Is Valeant a classic value trap?
It's been a rough past nine months for Valeant Pharmaceuticals' (VRX +0.79%) shareholders with its stock falling by roughly 90%, and its market value shedding north of $81 billion. Witnessing a near megacap company implode isn't something you see often; and watching it happen over a matter of months has made it unique (for all the wrong reasons).
Valeant's compounding woes
Recently, we took a closer look at nine key reasons why Valeant's woes still may not be over. Chief among these is Valeant's large debt load, as well as ongoing probes into the company's pricing practices.
Valeant Pharmaceuticals, which does have some research and development ongoing within its pipeline, has mostly grown over the years through acquisitions and therapeutic price increases. But with more than $30 billion in debt on its balance sheet, and lenders seemingly unwilling to extend its debt load any further, Valeant's long-term business model could be in jeopardy.
Valeant tinkered with the idea of selling off non-core assets to reduce its debt, but doing so may leave Valeant in a no-win situation. If it parts with its valuable assets and reduces a good chunk of its debt, it may cripple its future growth prospects. Conversely, if it doesn't sell enough assets, high levels of debt could constrain its corporate flexibility.
Now-former CEO, J. Michael Pearson. Image source: Valeant Pharmaceuticals.
On top of high debt levels, Valeant is contending with the admission from its now-former CEO J. Michael Pearson that it made mistakes when pricing cardiovascular drugs Nitropress and Isuprel, which were acquired in 2015. Following their acquisition, Valeant increased their average selling price by more than 500% and 200%, respectively, drawing the ire of consumers, and eventually, lawmakers.
Valeant is one of a handful of poster children for prescription-drug reform. If lawmakers push through new prescription-pricing legislation, or simply fine the heck out of Valeant for its pricing practices, it could be bad news for the company.
But that's far from the end of it. The month of May brought with it another three reasons to consider avoiding Valeant Pharmaceuticals altogether.
1. Non-GAAP financials under fire
First, we learned this past week, based on correspondence between Valeant and the Securities and Exchange Commission as reported by The Wall Street Journal, that the SEC has questioned Valeant's use of non-GAAP financial measures, or non-Generally Accepted Accounting Principles. Non-GAAP measures strip out non-recurring and one-time costs to give investors a better look at a company's underlying operations, but focusing solely on non-GAAP figures can also mask hefty fees.
The SEC, which at one point called Valeant's non-GAAP measures "potentially misleading," appeared to take exception to Valeant's practice of stripping out acquisition-related costs, which makes sense given that Valeant's core business model is dependent on M&A. During the past three years, Valeant has stripped out nearly $1.3 billion in acquisition-related expenses.
Valeant has defended its non-GAAP financial measurements, but it did agree to update its disclosures. With pricing probes still ongoing, and an internal review finding incorrectly recognized revenue from drug distributor Philidor Rx Services last year, this is the last thing Valeant and its shareholders needed to hear.
2. Hedge funds are selling
Secondly, with the release of 13Fs from financial money managers in mid-May, we learned that far more funds were selling Valeant than buying it. As noted recently by Foolish healthcare colleague Todd Campbell, some 6.9 million shares were purchased, but some 13.7 million shares were sold, making it somewhat of a battleground stock among billionaires.
What I saw was Valeant being evicted from a number of high-profile portfolios, including:
- Brahman Capital, which sold its 8.12 million shares. (Brahman first began investing in Valeant back in 2010.)
- Viking Global Investors, which parted ways with 7.79 million shares.
- Lone Pine Capital, which jettisoned 5.83 million shares.
- Coatue Management, which dumped 1.67 million shares.
- Jana Partners, which shed all 1.57 million of its Valeant shares.
Large money managers are sending a very clear message that Valeant's long-term business model is at risk, and they want nothing to do with it. I'm certainly not a fan of blindly following money managers' actions, but I think they're speaking loudly and clearly that Valeant is a risk that may not be worth taking.
3. Executives are taking home hefty bonuses
Finally, as salt in the wound, we found out mid-May that Valeant continued its practice of paying out huge bonuses to retain three top executives following the departure of J. Michael Pearson, and the hiring of former Perrigo CEO Joseph Papa.
Image source: Pictures of Money via Flickr.
According to SEC filings, three of Valeant's executives, including its CFO, received cash bonuses of $1 million (as long as they stay at their posts throughout the remainder of the year), as well as equity grants of common stock that will vest over the next 18 months. The grand total of these "bonuses" works out to $10.8 million.
Additionally, the severance packages for these executives is now double what it was previously. Mind you, this comes on top of the exorbitant pay package offered to bring in Papa. If Valeant retests its old highs from October, Papa could be in line to receive $100 million; and if Valeant somehow manages to hit $270 a share by 2020, he could rake in more than $500 million, per Forbes.
With Valeant's business model seemingly in jeopardy, handing out retention bonuses and boosting severance packages was probably the last thing shareholders expected to see.
Long story short, it's always possible that Valeant could weather the storm, and come out stronger on the other side after its ongoing probes wind down and it addresses its crushing debt levels. But my personal opinion is that Valeant is likely going to face tougher times before it gets better. As such, I'd suggest prospective investors keep at least a 10-foot buffer between their money and Valeant Pharmaceuticals' common stock moving forward.
