Over the past two years, only a small handful of publicly traded companies have the distinction of losing more than 90% of their value. Drugmaker Valeant Pharmaceuticals (BHC 0.70%) finds itself in that mix, having shed about 94% of its value since peaking in early August 2015 at $264 a share.
Valeant has faced a cadre of issues along the way, including allegations of wrongdoing by one of its online drug distributors, Philidor Rx Services, and has taken heat for its drug-pricing practices. Now-former CEO J. Michael Pearson admitted to a Senate committee last year that "mistakes" were made in the pricing of cardiovascular drugs Nitropress and Isuprel, which were raised a respective 525% and 212%, post-acquisition.
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Of course, the biggest issue for Valeant has long been its debt load and its debt covenants. At one point, Valeant's total debt grew to more than $32 billion, and at the end of the first quarter of 2017, its EBITDA-to-interest coverage ratio dipped to a new low of 1.83-to-1. Valeant's secured lenders closely watch this ratio, and if it were to dip below 1.5-to-1, it could trigger a default of its debt covenants and require the rapid repayment of its outstanding loans.
Valeant shows signs of life in the second quarter
Though Valeant's list of problems is a mile long, it's also made some progress under CEO Joe Papa, who's been with the company for more than a year now. Most notably, Papa laid out a goal of reducing the company's debt load $5 billion by February 2018. Through the latest quarter, Valeant was about 70% of the way there, and that didn't count the more than $800 million that was applied to its debt following the closure of its Dendreon asset sale to China's Sanpower. The additional sales of INova Pharmaceuticals for $930 million and Obagi Medical Products for $190 million should prove to be more than enough to get Valeant over that psychological $5 billion debt-reduction goal. By year's end, the company will probably have between $26 billion and $27 billion in remaining debt, although Papa has said the company is done selling off its non-core assets for the time being.
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Furthermore, we finally saw improvement in the company's debt covenant ratio. Though one quarter does not make a trend, the company's $951 million in EBIDTA it generated in the second quarter was 2.08 times higher than the $456 million it spent servicing its debt. While a 2.08-to-1 ratio is still remarkably low, it at least moved in the right direction in the second quarter, giving investors and the company's secured lenders a collective sigh of relief. If you're wondering why this ratio has worsened as Valeant has pared down its debt, it's because the company has adjusted the terms of its debt on numerous occasions, which has in turn meant the acceptance of higher interest rates. Thus, even with billions less in debt, it's still paying roughly the same debt-servicing fees as it was before. At least its debt maturity dates have also been pushed out.
Valeant also wound up standing by its full-year EBITDA forecast, even with the prospect of divestitures, which excited Wall Street and investors.
The ongoing issue with Valeant
There have clearly been a number of improvements in some of Valeant's most front-and-center figures. Nevertheless, an ongoing issue remains that could crush any attempt Valeant has of continuing its progress: a lack of organic growth. Put simply, where's the growth going to come from that's going to allow Valeant to continue to pay down its debt?
In the latest quarter, we did see growth from its core businesses, Bausch & Lomb and Salix Pharmaceuticals. However, that didn't stop its Branded Rx or diversified products segments from producing yet another year-over-year sales decline. (Branded Rx sales were flat on a constant currency basis, even with the aid of Salix's 16% growth.) Both dentistry and dermatology sales fell by 20% and 31% on a constant currency basis, with generics revenue also down 33%. Since Valeant admitted that it made "mistakes" in pricing some of its prescription medicines, regulators have been keeping a watchful eye on the company, and as a result it's had minimal to no pricing power.
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Second, like any drugmaker, Valeant is dealing with the loss of exclusivity on some of its drugs. Thankfully for investors in the second quarter, the company announced that some of its mature drugs won't face generic competition for a bit longer than expected. Nevertheless, considering that Valeant's strategy before its 2015 meltdown was to acquire mature drugs and to increase their price, it remains constantly threatened each year by losing hundreds of millions in sales to generic competition. At the same time, Valeant is unable to continue its debt-financed acquisition barrage, meaning it has to make do with what approved and pipeline products are already in house. Frankly, its existing portfolio and pipeline just aren't that exciting.
Lastly, it's a number game. Even if Valeant remains par for the course and it manages to stabilize sales around the $8.5 billion to $9 billion level annually, it's only on track to produce a little more than $4 in cash flow per share each year, according to Wall Street's consensus estimate. The company's $456 million in debt-servicing fees in the second quarter might get pared down to around $435 million by years' end, but it'll still require about $1.7 billion to fully service the company's debt each year. That $1.7 billion eats up nearly all of Valeant's cash flow, leaving next to nothing to make significant progress in organically paying down its debt.
How will Valeant make significant progress in paying down its debt without selling off more assets? I have absolutely no clue, and I would strongly suggest investors avoid the stock until we see marked progress from sales growth across its operating segments.
