There's as much of a chance that Valeant Pharmaceuticals (NYSE:VRX) wipes out its debt of nearly $28.5 billion anytime soon as there is of Donald Trump receiving a birthday present from football player Colin Kaepernick. Or vice versa.

But it's a mistake to think that Valeant actually needs to completely pay off its debt. Paul Herendeen, Valeant's CFO, made that point in his comments at the Cantor Fitzgerald Global Healthcare Conference on Monday. He said that "there is a role, and always will be a role, for a meaningful amount of debt in our capital structure." The big question, though, is this: Just how low does Valeant's debt really need to go? 

Businessman running from giant ball with debt printed on side

Image source: Getty Images.

Goldilocks level of debt

Herendeen didn't try to minimize the importance of Valeant's debt reduction efforts. In fact, one of his first comments was "We have too much debt." He acknowledged that the company's huge debt seriously limits Valeant's ability to make the investments that it would like to make. Herendeen stated that it wasn't the debt itself that kept him up at night, but rather the difficulty of capital allocation as a result of the debt.

On the other hand, though, Herendeen thinks that a company like Valeant should be able to function well as long as it can effectively manage its debt load and not have its hands tied when the right investment opportunities present themselves. So what is this "Goldilocks" level of debt -- not too high and not too low?

When asked this question at the Cantor Fitzgerald conference, Herendeen's instant response was that "sitting at [a debt-to-equity ratio of] seven, five looks pretty good." He added that if the company could get to a debt-to-equity ratio somewhere between four and five, it would allow Valeant to "make some transactions that present themselves."

If we assumed that Valeant's current level of shareholder equity remained constant, getting to a debt-to-equity ratio of five would require the company to reduce its debt to roughly $20 billion. Getting to a debt-to-equity ratio of four would mean that Valeant's debt level would need to stand at $16 billion. For Valeant to be at a "just right" level of debt (at least, in Herendeen's view), the company would need to slash its debt by another $8.5 billion to $12.5 billion.

Is selling assets enough?

Herendeen said that he is "comfortable with the pathway to address debt" and noted that Valeant has made significant progress in reducing its debt load. So far that progress has been achieved by selling off assets.

Over the last 18 months or so, Valeant has sold off its skincare brands CeraVe, AcneFree, and AMBI to French cosmetics company L'Oreal for $1.3 billion. It sold Dendreon to the Sanpower Group for nearly $820 million. Valeant is in the process of selling Obagi Medical Products for around $190 million and iNova Pharmaceuticals for $930 million. Both deals are expected to close before the end of this year. Valeant has sold several other assets along the way, as well.

When everything is tallied up, Valeant has announced $3.8 billion in asset sales since the beginning of 2016. With additional debt reduction from using its free cash flow, the company will beat its goal of reducing debt by $5 billion by February 2018. 

If Valeant could sell off another $8.5 billion of assets, would it be at the top end of Herendeen's debt goal? Actually, no. Remember that the target debt level of $16 billion to $20 billion assumed that Valeant would keep its shareholder equity at the current level. But selling off assets lowers shareholder equity. Herendeen acknowledged that Valeant will need to do more than merely sell off assets to get to where it needs to be.

Other avenues

According to Herendeen, Valeant intends to lower its leverage through cash flow and increased earnings before interest, taxes, depreciation, and amortization, plus equity and equity-linked securities in addition to selective asset sales. The first two avenues for debt reduction will be quite challenging for the company.

Although Valeant reported $1.2 billion in operating cash flow and net income of $590 million during the first six months of 2017, those numbers come with an asterisk. The drugmaker enjoyed a one-time income tax benefit of $908 million from a non-cash internal restructuring that occurred in the first quarter. Without this tax benefit, Valeant's operating cash flow and net income would have been much worse.

Valeant will likely find increasing EBITDA tough to do -- at least in the near term. The company faces loss of exclusivity for multiple products, which will mean hundreds of millions of dollars in lost revenue. 

What about new products that could boost the company's financial position? There is some good news on that front. Valeant recently launched psoriasis drug Siliq. Herendeen noted that the drug has "a rapid onset of action, best clearance rate, lowest growth selling price, and, depending on who you're going to, lowest net selling price." However, he also acknowledged that the black box warning for Siliq related to suicidal ideation presents challenges.

The company hopes to win regulatory approval for a couple of other psoriasis drugs, IDP-118 and IDP-122, in 2018. In addition, Valeant claims several other recent product launches and anticipated regulatory approvals. 

A long way off

Getting to Herendeen's target debt leverage ratio will be very difficult. However, it's not an impossible task.

Valeant needs a lot to go right. The new product launches must be successful. Sales for current products, especially gastrointestinal drug Xifaxan, need to kick it up a notch (or preferably, several notches). The company must also continue to sell non-core assets at attractive premiums. It can happen, but I suspect Herendeen's vision of a Valeant Pharmaceuticals that doesn't have to worry much about its debt load remains a long way off.

Keith Speights has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool has a disclosure policy.