Valeant Pharmaceuticals (NYSE:BHC) has had a wild nine months. Having once been on the precipice of crossing into megacap territory with a $90 billion market valuation, Valeant closed this past week with a market valuation of a comparatively paltry $9.7 billion.
Valeant's fall from grace
How exactly does a company of this size lose practically 90% of its value in less than a year? The blame can primarily be traced to two factors.
First, Valeant's woes began in September when U.S. lawmakers began taking a closer look at the pricing practices of certain drugmakers. Although Martin Shkreli, the "Bad Boy of Pharma," was a big catalyst for regulators, Valeant really stood out as a glaring target thanks to its regular practice of buying products or pipelines and immediately raising the price of acquired products.
Two drugs that lawmakers focused on in particular were cardiovascular therapies Nitropress and Isuprel, which were acquired in Feb. 2015 and had their average selling prices increased by 525% and 212%, respectively. Making matters potentially worse, the now-former CEO of Valeant Pharmaceuticals, J. Michael Pearson, stated in front of a Congressional committee that "mistakes" were made when pricing these drugs, possibly opening the door for future inquiries into Valeant's pricing practices. Long story short, with multiple probes open into the company's operating/pricing practices, and Valeant's business model looking uncertain, investors have run for the exit.
The other big issue for Valeant was the discovery of improperly booked revenue from drug distributor Philidor Rx Services, which it no longer does business with. Although we're talking about a relatively small amount of incorrectly recognized revenue ($58 million) in relation to Valeant's annual sales, it was more than enough for Valeant to delay the filing of its annual report, triggering the threat of debt defaults from its lenders. Even though it satisfied its secured lenders by filing its 10-K on April 29, more than a month late, it's brought the company's precariously high debt situation to light.
A ray of hope for Valeant and its shareholders
Late last week a rare ray of sunshine appeared on the horizon for Valeant shareholders. According to Bloomberg, Valeant was approached approximately six weeks prior about a possible takeover from a consortium led by Takeda Pharmaceuticals and investment firm TPG Capital Management. Based on the source providing this information, Valeant's board declined the proposal because it wanted to give the new incoming CEO at the time, Joseph Papa, time to assess the company before considering a sale. Nonetheless, the simple fact that an outside party showed interest in Valeant has optimists excited that another bidder could be on the horizon.
However, if you dig beneath the surface and look at the sum of the parts that currently make up Valeant, you'd see that the chance of Valeant selling itself, let alone at a substantial premium to its current price, is probably slim to none. Here are five reasons why.
Five reasons a sale of Valeant is highly unlikely
1. Valeant's debt is restrictive
Arguably the biggest issue for Valeant is its approximately $31 billion in debt. Discussions have been made about its Bausch & Lomb business being worth perhaps as much as $20 billion, and its Salix Pharmaceuticals' product portfolio and pipeline fetching an $11 billion price tag -- meaning a sale of these two would essentially wipe out Valeant's existing debt. But what rapidly growing options would Valeant have left if it jettisoned these two core assets in a sale? I'd say there may not be enough left to make up its current valuation, and it would most certainly struggle to grow its top-line without Bausch & Lomb and/or Salix. There's no easy way to work around Valeant's debt issues, and it's a major deterrent to any acquisition.
2. Its business model is still uncertain
There's also that little issue of Valeant dealing with three ongoing probes, as outlined by its 10-K filing. J. Michael Pearson's testimony may have opened Pandora's Box when it comes to the pricing power of drugmakers for existing medicines. It's always possible that Valeant's pricing practices are justified, or that something as simple as pricing reforms could be instituted in light of Valeant's price hikes on Nitropress and Isuprel. Conversely, it's also possible that lawmakers could throw the proverbial book at Valeant and levy fines for what it deems unfair pricing practices.
These are just some of the many unknowns of Valeant's business model. Without being able to access debt markets, its hands are essentially tied on further M&A -- and without M&A, no one is exactly certain where Valeant heads next.
3. Why bring in Papa if you're going to sell?
Thirdly, why on Earth would Valeant pursue Perrigo's long-tenured CEO Joseph Papa and offer him an incentive package for the ages if it was simply looking to put a for sale sign in the front yard? Papa was offered nearly $100 million in pay if Valeant returned to its Oct. 2015 high of $150 a share, and nearly $500 million in pay if Valeant's stock climbs to $270 by 2020. That's a pretty big show of confidence in the man that ran Perrigo for a decade, but also a ton of money to put on the line for a company with more questions than answers. This big pay package clearly indicates that Valeant's board wants to give Papa as long as is necessary to turn the company around, and that a sale is probably off the table.
4. The chance of getting a fair price for its assets is slim
Next, who says that Valeant Pharmaceuticals is going to even be able to get a fair valuation if it were to try and sell Bausch & Lomb, Salix Pharmaceuticals, or any other assets?
It's a secret to absolutely no one that Valeant's business model is distressed. Without access to additional debt, its M&A practices have stalled, and its lenders remain eager to secure their loans even after the late filing of Valeant's 10-K. In my opinion, there's virtually no chance that Valeant is going to have any pricing power when it comes to negotiating the sale of any of its assets, and there's very little incentive for other companies to get into a bidding war over Valeant's assets.
5. Long-time board members and investors are underwater
Last but not least, why would major shareholders like Pershing Square's Bill Ackman, or Valeant's board of directors, give the OK for a sale that would be well below where they made their own investments? The chances of Ackman and his money manager peers simply raising the white flag and accepting a price that was well below their buy-in price seems to be almost zero. I would see little in the way of support for a sale unless Valeant's business model and share were on much more solid footing.
Keep in mind this is just one man's opinion, and there may still be a chance that Valeant could be sold. You can never say never when it comes to investing. But placing your hard-earned money into Valeant with the expectation that your investment will catapult higher due to a buyout seems like a foolhardy proposition if you ask me.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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