With Valeant Pharmaceuticals Intl Inc (VRX) falling 22% over the past month, and now down 90% in the past year, the latest suggestion among Wall Street pros is that Valeant’s new management should divest assets to pay down debt.
After all, the days of rapid growth and Valeant are no longer compatible.
Instead, VRX stock is tied to the company’s ability to reduce debt, improve margins and multiple expansion.
So while it may make sense to reduce assets to lower debt and improve margins at a faster pace, it’s not a wise long-term decision.
4 Reasons VRX Should Keep Assets
Everyone knows that Valeant has almost $32 billion in debt. That equates to a debt to assets ratio of 65%.
Yes, those metrics are disturbing, and the more that people focus on those disturbing metrics, the worse it gets for VRX stock. Yet, in the midst of Valeant’s most recent selloff after reporting first-quarter earnings, the company disclosed some important information that suggests there is no need to sell off assets.
First, it has $1.2 billion in cash on hand. Second, it is going to generate $1.7 billion in free cash flow this year. So for all the criticism Valeant takes in regards to accounting, free cash flow is a metric that can not be manipulated.
Third, Valeant has just $272 million in mandatory debt payments for the rest of this year. And lastly, it is aiming to payoff $1.7 billion in debt.
Valeant Can Afford to Pay Its Debt
What many don’t realize is that Valeant could sell $3 billion worth of assets and its debt-to-asset ratio be unchanged.
However, if Valeant can responsibly pay off debt over time through operations, it will also be able to generate higher free cash flow by maintaining its assets. In other words, it is unlikely that Valeant could divest $3 billion in assets and keep its free cash flow guidance unchanged.
Ultimately, if Valeant can keep its assets, pay off debt over the course of many years and improve margins by cutting costs, then it can achieve a lower debt-to-asset ratio, higher margins and more free cash flow without divesting anything.
VRX Stock Investors Are Better Off
Currently, VRX stock trades at less than 4.5 times this year’s expected free cash flow. This makes VRX stock one of the most attractive long-term investments in biotech if it can really pay off debt through existing operations and improve its margins over time.
There is simply no reason to divest a big chunk of assets for the reason of making headlines and getting a 15% short-term pop. Instead, Valeant shareholders are better off realizing that debt reductions are going to take time, but as debt and the threat of bankruptcy reduces, VRX stock will go higher.
At the end of the day, there is more peak upside in VRX stock if management can figure out how to keep the business as is while digging out of the hole that previous management built.
Personally, I think Papa is the man for the job, and VRX stock will surge so long as management doesn’t fall into the short-term trap of selling assets to appease desperate investors.
As of this writing, Brian Nichols was long VRX stock.