It is interesting to see what is happening to Valeant Pharmaceuticals Intl Inc. (NYSE: VRX) ever since activist investor Bill Ackman announced that he had gotten rid of his stake in the pharmaceutical giant from Canada at a loss amounting to reportedly USD $ 2.8 billion or possibly even more. Bill Ackman’s Pershing Square Capital Management was the largest individual shareholder in the company spending an inordinate amount of time on a vast and expensive, highly publicised campaign to rejuvenate the stock price, which had declined by more than 90% since the commencement of the investment in the company. Mr Ackman pointed out the failed nature of the company business model, in which acquired assets were financed through borrowing, and success relied on product price increases before generics cut into market share. Since selling the stake, Ackman has been a strong critic of strategic errors from former CEO Michael Pearson and now feels that the time and effort required to revive and revitalized company may not be worth it.
What is wrong at Valeant
Mr. Pearson may be gone but investors were disappointed earlier this month when news broke that current CEO Joseph Papa took home a combined $62.7 million. This included a base salary of $980,769 a bonus worth $9.125 million and stocks and options worth nearly $52 million.
This was while Valeant’s stock lost nearly 62% of its value over the past year.
As at the end of December 2016, the company had $ 30 billion in debt balance by only $ 2 billion in operating cash flow and $ 3 billion in equity. At first glance, it would appear that the company will be unable to handle its debt problems and return value to investors. Most of the smart professional fund managers have fled the stock. While not following these professionals blindly, it is important to see how they act, especially if they have money in the game which they risk losing. Until recently, the stock was owned by most of the big hedge funds. The Sequoria Fund sold its stake, which costs the fund, $ 1 billion and ended the long career of manager Robert Goldfarb. Now Bill Ackman, till recently the biggest defender off the company, sold his stake acquired at an average of $ 196 a share for around $ 11 a share and the resulting loss of $ 2.8 billion is one of the biggest losses in the history of hedge funds. It looks as if fund managers have decided to sell to recover whatever money they can and only a few of the faithful, such as John Paulson remain.
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Investors should worry because Jim Chanos is arguably one of the most famous short sellers and contrarian investors and is reportedly short on the stock. He has shown a talent for finding problems in regulatory findings overlooked by many other investors and is famous for shorting stocks at their peak at a time when they are loved by Wall Street. Eventually, of course, the reality catches up, the stock price drops and Chanos takes his profits. He has compared this company with Enron at a time when the stock was a darling of Wall Street. He started shorting VRX when it is trading at $ 100 per share, noting that the lack of organic growth, the acquisition spree and aggressive accounting policies made him unhappy. Under previous CEO Michael Pearson, VRX did little drug research with R&D spending only around 3% of sales. Instead of the norm of 15% to 20%. Instead, the company would pile on debt to buy existing pharma companies and show profitability by reducing R&D spending and raising the prices of the acquired drugs.
Many people disliked the controversial strategy, including politicians who got the Senate to summon the company to Capitol Hill to question them about drug pricing. Long time Warren Buffett associate Charlie Munger accused the company of robbing hospitals. The company then promised to cut prices, even though some hospitals complained that they had achieved no cost savings. Moreover, a criminal probe was opened last year into the company and its relationship with Philidor the company in the mail order pharmacy business.
The financial problems
The growth by acquisition financed by large amounts of borrowing left it with a humongous amount of debt of around $ 30 billion. In contrast, the market capitalisation is only $ 3.71 billion and the revenue last year was only $ 9.67 billion. Metrics such as debt to equity of 9.47 and operating cash flow to that of 0.0699 do not look impressive. Moreover, the company made the inexplicable decision to take on a further $ 10 billion in debt as its stock price reached a high of $ 200 a share in March 2015. Prudence would have dictated an equity offering at high stock prices instead of additional debt. Twice last year, the company had to strike deals with creditors to relax the terms of its debt covenants and one third of the $ 10 billion in debt is floating rate borrowing. In an era where interest rates are expected to rise, an additional 100 basis points in interest rates will increase the interest bill by another $ 100 million.
While VRX stock has certainly disappointed many hedge fund and individual investors with a monumental stock price fall, and a bleak looking financial future, it should be noted: the VRX product pipeline has many products including household names like Bausch & Lomb and Wellbutrin. The current stock price is near a 9-year low and close to its book value. Annual revenues are still almost $10 billion and as recently as March 23, 2017, RBC Capital Markets issued a “sector perform” rating with a target of $18-23. The company was founded in 1983 and is headquartered in Laval, Canada.
Source: Broad Street Alerts Editor
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