome, or I would just sell the shares.

Valeant held a conference call yesterday discussing current events, expected 2015 numbers, and guidance for 2016. The market destroyed the stock by a 51.5% drop.

William Ackman wrote to investors yesterday, “We continue to believe the value of the underlying business franchises that comprise Valeant are worth multiples of the current market price.”

Pearson is claimed to have said, “Our business is not operating on all cylinders, but we are committed to getting it back on track.”

Analysts have been discussing that lenders very possibly will not force a default, since cash flow is being presented and guided in a positive light. The clock is ticking, loudly.
The company is being accused of accounting irregularities and federal fraud violations. It is possible, that if so, a death spiral could or would quickly occur. Perhaps value would occur for bond holders, if equity holders were wiped out.

Valeant released an 8-K yesterday. Here are some notes I gathered from the release:

1. “Preliminary unaudited fourth quarter results were impacted by softer-than-expected sales of the gastrointestinal business, as compared to previous guidance issued in December, driven by reductions in the wholesale and retail channel in reaction to Valeant’s announcement of an agreement with Walgreens.”

2. 2016 Total First Quarter Revenue expected to be $2.3 - $2.4B, prior guidance was $2.8 - $3.1B. Total 2016 Revenue is projected to be $11.0 - $11.2B, prior guidance was $12.5 - $12.7B.

3. 2016 non-GAAP eps is expected to be $9.50 - $10.50, prior guidance was $13.25 - $13.75B.

4. “In discussion with the Board, we have assumed lower growth in our U.S. dermatology, gastrointestinal, and woman’s health portfolios, as well as certain geographies like Western Europe, while keeping our expenses largely unchanged. We plan to work hard to improve these metrics by delivering higher revenues and reducing our costs and, if successful, we hope to beat this guidance in the quarters to come. In the meantime, we are comfortable with our current liquidity position and cash flow generation for the rest of the year, and remain well positioned to meet our obligations.” Michael Pearson CEO

5. “On the revolver, we ended the year with $250 million drawn on the revolver and we're now at $1.45 billion. We obviously are generating cash in the first quarter. We did have, however, some large payments in the first quarter that we discussed. $500 million for Sprout that we talked about.” Linda LaGorga, Treasurer



The risks include:

1. A formal investigation by the U.S. federal prosecutors for overly aggressive pricing and potential insurance fraud.

2. Drug price policy reform by the U.S. government. This would be a concern for most of the specialty pharmaceutical industry.

3. Excessive debt levels, which could become difficult or impossible to maintain. Valeant mentioned they will be able to meet debt levels, but of course that can be taken with a grain of salt.

4. Default risk with delays of releasing its annual statements (10-K). Valeant claims they are negotiating with lenders to cure the late filing default provisions. It is my understanding that if this is allowed; it will often come with a cost, which could be 1% of the technical defaulted obligations.

5. The presentation of Non- GAAP numbers are concerning, primarily because management has given us no reason to trust them. The non-GAAP looks to eliminate all the bad stuff such as stock compensation, various asset step ups because of business combinations, acquisition related costs, impairment charges, restructurings, amortizations and foreign exchange. All a bunch of crap, especially from a company who doesn’t seem to know its ass from its head.

6. Potential exodus of employees departing in mass.

7. Lack of liquidity exaggerated by inability to divest non-core businesses.

Valeant has some meaningful institutional ownership:

Graphic not included, but you know the players, ValueAct, Ackman, Paulson and Lou Simpson, etc.

Bonds

The credit default swaps are not deteriorating as much as the stock is. Yet, an article in the Wall Street Journal today stated: “The cost to insure Valeant bonds against default using Credit Default Swaps spiked.” This contradicts the chart below. Keep in mind, I am hardly an expert on Credit Default Swaps, and could in theory be using faulty data.

Bonds are showing deterioration, but not death star (yet):

Bonds 2020 – 2025 seem to be trading (bidding) at the 10% to 11.5% range. Pricing ranges from 75bps to 85bps. Bonds at this point do not appear to be showing imminent death.

Morningstar wrote today

“As long as the company can stabilize performance and address near-term volatility from the discontinued Philidor relationship, we currently envision Valeant can produce sufficient cash to pay its $1.6 billion cash interest payments in 2016 with some leftover to help pay management’s target debt reduction of nearly $1.7 billion. At the end of the year, Valeant’s senior secured leverage ratio of 2.1 came in under the 2.5 debt covenant, and EBITDA interest coverage of 3.3 similarly surpassed the 3 times covenant requirement. However, the company’s delayed 10-K will remain a concern as management attempts to negotiate with lenders on a cross-default risk by missing its financial reporting covenant. As long as Valeant can file its 10-K by the end of April, we anticipate the company is likely to avoid a technical default with lenders.” Morningstar 3/15/16
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