Read closely, because we don't get to say this all too often: Valeant Pharmaceuticals' (BHC -1.64%) stock had a great day on Thursday. The embattled drugmaker, known for growing by acquisition, had lost 95% of its market value since reaching $264 per share in the summer of 2015. However, on Thursday, June 8, shares of the company moved higher by a healthy 9%, to close back above $13.
Here's why Valeant's stock is soaring
What was the catalyst, you wonder? Look no further than the disclosure of another asset sale. Valeant announced that it was selling iNova Pharmaceuticals, its Australian business that sells over-the-counter and brand-name weight-loss, pain-management, and cough-and-cold products, for $930 million to a company jointly owned by The Carlyle Group (CG) and Pacific Equity Partners. The deal is expected to close during the second-half of this year.
Mind you, this follows the completion of two other deals earlier this year. It completed the sale of three medicated skincare products to L'Oreal for $1.3 billion, of which $1.1 billion in proceeds was applied to the company's enormous debt pile, and it's still waiting for its $820 million sale of Dendreon's assets to China's Sanpower to close. Dendreon was scooped up by Valeant after the company known for Provenge, a cancer immunotherapy designed to treat metastatic castration-resistant prostate cancer, filed for bankruptcy.
According to Valeant's first-quarter earnings press release, it's paid down $3.6 billion in debt since CEO Joseph Papa came onboard, and it remains on target to reach $5 billion in aggregate debt reduction by February 2018. Once the Dendreon and iNova sales are complete, Valeant should be at its short-term debt-reduction goal.
Valeant came up well short with its iNova Pharmaceuticals sale
While this Fool can certainly understand why Wall Street and investors would be excited by Valeant's efforts to reduce its debt, a deeper dig reveals very little to be excited about.
Let's look at the iNova sales. Yes, the company did secure $930 million that it'll use to reduce somewhere in the neighborhood of $800 million in debt. However, Valeant didn't get anywhere near its asking price for iNova.
The company was put on the chopping block last September and wound up taking nine months to sell -- and that's with Goldman Sachs being appointed to actively lead discussions on divesting the over-the-counter and branded drug producer. With various news sources claiming that iNova generated around $100 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2015, and Valeant desiring to get 11 times EBITDA on the divestment of its assets, Thursday's sale implies only around nine times EBITDA and around four times annual sales.
In short, Valeant caved in to a subpar sales price to Carlyle Group and Pacific Equity Partners. This shouldn't be a shock considering that Valeant's peers are fully aware of its debt concerns, and are unlikely to pay a high premium for its assets.
And there's this persistent issue
However, Valeant's disappointing sales price on iNova is really the least of its worries. A far bigger problem is that, while Valeant is making progress on its debt pile, its EBITDA-to-interest coverage ratio, which is what its debt covenants are tied to, has gotten progressively worse each and every quarter.
Valeant ended the first quarter with $28.54 billion in debt, down from more than $32 billion at one point. Unfortunately, the amount of EBITDA it's generating from its operations has progressively fallen, which is a function of weaker pricing power, poor public relations, and even the divestiture of assets. Valeant's secured lenders keep a close eye on the company's EBITDA as a gauge of the "safety" of their loans.
On numerous occasions over the past year, Valeant has had to rework its debt covenants in order to satisfy its lenders, accepting fees and higher interest rates in the process. Thus, even with debt reduction, Valeant's costs to service its debt -- i.e., pay interest on its debt -- have risen. At the end of the first quarter, Valeant's EBITDA-to-interest coverage ratio was a meager 1.83-to-1, which is exceptionally low. A figure this low suggests that, even with its debt maturities pushed out and its interest payments being made on time, Valeant could violate its debt covenants with its secured lenders, triggering a quicker repayment schedule.
What's more, the company has had very little success in organically paying down its debt. In the first quarter, it relied almost exclusively on the sale of its three medicated skincare products to L'Oreal and its cash on hand to reduce its debt. Very little came from organic pay down, which is pretty scary considering that Valeant could have $27 billion in debt still on its balance sheet by the end of the year.
The Motley Fool recommends and owns shares of the company, but I'd strongly suggest investors avoid Valeant's stock until we see a major improvement in its EBITDA-to-interest coverage ratio. Don't be surprised by the diversity of opinions -- we are the Motley Fool, after all.