Biovail: Dividend Cut, Recent Acquisition Positive for Shareholders

Summary:

Biovail (BVF) is in the business of selling generic drugs. Over the past 5 years, Biovail lost its way. It depended on to a number of "blockbusters" that simply did not perform to expectations. It generated growth by acquiring.

Both approaches, by its very nature, “should have” resulted in significant revenue growth. Instead, Biovail faced declining margins and lost its way trying to recover.

Its recent acquisition and dividend cut action, however, is in fact positive for shareholders. In this writing, I will discuss why I am long on the future for Biovail for the next three years.

Reasons to Be Long BVF:

1. Quarterly Results Summary
2. Margin of Safety - Revisions to Calculations
3. Back to Basics
4. Making Peace
5. Acquisitions

1) Quarterly Results Summary

• EPS $0.25 ($39M) vs $0.35 ($56.4M)
• Dividend cut will result in 480M additional cash flow *
• Revenue fell 16.9 percent to $173.3 million.

(*) Comments: I calculate that BVF will improve its after-tax cash flow by $180M by reducing its dividends ($237M reduced to 56.8M).

2) Margin of Safety - Revisions to Calculations

I previously assessed an 18% margin of safety for BVF. It was also noted that the dividend appeared unsustainable (based on cash flow analysis). Even with a dividend cut, the base margin of safety was still between 3% and 9%."

Biovail did in fact cut its dividend. The yield is now 2.8% (0.36 / $12.71 stock price).
With BVF acquisition, however, a higher forward EPS of $1.60 should be applied. That results in an earnings power of 12.6% (1 / 7.95).

The industry growth was 13% in the past 5 years, Biovail had a growth rate of 0.3% (according to Zachs). Growth rate for the industry is expected to be 10%.

Using Graham's formula (excluding for corporate debt interest rates) for valuing a company based on average EPS and growth rate (of 5%, 50% below that of the industry average), below is a table with varying projected growth rates and the resulting stock price for BVF:

Trailing Avg EPS; Target Price (3yr avg)

1. $1.35; $18.23
2. $1.30; $17.55
3. $1.26; $17.01 ***

In case (1), the 4-year EPS average rises to 1.35 if BVF is able to generate $1.60 EPS this year. This translates to a company value of $18.23US. If value was based on the past earnings between 2006-2008, the company value would be $17.01.

When the bullish scenario for BVF is excluded, there is still a 30% discount in the stock price today.

3) Back to Basics

At some point in time, Biovail decided to become a "REIT-like" investment by paying out most of its earnings. Its dividends were too high and too unsustainable. With the dividend cut, the stock is paying out at more reasonable levels, at just under a 3% yield. A text book definition for a bad stock would be about a company that is cutting dividends. It suggests problems are on the horizon.

However, BVF immediately made strategic acquisitions to boost margins. This is being accomplished by acquiring rights to Wellbutrin XL from GSK.

Biovail is returning to its roots. Acquisitions and generic drugs provided BVF with the "growth' aspect to the company, and the company is clearly taking the right steps to be what it was before. There's a good tweaking to this strategy. The company is focusing on CNS (central nervous system). Top-down analysis would suggest that this area of health care is growing.

Using bottom-up analysis, however, I would much rather prefer the company have knowledgeable staff focused on one area of drug type than to be distracted trying to play on an array of drugs. The R&D cost for releasing early-trial drugs is both time consuming, expensive, has a notoriously high failure rate.

The market for generic drugs, which is BVF's specialty, makes Biovail a more attractive and a less risky holding as compared to other drug companies threatened by patent expiries.

4) Making Peace

Melnyk was the founder and former CEO for Biovail. For the last few years, there was a very public war between Melnyk and Biovail. Biovail was also distracted when it went after a stock financial analyst because the analyst put together a bad write-up for BVF. Both have since been resolved. In fact, Melnyk most recently supported all board members.

Of all the points I have made in this report, this peace will prove to be very significant for BVF stock. Management was deeply distracted with winning over shareholder support, whilst fighting with Melnyk. Now, management, and the company, may focus on CNS and on increasing revenue, and margins for the shareholder.

A less distracted company is a better company to invest in, but this statement will need to be validated by strong revenue growth in all existing and new ventures.

5) Acquisitions

Biovail will continue to acquire companies and rights for drugs that treat CNS disorders. Most recently, Biovail acquired rights to Xenazine:

Xenazine was launched in the United States, where it has orphan drug status through August 2015 for the treatment of chorea associated with Huntington’s disease.

Biovail is paying $230M to acquire this company. It is estimated that this will add an additional operational cash flow of $23M-26M for the company in 2010. That's an 11% gross return. If a profit margin of about 25% is applied that adds about $5-6M in profits.

Using this acquisition as a guide to forecasts future returns, I calculate a net return of about 2.6%. To be conservative, any cost reductions and efficiencies that results from this acquisition was excluded.

Conclusion:

I value BVF at $17.01 using a 3-year trailing average EPS of $1.26. Applying a forward 12x - 15x, the stock trading exit price for BVF is $19.00.

Disclosure: I have a long position in my kaChing virtual portfolio and personal account on BVF. My kaChing portfolio is being followed by ~350 users.

Comments

[CGP:]

You didn't mention or discuss accounting scandal.

Note the quarterly loss due to an accident involving a single truck shipment.

Jun 04 01:10 PM

[Living4Divi...:]

BVF's dividend cut has been long overdue.

Why is that a positive for the stock?

Instead of paying a dividend, BVF has gone on an acquisition spree.

Again, Why is that a positive for the stock?

Jun 04 04:51 PM

[Clearlead:]

(a) management has cleaned/cleaning up the Melnyk problems/scandals and they have made peace, which author addressed the merits of. why mention things that occurred under Melynk that doesn't seem fair to the current management?
(b) the divy cut is positive b/c they ended the issue of it being unsustainable, and one might say now it can grow the divy in a manner that appropriately reflects growth and hopefully maintains a reasonable balance sheet..i do believe the author hit on this point enough.
(c) acquisition = growth, etc., which author also addressed.

frankly this company was a train wreck and it's making a turn around, which the author has emphasized.

but what is concerning to me is the convertible offering, and whether they can now quickly execute some more good news and acquisitions to merit this move.

yes, I am long bvf.

Jun 04 08:01 PM

[Chris Lau:]

The truck scandal was a terrible time for BVF. I knew it was a fake story the moment it came out. After that, it was clear that BVF had many issues.

The convertible offering is significant, but this was released after I wrote my article. Note the conversion offering price, and the terms (interest payments). It is FAR lower than the terms for Teck Corp. This is not a good comparison to make (resource company versus pharma), but I bring this point up because BVF may raise capital without paying excessively.

Looking forward, we investors must ensure that BVF is able to produce strong revenue and improving margins. If this does not happen, then I would not accumulate this stock. If this does happen, it would be a good idea to buy more shares.


On Jun 04 08:01 PM Clearlead wrote:

> (a) management has cleaned/cleaning up the Melnyk problems/scandals
> and they have made peace, which author addressed the merits of. why
> mention things that occurred under Melynk that doesn't seem fair
> to the current management?
> (b) the divy cut is positive b/c they ended the issue of it being
> unsustainable, and one might say now it can grow the divy in a manner
> that appropriately reflects growth and hopefully maintains a reasonable
> balance sheet..i do believe the author hit on this point enough.
>
> (c) acquisition = growth, etc., which author also addressed.
>
> frankly this company was a train wreck and it's making a turn around,
> which the author has emphasized.
>
> but what is concerning to me is the convertible offering, and whether
> they can now quickly execute some more good news and acquisitions
> to merit this move.
>
> yes, I am long bvf.

Jun 05 06:19 PM

[CGP:]

<<why mention things that occurred under Melynk that doesn't seem fair to the current management?>>
- The taint from accounting "irregularities", more than anything else, fairly or not in the current situation, must be cleared before institutional investors touch this stock.

W\o big investors this stock will not move. That being said, I sense some are at least receptive to a new story but the uncertainty about the direction of healthcare in the US is an overhang.

Jun 06 08:19 AM