All good investors must understand the potential downside of any stock, as proved of late by Valeant Pharmaceuticals Intl Inc (NYSE:VRX). VRX is down a stunning 95% in less than two years. Over that time, the narrative surrounding VRX has, unsurprisingly, changed dramatically.
Less than three years ago, VRX stock was one of the hottest growth names on Wall Street. The company was trying to buy Botox maker Allergan plc (NYSE:AGN) for $53 billion, only to be outbid by Actavis. (Actavis would keep the Allergan name after the deal.) Now, VRX’s very ability to survive is in question, and VRX stock is worth less than $5 billion.
For an investor looking to time the bottom in VRX, understanding the downside remains critical. Clearly, the worst-case downside for VRX stock is zero.
Valeant Pharmaceuticals has over $30 billion in debt. The company is selling assets to pay down some of that debt, but it’s a strategy that might not work. But, just as important from both the long and the short side is understanding how much time Valeant might have left, particularly in a worst-case scenario.
Even if Valeant’s debt turns out to be too much to handle, VRX stock won’t sink to zero until Valeant Pharmaceuticals goes bankrupt. And, Valeant won’t go bankrupt until that debt matures.
So, it’s important to understand the timing of Valeant’s debt when considering taking a position in VRX stock. A closer look shows that, while Valeant has some time, it may not have all that much.
VRX Stock Should Survive Through 2019
Valeant Pharmaceuticals has no significant maturities due in 2017. VRX must pay interest on its $30 billion in debt, which alone should be in the range of $1.8 billion-$1.9 billion next year. But, management has said that after Q3 it plans to make the mandatory principal payments for next year by the end of Q4 2016.
Barring some sort of “pre-packaged” filing (essentially an admission that there’s no hope left), there’s no reason to expect bankruptcy within the next 12 months.
2018 could be a little dicier, but still looks doable. Last summer, Valeant pledged to pay down $5 billion of debt by February 2018. Earlier this month, management announced divestitures that will bring in more than $2 billion in cash through the sale of skincare brands to L’Oreal SA (ADR) (OTCMKTS:LRLCY) and of Dendreon to China’s Sanpower Group.
VRX is targeting another $6 billion or so in asset proceeds as well, an update provided by new CEO Bob Papa following the company’s Q2 report in August.
Yet, less than $4 billion in principal is due in 2018, even if VRX can’t extend the maturity on its revolver. Only $2 billion needs to be repaid in 2019. Meanwhile, Valeant is still on pace to generate approximately $1.8 billion in free cash flow in 2016.
Keeping that cash flow figure stable over the next three years and adding in $8 billion in asset sales (including the recent divestitures) could get debt down below $17 billion heading into 2019. The problem is that even, stable free cash flow might be difficult — and come 2020, solvency could likely start to become a serious concern.
The Bill Comes Due for Valeant Pharmaceuticals in 2020
As of the end of Q3, Valeant Pharmaceuticals has more than $8 billion in debt that comes due in 2020. That’s a huge problem for VRX stock. To clarify, there’s no guarantee that VRX will declare bankruptcy three years from now, but it indeed looks like a material possibility. Even if Valeant manages to refinance that debt, there’s a major issue as to whether or not it will lead to higher interest costs.
The problem for VRX stock isn’t just its debt; responding to that debt will be difficult, given the company’s current earnings power. If free cash flow remains stable, Valeant could have a chance to repay that $8 billion. VRX would have $13.5 billion in cash coming in over 2017-2019 (approximately $5.5 billion in free cash flow and $8 billion from asset sales) and about $6 billion in principle, to be repaid over the period. But, it’s going to be very difficult for that cash flow to stay stable.
For one, Valeant is giving up cash flow in the form of divestitures. Dendreon, for instance, generates nearly $40 million per year, according to a conference presentation from last month. Secondly, Valeant has some significant patent problems in its top-10 portfolio.
VRX’s No. 1 drug, Xifaxan, is facing a challenge from Actavis. Elidel and Solodyn will come off-patent in 2018. Sales of Glumetza were down more than 50% year over year in Q3 after generic competition entered the space. Jublia has collapsed, and two other key drugs (Uceris and Apriso) are dealing with patent challenges.
If free cash flow declines even slightly, the $8 billion-plus due in 2020 represents a significant problem for Valeant Pharmaceuticals. The company could refinance its debt, but VRX would also have to pay higher interest costs. A mere one-point increase in interest rates alone would add more than $80 million to the $8 billion due. Rates would likely increase more sharply, given higher interest rates overall and the vastly more risky nature of Valeant’s portfolio.
Bottom Line on VRX Stock
The problem for VRX stock, even at multi-year lows, is that the path simply to survive looks rather narrow. A hike in Fed rates would also cause a problem. Management must cut costs to maintain profitability, while still developing new drugs. VRX must sell assets to pay debt, but keep free cash flow stable.
If anything at all goes wrong over the next three years, lenders will likely have the opportunity to push the company into bankruptcy in 2020. There’s a reason the stock has dropped so far, and there’s a reason most Valeant bonds are priced around 80 cents on the dollar. Simply surviving a few more years doesn’t mean VRX stock is a buy right now.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.