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Is Valeant Pharmaceuticals International, Inc. a Buy?

By George Budwell - Feb 23, 2018 at 12:52PM

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Valeant's turnaround story is running out of steam.

Valeant Pharmaceuticals (BHC -2.06%) has seemingly defied the odds after a calamitous period that saw the company lose over 90% of its value in short order. In fact, the company appeared destined for a fatal trip to bankruptcy court less than just 16 months ago, but it has since rebounded to return a healthy 28.5% on capital to shareholders over the last year. 

The backstory is that CEO Joseph Papa has acted to quickly to stabilize the business by selling off a number of non-core segments, such as the cancer unit Dendreon, the female viagra developer Sprout Pharmaceuticals, as well as the skin-care subsidiary Obagi Medical Products. By doing so, Papa has been able to reduce the drugmaker's staggering debt load by over $6.5 billion since the first quarter of 2016, and he has also been able to kick the can down the road on all of the company's long-term debt maturities until 2020.

A man with his back turned, staring at a concrete wall depicting money bags and question marks.

Image source: Getty Images.

Even so, the bears have started to renew their attack on this battleground stock, causing Valeant's shares to fall by over 12% since the beginning of the year. The short thesis essentially centers around the company's ability -- or lack thereof -- to reduce its remaining debt load of over $25 billion mainly through organic growth. Wall Street analysts apparently aren't convinced that Valeant's clinical pipeline is up to the task based on their average 12-month price target of $17.29 -- which is 5.3% below where the drugmaker stands at the time of writing.    

Is Wall Street correct in its pessimistic outlook? Let's take a deeper look to find out. 

Green shoots in dermatology 

Papa is apparently banking on new product launches and product approvals in dermatology help boost the company's all-important free cash flows moving forward.

On this note, Valeant did recently secure the FDA approval of psoriasis drug Siliq, and it filed for regulatory approvals for the plaque psoriasis medicines Duobrii (IDP-118) and Jemdel in the United States. The company also filed regulatory paperwork for its experimental acne medication Altreno earlier this year as part of its ongoing pivot toward dermatology. So, Valeant should end up launching multiple new high-value dermatology products this year. 

Why should investors take note? The key issue is that Valeant's Ortho Dermatologic's unit could double in size in the years ahead. Unfortunately, this stellar growth rate may still not be enough to correct the company's underlying debt problem.

It's all about the debt

Despite Valeant's rapid debt reduction over the last two years, the company remains in a serious hole that it may not be able to climb out of without selling off a core asset. As things stand now, Valeant's free cash flows of around $2.3 billion are barely enough to service the ginormous annualized interest on its long-term debt, after all.

The point is that the best-case scenario investors can arguably hope for is that the company reduces its debt by a few hundred million this year -- that is, without gutting its core Bausch & Lomb or Salix businesses. In fact, Valeant's free cash flows could even double from current levels, and it still wouldn't be able to make a much of a dent in its debt load for perhaps another decade. And that's assuming the company decided to plow almost all of these hypothetically elevated free cash flows into just paying down debt. 

Even more problematically, Valeant no longer has the financial flexibility necessary to invest sufficient amounts of capital in key value drivers like M&A and R&D. So, at some point, the rubber will meet the road, and Valeant will be forced to part ways with either Bausch & Lomb or Salix to get out from underneath its mountain of debt. 

Is Valeant a buy?

The short answer is no. The company simply can't generate enough free cash to keep it from having to part with a major asset. Stated simply, Valeant can probably muddle along for the next few years as currently constructed, but it won't be able to create value for shareholders thanks to its jaw-dropping debt load. 

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