Valeant Pharmaceuticals (NYSE:BHC) is laser-focused on reducing its debt, and it took another step toward improving its balance sheet yesterday by agreeing to divest its iNova Pharmaceuticals business to a company backed by the investment managers Carlyle Group and Pacific Equity Partners. The deal gives Valeant Pharmaceuticals another $930 million to help right-size itself. Let's take a closer look at Valeant, the agreement, and how it will affect the company.
Fixing a broken model
Valeant Pharmaceuticals used a buy-reprice-relaunch strategy to turn itself into one of the world's biggest pharmaceutical companies. However, allegations of price gouging led to scrutiny, resulting in the shuttering of the relationship with its drug distributor. As a result, sliding sales have made it impossible for the company to buy any more businesses to jump-start growth.
In attempt to fix its broken business model, Valeant Pharmaceutical' hired CEO Joseph Papa, an industry veteran that left the top spot at Perrigo to join Valeant last year. Papa's fix-it strategy is simple: stabilize sales in Valeant's core business, divest non-core assets, and avoid defaulting on debt.
So far, Papa's performance is mixed.
Sales of the company's struggling dermatology drugs continue to slide, causing first-quarter branded prescription segment sales to clock in at $604 million, down from $665 million in Q1, 2016. Generic segment sales also fell 37% year over year in the quarter. To top it off, revenue at Bausch + Lomb (arguably Valeant's crown jewel) only inched up 4% versus a year ago, on an ex-currency basis. Including the currency impact, sales for the segment were essentially unchanged.
Papa is making headway, however, in terms of selling non-core assets. The company unloaded skincare assets to L'Oreal for $1.3 billion earlier this year. It's on track to sell prostate cancer drug Provenge for about $820 million soon, and now it will pocket another $930 million from selling iNova Pharmaceuticals.
Valeant acquired iNova Pharmaceuticals' prescription and over-the-counter products business in 2011 for 625 million Australian dollars upfront, plus potential milestones. At the time, iNova Pharmaceuticals was generating about AU$200 million in annual revenue from products used in weight management and treating cough and cold.
Management's using proceeds from sales to reduce debt and help keep creditors at bay, but avoiding default has been costly. Despite paying down $3 billion in debt already and reducing its total long-term liabilities below $29 billion, renegotiating debt terms and covenants to avoid default has led to it paying more in interest expense now than it was a year ago. In Q1, the interest tab was $471 million, up from $405 million in the same period one year ago.
The good news is that the financial wolves are being held off, but the bad news is that the debt remains a big drag on this company's attempts to get back to consistent profitability.
A slow turn?
Coming out of the first quarter, investors were encouraged that management upped its full-year earnings before interest, taxes, depreciation, and amortization (EBITDA), but there's still a long way to go.
The company's targeting EBITDA between $3.6 billion and $3.75 billion this year, up from a range of $3.55 billion to $3.7 billion previously, but that guidance doesn't include the negative impact associated with divesting Provenge or iNova Pharmaceuticals, both of which will reduce earnings once they're sold.
As long as Valeant Pharmaceuticals keeps its interest coverage ratio (earnings before interest and taxes/interest expense) above 1.5:1, creditors will sit back and keep happily collect their interest payments. But if Valeant Pharmaceuticals' earnings from its remaining businesses falls more quickly than interest expense, the company could still end up in default. Additional uncertainty is associated with unsettled lawsuits that could impair the company's financial position.
I don't think it makes sense to be buying its shares until we're confident that the sales decline is done and that the risk of default is completely off the table. (Note, however, that the Fool's analysts disagree: Valeant Pharmaceuticals is part of The Motley Fool's Everlasting Portfolio.)