Bausch Health Companies (BHC 0.62%) has been one of the past year's top-performing pharma stocks. In the last 12 months, the firm returned 86%, hands down beating the S&P 500's 40% total return over the same period. A large portion of the stock's gains came in February, when billionaire investor Carl Icahn decided to invest 27.8 million shares in Bausch Health-- a 7.83% stake. 

It is important to note, however, that Bausch Health is heavily leveraged. The firm's net financial debt is more than 7 times its operating income less non-cash expenses (EBITDA). When a company's financial leverage ratio is greater than 5, that usually indicates it's at serious risk of default. Just what could be so enticing about Bausch Health that led Icahn to purchase a massive stake in it?

Woman changing contact lenses.

Image Source: Getty Images.

A troubled legacy 

Beginning in 2010, Bausch Health (then known as Valeant Pharmaceuticals) engaged in a series of leveraged acquisitions in the biotech sector, racking up tens of billions of dollars in debt in the process. The company then fired large numbers of employees from those newly acquired businesses, closed their corporate offices, and raised drug prices to boost profits. Though morally deplorable, its strategy worked. Drug prices on the whole were largely on the rise during that period; Valent just took it to an extreme.

By 2015, however, the business practices of pharmaceutical giants were earning heavier scrutiny from regulatory agencies. That was also the year in which short-sellers discovered Valeant had been inflating its revenue by falsely invoicing drug sales to its Philidor subsidiary. It had offered premiums in its many acquisition deals that were based on the theory that it would be able to keep boosting drug prices (essentially) forever. When that proved not to be the case, the company recognized billions of dollars in asset impairments, and its stock price has since collapsed. As of March 10, it was trading at $34, down from nearly $300 five years ago.

Now called Bausch Health Companies (after a 2018 name change), it brought in about $8.027 billion in revenue last year. However, its net debt amounted to a staggering $23.58 billion net of cash. Its interest expenses alone are about $1.5 billion per year. 

For 2021, it expects to generate $8.8 billion in sales, $3.55 billion in EBITDA, and $1.5 billion in operating cash flow, representing virtually no growth compared to the same metrics in 2019. 

Due to its poor history of capital management, Bausch Health can only spend about $450 million each year on research and development (R&D) -- not quite 6% of its 2020 revenues. Across the industry, pharmaceutical giants usually devote around 20% of revenues to R&D. That's not all: Bausch Health must allocate this amount across its three core business areas -- contact lenses and eye care, gastrointestinal medications, and dermatological drugs.  

That said, the company is slowly moving on from its past. Last year, it settled a Securities and Exchange Commission (SEC) investigation into its 2015 Philidor dealings for $45 million. It also paid $71 million to settle a Canadian class action lawsuit regarding its 2015-2016 stock price collapse. 

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Is Icahn onto something? 

After all of its troubles, it's something of a miracle that the company still exists as an independent entity. Moreover, Bausch Health held on without diluting shareholders -- the company's shares outstanding rose only marginally over the past five years. As long as the company can pay its interest obligations, it should be able to refinance its debt when it comes due. Right now, many investors are excited about the stock due to the involvement of Carl Icahn.

Among his many other previous activist investment stakes, Icahn famously took a large position in Herbalife after short-sellers alleged the company to be nothing more than a pyramid scheme. When its stock price subsequently recovered, that investment netted him a $1 billion profit. Perhaps the billionaire investor recognizes the deep value behind Bausch Health stock at the moment.

But investors shouldn't jump on the bandwagon purely because one successful investor has. Even the good things that Bausch Health has going right now will eventually come to an end. In 2028, its irritable bowel syndrome treatment, Xifaxan, will lose patent protection. That blockbuster drug accounts for about 24% of the company's sales.

Still, Bausch Health has about seven years to come up with something to offset the inevitable loss of revenue that will occur when generic versions of Xifaxan hit the market. It does have a decent product portfolio ready to go. For starters, the firm's silicon gel contact lens is expected to generate $250 million in annual sales. For these reasons, I do think that for the risk-loving investor, it could be worth giving the company a shot, especially at the current low valuations of 1.5 times sales and 15 times free cash flow. These days, it's rare to find a large pharma company trading for less than 5 times revenue and 31 times earnings.