On Monday morning, Seeking Alpha contributor “Shock Exchange” did some serious number-crunching for Valeant Pharmaceuticals Intl Inc (NYSE:VRX). Based on its recently completed third-quarter results, the commentator concluded VRX stock was worth $1 per share. That’s 94% less than the current value of the stock, and that would be in addition to the 93% pullback VRX has already dished out since peaking in the middle of last year.
To be fair, it’s the kind of sensationalistic extremism that Seeking Alpha has become known for. Yet, while the suggested value borders on the edge of ridiculous, there’s actually a fair amount of logic to the premise that VRX stock is worth practically nothing.
It’s All About Valeant’s Debt
Valeant Pharmaceuticals’ debt woes are nothing new; yours truly here has discussed them at length, even as far back as the middle of last year before anyone else cared to recognize how big of a problem it was becoming. As warned, that $30.4 billion in long-term debt came back to haunt VRX stock in the meantime.
It’s that mountain of debt that Shock Exchange says makes Valeant worth essentially nothing.
His superficial math and theory make sense. Based on last quarter’s EBITDA of $1.06 billion — which is arguably the new norm for Valeant — and annualizing that figure and then multiplying it by a fairly typical industry valuation of 7.1, you come up with an enterprise value of $30.0 billion. Subtracting the company’s $30-plus billion in debt from that value, you’re pretty much left with zilch.
Crude math that doesn’t take into account all the unquantifiable things Valeant Pharmaceuticals is doing now to turn the ship around? You’ll get no argument from me that Shock Exchange’s approach likely oversimplifies a complicated situation. Indeed, Valeant would likely be acquired before Valeant stock actually fell that much.
His broad brush strokes, though, still paint a picture that can’t be unpainted with a small handful of “buts.”
Charts Tell the Tale of VRX Stock
Yes, Valeant Pharmaceuticals is mulling the sale of assets in an effort to pay down its debt. That’s a bit like setting your house on fire to keep warm when it’s cold though — it’ll work for a brief while, but it’s ultimately a step in the wrong direction. For Valeant, selling revenue-bearing assets as a means of reeling in debt not only crimps earnings, it crimps its ability to service any remaining debt.
On the flipside, it’s not as if the alternative is any better. Indeed, it may be worse.
Take a look at the chart of Valeant’s historical revenues and expenses. The trend is clear. Revenue is falling, expenses are rising and it’s happening before Valeant has even started to lop off pieces of itself.
Click to Enlarge Valeant’s basic, recurring, and unavoidable expenses are already in excess of revenue. Valeant is already backpedaling. It’s already losing money, and not just because of one-time hits.
Look closely at the chart again. The tipping point was reached during the fourth quarter of last year, before its reputation began to unravel and it became toxic to deal with.
In layman’s terms, Valeant is stuck between a rock and a hard place.
As it stands right now, neither looks like a very viable option. If it chooses to retain more assets than it dumps, it’s unrealistic to think those remaining assets will actually pay all of its operating expenses including the “ITDA” in its EBITDA figure … very real expenses that must be accounted for. On the other hand, if it sells the bulk of itself, that may still not adequately pay down the debt that soared after Valeant arguably overpaid for several drugs and pipelines.
Bottom Line for VRX
The Shock Exchange valuation model for VRX stock is gratuitously extreme, though not wildly so.
That is to say, Valeant would have to perform a few miracles to remain viable with its current portfolio and pipeline, to continue turning a measurable profit AND pay $1.8 billion worth of interest payments every year. That’s a very tall hurdle. Remember, it was just a few days ago Valeant CFO Paul Herendeen warned “We simply do not expect to be able to overcome the overall growth drag of the neuro and generic businesses in 2017.”
At the very least, the alarming math done by the SeekingAlpha contributor should be prompting questions from VRX stock holders … questions like what the numbers are realistically going to look like, whichever path the company takes.
It’s not a matter of something that should change. Something has to change. Valeant can’t financially engineer its way out of the hole it has dug itself into. It would have to do it with organic growth.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
