Money Inside Pills Flickr User Chris Potter

Image source: Flickr user stockmonkeys.com

Newly appointed CEO Joe Papa has a lot of work to do to restore confidence in Valeant Pharmaceuticals (NYSE:VRX). The company has struggled in the past year following a spate of bad publicity over alleged price gauging on its drugs. In one notable but hardly unusual case for the company, it acquired two life-saving heart medicines last year, then immediately hiked their prices by five-fold and two-fold, respectively. Push-back from payers, as well as further scrutiny that led Valeant to shutter its too-close-for-comfort relationship with specialty drug distributor Philidor, have caused revenue and adjusted profit to tumble, and led to the replacement of longtime CEO Michael Pearson with Papa.

Among Papa's top priorities will be reestablishing trust with investors, who have endured significant losses. Papa got his first chance to do that when he hosted the first-quarter earnings conference call recently. However, Papa cut the company's full year sales and profit outlook during that call, and that admission did little to suggest to investors that the company's future is brightening.

Papa's latest attempt to bump up investor confidence was his purchase of 202,000 shares of Valeant at $24.48 apiece. Papa's $5 million bet that he can turn the company around adds conviction, but Main Street investors may find that patience and caution are still the best approaches to this stock.

Headwinds remain

In order for Papa to get Valeant back on track, he'll need to stem sliding sales and profit, and to do that, he'll need to iron out the kinks in the company's new distribution deal with Walgreen Boots Alliance (NASDAQ:WBA).

One big reason why Valeant Pharmaceuticals' sales have fallen is the shuttering of Philidor, its former specialty distributor. Scrutiny around pricing resulted in additional revelations of arguably unethical practices by Philidor that resulted in patients being prescribed Valeant's medicines rather than less-expensive generics. 

Valeant cut ties with Philidor last fall, but it has struggled to replace the sales that have been lost due to that move.

In December, Valeant's former CEO inked a new distribution agreement with Walgreen Boots Alliance in which its retail pharmacies fill scripts for Valeant's patients. However, despite Walgreens Boots Alliance operating a massive retail pharmacy network, results from this arrangement were disappointing in the first quarter.

Because Walgreens Boots Alliance is acting as a middleman, Valeant records revenue when prescriptions are paid for by insurers and other payers, not when a pharmacist fills a script. Unfortunately, there have been delays in obtaining reimbursement, and in certain cases, reimbursement levels have been too low to turn a profit on some patients. 

Papa was quick to remind investors during the company's Q1 conference call that this relationship is in the early stages, and said that the challenges were being addressed; however, assurances by Valeant's management haven't translated into a stabilization of the company's business or its shares in the past, and that suggests that investors aren't all that willing to give Papa the benefit of the doubt.

Restoring financial flexibility

Previously, Valeant's strong share price and rising revenue via M&A propelled the company's sales from $1 billion to $10 billion between 2010 and 2015. That success made creditors willing to lend to Valeant Pharmaceuticals. Now that shares have lost 90% of their value and sales are falling, creditors are increasingly leery of the company's financial position.

As of March, the company's long-term debt totaled more than $31 billion and its cash and equivalents totaled just $1.3 billion.

Because Valeant is highly leveraged (its debt-to-equity ratio is 515), lenders are pressuring the company to reduce its debt load and improve its financial outlook. Unfortunately, that pressure is coming at a time when the company's ability to sell non-core assets for premium prices is crimped by slowing sales.

According to Bloomberg, Papa has brought in advisors from Morgan Stanley to help it sell its dermatology businesses, Obagi Medical Products and Solta Medical. Industry-watchers think they could fetch $500 million, but Valeant paid $418 million for Obagi and $250 million for Solta in 2013.

Looking ahead

While it may be tempting to join Papa in buying shares in Valeant Pharmaceuticals, doing so remains risky. There's no telling when its deal with Walgreens Boots Alliance will pan out, and it's still not that clear what else the company may have to sell to improve its balance sheet. Additionally, its become a bit tricky to value Valeant appropriately because the company continues to provide guidance to analysts in adjusted, non-GAAP figures that blur the company's financial picture by including one-time events and things like stock option grants. Until Papa can prove that he's stabilized revenue and can produce a profit on a GAAP accounting basis, it may be best to remain on the sidelines on this stock.

 

Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. Like this article? Follow him on Twitter where he goes by the handle @ebcapital to see more articles like this. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.