Give credit where credit is due. New CEO Joe Papa has done a nice job in his efforts to turn around Valeant Pharmaceuticals Intl Inc (NYSE:VRX). So far, it hasn’t done much for the VRX stock price, which is basically flat so far in 2017. But flat performance in this market actually isn’t that bad.
Generic drugmakers have been taken to the woodshed, with Teva Pharmaceutical Industries Ltd (NYSE:TEVA) down 67% year-to-date and Mallinckrodt PLC (NYSE:MNK) off 56%. Even branded leaders are lagging the market: Merck & Co., Inc. (NYSE:MRK) is down 6%+ after a third-quarter wipeout and Pfizer Inc. (NYSE:PFE) has gained just 8%.
It’s simply a brutal environment for drugmakers at the moment, which makes Valeant’s performance of late more impressive. Any hugely indebted company in a pressured market is going to see its stock struggle. But the prices of the debt shows that the company has made progress. Valeant bonds actually have gained nicely this year, with prices moving from the 70s and 80s — and implying a material risk of bankruptcy — back toward par.
But that progress doesn’t necessarily mean the VRX stock price should move higher. And it certainly doesn’t mean Valeant Pharmaceuticals is out of the woods yet — or even close. History (and a former price above $200) aside, Valeant remains a dangerously indebted company in a challenged industry whose sales and profits are declining.
What Papa and Valeant have done so far might be enough to give the company more time and avoid near-term bankruptcy, but avoiding bankruptcy isn’t enough to support a $5 billion market cap. In fact, I still don’t see what does.
Again, some credit is due, as Valeant has taken steps this year to reverse the long, painful decline in the VRX stock price. Over the last six quarters, debt has come down roughly $6 billion, per the Q3 earnings presentation. The company had promised $5 billion by February 2018 — and beat that target on both fronts.
A number of businesses have been divested, most recently Sprout Pharmaceuticals. Valeant paid $1 billion for the maker of Addyi, referred to by some as “female Viagra”. But the drug never took off, and Valeant has seemingly wisely stopped throwing good money after bad.
Working capital management has improved, boosting cash flow. And a series of debt transactions have pushed the company’s nearest maturity out to 2020, giving Valeant some time and breathing room.
That’s all good news. But, again, this is a company with a $5 billion market cap. Better news than the company posted last year, when bankruptcy looked like a possible near-term outcome, isn’t necessarily enough to support upside from these levels.
Sum of the Parts
In fact, the progress made doesn’t even come close to arguing that Valeant is somehow “fixed”. Yes, debt has come down $6 billion, but Valeant still has over $25 billion owed, net of around $2 billion in cash on the balance sheet. That’s a net leverage ratio of nearly 7 in a market where an entire business like Teva is trading for 6x+.
Bausch & Lomb is performing well, with 6% growth in Q3. But it’s still in fourth place in the contact lens space, behind leaders Johnson & Johnson (NYSE:JNJ) and Cooper Companies Inc (NYSE:COO). Valeant paid $8.7 billion for the business in 2013; even assuming it’s worth 50% more, a sale would only cover about half of Valeant’s debt.
Salix had a solid quarter as well. But key drug Xifaxan will face generic competition next decade. Valeant paid $14.5 billion for Salix in 2015 and reportedly was seeking $10 billion during deal talks last year.
In an optimistic scenario, Valeant maybe could pay off its debt with B&L and Salix. But that seems a highly optimistic scenario, assuming B&L is worth $12-$13 billion and Salix roughly the same. And what’s left?
In Q3, those two businesses generated 77% of revenue. The next best-selling drug after Xifaxan ($286 million) was Glumetza at just $46 million. Revenue for the #2 through #10 drugs declined 10% year-over-year in Q3.
This simply is not an attractive portfolio beyond the two trophy assets. And with R&D being slashed, it’s hard to see how it gets much better.
VRX Stock Price Is Too High
The math simply doesn’t work, particularly in this market. In an optimistic scenario where B&L and Salix combined are worth $25 billion-plus, VRX shareholders are paying $5 billion for a little over $2 billion in declining revenue from the rest of the portfolio.
That’s not a good deal… and neither is VRX stock.
As of this writing, Vince Martin has no positions in any securities mentioned.