There are no two ways about it: Embattled drug company Valeant Pharmaceuticals (NYSE:BHC) had a miserable 2016, ending the year down by 86%. Even worse, between the summer of 2015 and the end of 2016, Valeant's share price had fallen by about 94%. Yuck!
Here's what took Valeant from megacap to "megawreck"
Valeant has been dealing with a trio of serious problems. To begin with, it has a mountain of debt owing to its aggressive acquisition strategy over the past couple of years. Valeant ended the third quarter with $30.4 billion in debt and, more importantly, had an EBITDA-to-interest coverage ratio that was well below three, which is worryingly low. On two separate occasions last year Valeant wound up renegotiating the terms of its debt with secured lenders, accepting fees and higher interest rates in the process. This debt acts like a concrete block around Valeant's metaphorical ankles.
Secondly, Valeant has potentially serious legal concerns it may have to contend with. In November, federal prosecutors in New York wound up filing criminal charges against a former Valeant executive and the former CEO of Philidor Rx Services, which had been a drug distributor for Valeant. It was also a Valeant-owned entity. Prosecutors have alleged a kickback scheme whereby a large amount of distribution was being sent Philidor's way in exchange for cash kickbacks for the Valeant exec. Even though prosecutors haven't filed any additional charges resulting from their investigation, it's not out of the question that Valeant could face fines or sales restrictions.
The third issue is that Valeant's underlying business model is suffering, and there appears to be no quick fix. Based on its 2016 quarterly reports, sales of its flagship dermatology business are down more than 50% on a year-over-year basis. Valeant's weaker pharmaceutical sales could owe partly to bad PR: The company was publicly shamed after it acquired cardiovascular drugs Nitropress and Isuprel and promptly raised their prices more than 500% and 200%, respectively. With all eyes on Valeant's pricing practices, the company has lost some of its critical pricing power.
Things are beginning to look up
Turnarounds of the magnitude that Valeant Pharmaceuticals needs simply don't happen overnight. They take time and many, many baby steps. Thankfully for shareholders, Valeant has finally taken a few steps in the right direction over the past couple of weeks.
Earlier this month, Valeant announced that it had negotiated two asset sales for a combined $2.1 billion. It wound up selling three medicated skincare brands (AcneFree, Ambi, and CerAve) to L'Oreal for $1.3 billion so L'Oreal could better compete with Nestle in U.S. markets, and it sold Dendreon's assets for $819.9 million to Chinese company Sanpower.
Selling these assets is important because it could allow Valeant to make a decent-sized dent in its debt. But what was really surprising about both asset sales is that Valeant got a great price. Valeant isn't exactly in a position to play hardball with potential asset buyers, so to see the company getting nearly eight times the annual combined revenue of the three skincare products it sold to L'Oreal is fantastic.
Additionally, Valeant acquired Dendreon's assets following its bankruptcy filing for $445 million, meaning its slightly more than one-year turnaround sale for $819.9 million is another great deal. Dendreon's only Food and Drug Administration-approved product, Provenge, for the treatment of advanced prostate cancer, has taken a backseat to less expensive and arguably more effective treatments, which makes it a smart move for Valeant to part ways with this asset.
On top of all that, pessimists are beginning to pick up their chips from the table. In December, short-sellers held 33.7 million shares of Valeant stock (short-sellers are investors who make money when the price of a stock falls and lose money when it rises). New data released for January shows just 29.1 million shares being held by short-sellers. Some of the drop could very well have to do with profit-taking, given Valeant's swan dive in 2016. However, a double-digit percentage decline in short interest may also indicate a change in sentiment surrounding Valeant.
The sum of the parts is getting more attractive
In mid-June I took a deeper look at Valeant from a "sum of the parts" perspective and came to the conclusion that the company was probably fairly priced in the low-to-mid teens. Valeant's stock was trading at $22 at the time. Over the past two months, Valeant has indeed been trading in the low-to-mid teens, meaning it's probably time to re-evaluate the initial fair-value thesis.
Some aspects of Valeant haven't changed much since the last deep dive. For instance, the company's debt levels have declined only marginally. However, the sum-of-the-parts equation has become a bit more attractive, with Valeant netting a good sales price on its medicated skincare and Dendreon assets.
Originally, CEO Joe Papa had suggested that Valeant could move non-core assets representing about 20% of its annual sales for about $8 billion in aggregate. It also had two core assets that it could dangle as a carrot: Salix Pharmaceuticals and Bausch & Lomb. Valeant had been in discussion with Takeda Pharmaceuticals to sell Salix for approximately $10 billion, which would include an $8.5 billion up-front cash component, but the deal never came to fruition.
The wildcard here is in figuring out how much potential acquirers would be willing to pay for Valeant's core assets. Salix's lead drug, Xifaxan, could wind up with peak annual sales north of $2 billion, in which case a $10 billion price tag for Salix's entire pipeline could make sense. As for Bausch & Lomb, which Valeant gobbled up for $8.7 billion in 2013, some estimates peg the value of the business at less than what Valeant paid, while others suggest it could draw a significant premium. Assuming a rough middle-ground estimate, Valeant's two core assets could be worth $20 billion on a combined basis.
The key here is whether or not Papa and his team wait patiently to get an attractive sales price for core and non-core assets, and whether the company keeps apportioning a large percentage of its annual cash flow to debt reduction. If Valeant's management team stays on track and eliminates something like $5 billion in debt this year, then I'd be willing to suggest that Valeant's stock could find a bottom soon.
Not a resounding buy
However (and this is a big "however"), just because the sum of the parts is looking more attractive, it doesn't mean Valeant Pharmaceuticals is worth buying. The company has a long path it needs to take to reinvigorate sales and regain the trust of the public and physicians. It also has a long way to go before the company's debt situation is no longer a concern.
While we could be moving beyond Valeant's darkest days, it could be a while before the sun pokes out from behind the clouds. In the meantime, I'd suggest sticking to the sidelines and keeping a close eye on Valeant.