On Sunday, shareholders of Valeant Pharmaceuticals Intl Inc (NYSE:VRX) got more news than they had been expecting. In addition to the pharmaceutical company’s fourth-quarter earnings figures, owners of VRX stock also learned it was acquiring Salix Pharmaceuticals, Ltd. (NASDAQ:SLXP) at $158 per share of SLXP stock — a total of $10 billion.
The announcement mostly fell on enthusiastic ears, although the decision did draw some criticism from investors who believe Valeant CEO J. Michael Pearson is relying too heavily on expensive and frequent acquisitions to fuel the company’s growth. In that light, the news does beg the question … what exactly are owners of VRX stock getting for their $14.5 billion?
Why Salix Pharmaceuticals?
Salix Pharmaceuticals is, by and large, a gastrointestinal medicine company. It has more than a dozen drugs on the market, including recognizable names like Pepcid and Colazal. The former is for heartburn relief, while the latter treats ulcerative colitis, which can bring about a myriad of symptoms such as diarrhea, rectal bleeding and stomach pain.
All told, the Salix Pharmaceuticals portfolio has generated $1.8 billion in revenue over the past 12 months. The company also took losses during that time, to the tune of $76.9 million, or -$1.22 per share of SLXP stock.
Just for the record though, it’s been an unusual past 12 months for Salix Pharmaceuticals, with a couple of hefty non-operating expenses eating into profits. In the years leading up to last year, Salix Pharmaceuticals was a reasonably profitable company. In 2013, for instance, Salix turned revenue of $933.8 million into net income of $143 million. That translated into a profit of $2.18 per share of SLXP stock.
Still, in that light, Valeant Pharmaceuticals appears to have paid dearly for Salix. There’s a reason SLXP may have actually been worth $158 per share, however: the pipeline.
“Salix’s market-leading gastrointestinal franchise is an ideal strategic fit for Valeant’s diversified portfolio of specialty products. The growing GI market has attractive fundamentals, and Salix has a portfolio of terrific products that are outpacing the market in terms of volume growth and a promising near-term pipeline of innovative products. This acquisition offers a compelling opportunity for Valeant to create a strong platform for growth and business development.”
The pipeline Pearson is referring to is predominantly existing drugs Xifaxan and an oral version of Relistor. Xifaxan is up for approval as a treatment for IBS-D, while an oral Relistor will broaden its usefulness.
The Upside for VRX Stock
The math that Valeant cited when selling the deal to shareholders on Sunday was certainly attractive enough. The company believes the merger could generate annual cost-saving synergies of $500 million, if not more.
Moreover, by bringing Salix into the fold, Valeant Pharmaceuticals expects its operating profits per share of VRX stock to increase an additional 20% by 2016 after pushing past some of the inventory turbulence Pearson acknowledges his company is going to experience this year because of the deal.
As for what this specifically means in the grand scheme of things, one only has to look at Sunday’s other news from Valeant — last quarter’s and 2014’s full-year results.
Last year, Valeant Pharmaceuticals generated $8.3 billion in sales, and posted an operating profit of $8.34 per share of VRX stock. It incurred operating expenses — not including cost of goods sold — of $4 billion, and turned a total operating profit of $2 billion. Total net income was $913.5 million.
Meanwhile, Salix Pharmaceuticals generated sales of $1.8 billion for the last 12 months. Operating expenses reached $662 million in 2013 before soaring in 2014 due to some alarmingly high selling expenses over the prior three quarters.
The Salix top and bottom lines will be added to the top and operating bottom lines for Valeant in a fully accretive manner when the deal is done later this year. And, the pending approval of new drugs (and old drugs for new uses) will incrementally boost Salix Pharmaceuticals’ revenue and earnings contribution.
But, bluntly, it’s difficult to see where Pearson thinks he can cut $500 million in costs while fulfilling his promise not to meddle with the Salix sales force. The plan is to reduce corporate overhead and research and development to generate that cost savings, but the bulk of the company’s costs and the recent cost surge surge has been the growing sales effort.
Bottom Line for VRX Stock
While the numbers are compelling, investors may want to bear in mind there’s no particular recourse should Valeant fail to create half of a billion dollars worth of cost-savings with its purchase of Salix Pharmaceuticals. Still, some synergies are better than none, and Valeant has proven itself as a good integrator of its acquisitions in the past. This one should prove beneficial in the long run as well, even if it doesn’t live up to present expectations.
At 7.3 times its trailing sales and nearly 41 times its projected 2015 income though, it certainly wasn’t a cheap deal for Valeant.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
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