Valeant Pharmaceuticals International Inc. (NYSE:VRX) suffered a horrific year in 2015, as the stock lost 29% of its value. This Fool is on record with the prediction that the stock would post a negative return in 2016, so keep in mind there may be a bit of confirmation bias when I discuss Valeant. Nevertheless, I've given some thought to scenarios in which I am proven wrong. Here are three reasons Valeant's stock could rise:
Valeant appears to have cultivated complexity in a number of areas. Think, for example, of its complicated relationship with specialty pharmacy Philidor RX Services -- a relationship that Valeant has since severed, forcing the pharmacy to shutter.
One illustration of this complexity: Valeant's 10-K report for 2014 is 537 pages long -- 75% more pages than the equivalent report from the largest U.S. bank by assets, JPMorgan Chase!
As New York University finance professor and Aswath Damodaran pointed out last November, "Complexity is a double-edged sword, though, since in good times, investors assume the best about the things that they do not know or understand and in bad times, the fog created by complexity creates a backlash."
The current valuation clearly contains a "complexity discount." If Valeant's management indicated that it will reduce that complexity -- and followed through -- the market might be willing to reduce that discount, raising the stock price.
Valeant led off its Oct. 25 Powerpoint presentation to investors by stating that "our approach to transparency is to provide you with the information we would want if our positions were reversed, (i.e., if you were the portfolio manager and we were the investor)."
This looks to me like it was borrowed from the annual letters Warren Buffett pens to Berkshire Hathaway shareholders, in which he includes the following sentence:
Our goal is to provide you with the information we would wish to have if our positions were reversed, with you being the reporting manager and we the absentee shareholders.
Unfortunately, Valeant's performance with regard to this goal falls far short of Berkshire's. For example, Philidor was never mentioned in that 537-page 10-K, despite the fact that it came to represent 5.9% of Valeant's revenues.
Investors' dismay and confusion on discovering its existence explain why the stock was so vulnerable to the publication of a sensationalistic report from short-seller Citron Research on Oct. 21 comparing the company to Enron. With insufficient confidence in the quality and relevance of the information they were receiving from Valeant, investors sent the shares down 19% on the day.
Improved transparency goes hand-in-glove with efforts toward simplification, and if Valeant made real strides in this area, it could do wonders to close the "opacity discount" the stock currently suffers from.
(Mind you, there is always the risk that increased transparency would bring to light information that is unfavorable to the stock.)
Revenue growth that beats expectations
One of the results of Valeant's poor transparency and its serial acquisitions is that investors have a hazy view of the split between organic growth and growth from acquisitions and the relative contributions of volume increases versus price increases. That uncertainty has been a source of increasing concern among investors.
Valeant's guidance for 2016, which the company provided on Dec. 16, 2015, calls for the following:
- 2016 revenues of $5.5 billion to $5.7 billion. The midpoint of that range implies a 20% increase over the revenue estimate for 2015.
- "Double-digit same-store sales organic growth -- primarily driven through volume."
Moreover, Valeant's CEO told investors and analysts that double-digit organic growth will continue in the years beyond 2016.
Wall Street doesn't appear to have a lot of confidence in those objectives. The consensus revenue estimate for 2016, $5.52 billion, is the low end of Valeant's range. Beyond that, analysts expect revenue growth of 9.4% in 2017, falling to just 6.9% in 2018.
Evidence that confirms that Valeant can achieve solid growth without the benefit of acquisitions or significant price increases would be music to the market's ears and would certainly help to lift shares higher.
I don't happen to think Valeant's shares are significantly undervalued, and I continue to believe they won't finish the year any higher than where they ended 2015. Still, it's a fact that sentiment on the stock has been dreadful. In that context, it might not take much to raise the stock price, and management certainly has a few levers at its disposal.
Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway and Valeant Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.