Valeant Pharmaceuticals Intl Inc (VRX) Is Only for the Brave … And Patient

On Friday April 29, Valeant Pharmaceuticals Intl Inc (VRX) stock opened north of $36 per share. By the next Monday, shares had fallen below $29, only to surge to $38 on Tuesday. So during a three day span, VRX stock literally lost and gained back a quarter of its value.

Valeant Pharmaceuticals Intl Inc (VRX) Is Only for the Brave... And Patient What’s really crazy is that volatility like this is nothing strange, with the stock surging 400% in less than four years beginning in 2012, and now falling a whopping 86% over the last 12 months.

Given this mind-boggling volatility, I ask a very important question:

Who Should Own VRX stock?

The obvious answer to this question is gamblers. After all, VRX looks more like a game at a Vegas casino than the actual reflection of a company’s operating performance. However, Valeant has no one to blame but itself.

After rising to biotech stardom with an acquire-and-grow business strategy, Citron Research uncovered a messy situation that involved phantom revenues, income statement and balance sheet manipulation and criminal activity. Needless to say, Valeant was no longer worth $80 billion. Despite these issues and the aftermath, VRX is still worth more than $10 billion.

With that said, VRX stock looks great for value investors with a long-term time horizon who can stomach some serious volatility. It’s not for traders who monitor the day-to-day performance of their investments.

At the end of the day, VRX had to restate its financials, drop its aggressive drug pricing strategy and instead of using equity for additional acquisitions, it now has to use profits to pay down debt. Hence, Valeant’s past crimes and mistakes are costly, yet VRX stock still looks very attractive relative to what the company now expects for the full year, based on conservative guidance.

Valeant is guiding for full-year revenue at a midpoint of $11.1 billion, which despite its many problems, still represents mid-single digit revenue growth versus 2015. While Valeant plans to use most of its earnings to repay debt, it is guiding for non-GAAP earnings per share at a midpoint of $10 per share.

With VRX stock now trading at roughly $30, it is clear the company is very cheap at just 3 times fiscal year 2016 non-GAAP EPS. Among larger biotech companies with revenue greater than $5 billion annually, VRX stock is by far the cheapest, several times cheaper than any other company in its industry.

Potential Risks With VRX

If you consider that Valeant is still a growing company that’s trading at 3 times this year’s EPS, it would seem the risk is marginal, and that everyone would be onboard. However, it is important to note that VRX stock is still a risky investment.

For one, it is under new leadership, and with new policies in place there is no way of knowing if all the shady deals that past management were involved in are known by the public. Second, Valeant’s growth is driven by past acquisitions, which has built a debt haul of more than $30 billion. Lastly, Valeant’s EPS looks great, but much like Jim Chanos noted, the company’s pro forma EPS is “very, very misleading.”

Specifically, Valeant’s earnings go straight back to creditors to pay for acquisitions that were clearly overpriced. Furthermore, Valeant has enormous depreciation and amortization costs, along with “extraordinary items” that boost Valeant’s EPS. Still, even when you consider these facts, VRX stock is massively oversold and Valeant is a company that will likely create $2 billion in free cash flow this year.

Buy, Hold and Forget

Therefore, if you find it hard to value Valeant based on its EPS guidance, use $2 billion in FCF, and you will arrive at a multiple that is still cheaper than anything else in biotech or big pharma. Nevertheless, there are strong opinions surrounding VRX stock on both sides, and it is going to take time before the market and investors trust the company.

For that reason, VRX stock is going to be volatile, with far more days of 25% gains and losses than many investors are comfortable with. As a result, investors that aren’t bothered by such volatility should hold this stock. Given how quickly it moves, VRX stock is not a good trading security, and with it so cheap, Valeant stock really is un-investable if you are short.

Thus, if you are willing to take a risk on VRX stock, the only way to do so is buy, hold and forget.

As of this writing, Brian Nichols was long VRX. 

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