The theme of 2017 for embattled drug developer Valeant Pharmaceuticals (BHC 0.16%) is "baby steps." After a miserable 2015 and 2016, which saw the company get buried under debt and accused of numerous scandals, the current management team has been doing its best to stay under the radar and make incremental improvements for its shareholders.
Valeant takes some notable steps forward
Since Joe Papa took over as CEO last year, Valeant has announced numerous divestments, including cancer-drug developer Dendreon, Australia's iNova Pharmaceutical, and Obagi Medical Products. Once the latter two deals are closed, Valeant should have reduced its total debt by more than $5 billion since it peaked at over $32 billion. Having less in the way of debt is deemed as critical for providing Valeant with financial flexibility.
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The company has been actively pushing out its debt maturities, too. Presumably, the longer the company has to repay its debts, the more time it'll have for its core operations to deliver better results. Valeant's biggest maturities have been pushed to 2020 or beyond in recent months.
Valeant also made headway with a key debt covenant: the EBITDA (earnings before interest, taxes, depreciation, and amortization)-to-interest coverage ratio. This debt covenant is what its secured lenders use to determine how safe their loans are to the company. The higher this ratio, the safer the loan. In the first quarter this year, this ratio dipped to 1.83-to-1, which is dangerously close to the 1.5-to-1 default level. However, in the sequential second quarter, this ratio rose to 2.08-to-1. While still very low, Valeant has things moving very slowly in the right direction.
Say what? Valeant is issuing more debt
Nevertheless, some of the moves Valeant has made during this turnaround process are proving to be a bit of a headscratcher.
For example, yesterday, the already debt-riddled Valeant announced that it was pricing a $1 billion senior secured note offering that'll mature in 2025. That's right -- with $28.5 billion in debt as of the end of Q2, Valeant is issuing more debt. However, this debt isn't being used to fuel acquisitions, which is how the company got itself into trouble in the first place. Instead, this debt will be used to pay off 7%, 6.375%, and 5.375% senior notes coming due in 2020. In effect, Valeant is looking to sweep its debt issues under the rug and trade 2020's problems for potentially bigger issues in 2025.
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Getting this additional capital up front in order to give the company more time to turn itself around might sound great on paper, but Bloomberg data shows that this move may be anything but great. The 5.5% coupon being offered on this $1 billion secured loan is still higher than the coupon rate Valeant could get on a $2 billion unsecured loan back in 2015 before the wheels fell off the wagon. The company is paying more than 6%, on average, for its debt load, which means setting aside between $1.6 billion and $1.7 billion annually just for interest.
Making matters worse for Valeant, the company's kick-the-can approach that saw it push its maturities out to 2020 or beyond came with a pretty notable consequence: higher interest rates. In exchange for restructuring its debt with secured lenders on a few occasions in recent quarters, Valeant agreed to higher interest rates and fees. Thus, even though Valeant has made $3.6 billion in headway in reducing its debt as of the end of the second quarter, the amount of interest it's owed its lenders hasn't dropped by much, if at all.
The jury is out
In order for Valeant to truly turn things around, it's going to need to do more than slight-of-hand debt tricks to impress Wall Street and investors like myself. Instead, we're going to need to see genuine improvement in its top-line.
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The good news in this respect is that the company's core operations are finally beginning to show signs of life. During the second quarter, we saw organic sales growth at Bausch & Lomb increase by 6%, if divestitures are removed from the equation. Also, sales for Salix Pharmaceuticals surged 16%, helped most by a 17% increase in irritable bowel syndrome drug Xifaxan.
However, the issue is what's going on with everything else in Valeant's portfolio. The second quarter also produced double-digit percentage sales declines in dermatology and dentistry.
Also, because Valeant's strategy during its rapid expansion was to acquire mature drugs and jack up their list prices, it's now facing what could be a sea of patent expirations in the coming few years. Valeant not only has to focus on its core brands and paying down debt, but it'll need to find a way to replace sales likely to be lost to generic competition.
Can it be done? This writer would suggest the jury is still out.
