Will This Cure What Ails Valeant Pharmaceuticals?

A tumultuous year of disappointing news caused shares of Valeant Pharmaceuticals (BHC -0.92%) to lose 85% of their value in 2016. Can management turn things around in 2017?

In this clip from the Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes is joined by contributor Todd Campbell to discuss Valeant's challenges, and how it can get itself back into investors' good graces. Should the company break itself apart? Or is it better to stay the course? Listen in to find out.

A full transcript follows the video.

This podcast was recorded on Jan. 4, 2017.

Kristine Harjes: This is an even more troubled company over the past year than Gilead Sciences -- Valeant Pharmaceuticals, which is a company that is down 85% over the past year. What do they need to do?

Todd Campbell: Something.

Harjes: (laughs) Anything?

Campbell: (laughs) Anything. Valeant is a struggling company. It had this wonderful business model that everybody was walking to years ago, where you buy a drug or acquire a company, you reprice that drug higher, and then you relaunch it with a brand-new marketing campaign. They chose to go that route and forgo internal development of candidates. They're one of the drugmakers that invests very little historically, relative to peers, in their own internal R&D pipeline. So, now they've run into a situation where they're incredibly heavily indebted, they've run afoul of regulators on some of their past practices for sales and marketing, and that's cast a long shadow over them. How is this company going to go from all of the struggles it's been enduring and be able to show investors, "This is how we're going to succeed in the future?" They're doing some things right, but there's still a lot of question marks out there that I think they need to resolve to put those question marks behind them, and show investors, "This is where we're going to be in the next three years, five years, 10 years."

Harjes: Right. They have a couple of different ways that they could go about trying to turn themselves around. I do think we need a little bit more guidance on what exactly that will be. One thing that many investors have speculated is that they could sell part of the company, in particular, one name that comes up, the Bausch + Lomb subsidiary of Valeant, which makes up roughly half of their revenue. This is a company that they acquired back in 2013 for $8.7 billion. Back then, it was generating $3.3 billion in annual revenue. This unit is now generating $4.6 billion annualized, based on Q3 earnings. So, in theory, that could make it worth around $12 billion, although everybody knows that Valeant is under pricing pressure and under all sorts of scrutiny, so I'm not sure what they would even be able to get for this unit at this point. It's such an interesting contrast to the Actelion bidding that you mentioned earlier with J&J, where the pricing is just going up and up and getting inflated. I think Valeant is the complete opposite right here.

Campbell: Right. They're just not in a power position. They don't have the bargaining power. Frankly, Bausch + Lomb is the crown jewel of their organization. It's the only one of their three segments that posted year-over-year growth in the Q3. My fear would be, you get rid of that unit, and you're left with the other stuff, to be diplomatic. These other parts of the business that aren't nearly as attractive. So yeah, if they go out, and they might get $12 billion, you're still stuck with $20 billion of debt on the balance sheet, and now you have two slow-growing or no-growing parts of the business that are left. It's almost like they need to rebrand themselves, get rid of the Valeant name, take the Bausch + Lomb name, and toss the other parts of the business to whoever will take it, say, "Take it off our hands and take some debt with you."

Harjes: Yeah, trim the fat. I could see that, too.

Campbell: It's going to be a very interesting year for them. The other thing I'd like to see them do, Kristine, and I know you and I follow this stock, quarter after quarter after quarter, they've continued to cut their estimates, where they think they're going to earn. You can't continue to do that and restore confidence.

Harjes: Yeah, those are diametrically opposed.

Campbell: Right. You have to rip the band-aid off. We have new management there, that should encourage some people. That's good news. But you have to rip the Band-Aid off, you have to lowball those estimates for 2017, and then overdeliver. If they can do that, I think you restore some confidence. People start to get a little bit more enthusiastic. You cut some of that SG&A expense. Their SG&A as a percentage of revenue is about 27%. To put that in perspective, that's like 5% higher than J&J. That's double what Gilead Sciences is. They have to do a better job, if the sales are going to decline, of keeping up on cutting the SG&A.

Harjes: That actually sounds extremely New Year's resolution-y. Make a fairly small goal and knock that one out of the park, as opposed to saying, "I'm going to lose 20 pounds," and when you don't lose it, you immediately give up.

Campbell: Right. If you're working in the right direction, show investors that you are indeed working in that right direction. You can't just say, "Well, sequentially, we're seeing some improvement," and then cut forward guidance. That's not going to do it. You have to say, "Sequentially, we're improving, and look, we're exceeding the guidance we gave you." If they can do that, they don't need to sell these other parts of the business, they have some time. And eventually, the year-over-year comparisons will get easier. As long as creditors are willing to play ball with them, and I think at this point they are, then 2017 could, if they play this right, end up being a transition year.

Harjes: And that's how you build back up the confidence.