This Could Be Valeant's Route To Bankruptcy

| About: Valeant Pharmaceuticals (VRX)

Summary

Xifaxan patent protection looks very shaky in my opinion. After March 2017 for HE and after August 2019 for IBS-D, I believe there is no patent protection.

Uceris and Apriso patent protection looks exaggerated in the 2014 10-K. I believe the Salix acquisition might have wiped out Valeant's equity.

FDA is shortening generic drug approval to 10 months for applications filed after September (bipartisan Republican Senators and Hillary Clinton pressure). Currently, it takes 48 months for approval.

Valeant's interest rates on its debt have doubled, refinancing would be very expensive, but debt maturity is very short.

When all of the above are considered along with other patent expirations, there is a possibility that Valeant's equity would get wiped out in my opinion.

Introduction

Salix (NASDAQ:SLXP) was a soap opera. The CFO and CEO both lost their jobs. Salix repeatedly misled everyone about Salix's wholesaler inventory levels. The actual inventory levels turned out to be many times what it told everyone on earnings calls. These are chronicled in Seeking Alpha's quarterly earnings call transcripts for Salix. Salix was auctioned when the inventory scam became known to everyone. That was when Valeant (NYSE:VRX) and its clone, Endo (NASDAQ:ENDP), got into a bidding war over Salix that Valeant won.

In my opinion, Salix's management may have exaggerated their patent protection in the 2014 10-K. To see this, we should compare the 2014 10-K to old 10-Ks of Salix and Santarus (Santarus was acquired by Salix). Valeant paid around $15 billion for Salix, including assumed debt.

Valeant boasted about how fast it moved to buy Salix:

"This happened all quite quickly," Mr. Pearson said in an interview on Sunday. "One of the reasons we were able to get this deal done is because we were prepared to move fast."

Bipartisan consensus on FDA generic drug backlog

In an earlier article, I wrote that the FDA was going to prioritize applications for 125 generic drugs that have only one manufacturer. Valeant has long boasted that only a small portion of its revenue was exposed to patent expiry, and despite having a generic-heavy product portfolio, its operating margins were like those of companies inventing cures for cancer. Who needs patents or R&D, when you have Philidor?

Let us see how much of Valeant's revenue is under threat from the FDA clearing its generic backlog. This article has a lot of details about the pressure from Senators on the FDA and what the FDA plans to do in response. Note that this pressure is bipartisan, the Senators quoted in the article are all Republicans. Hillary Clinton has also been asking the FDA to reduce the generic backlog. So you can be sure something will get done about it due to the bipartisan consensus. Both Republicans and Democrats want to check generic drug price-gouging (Bill Ackman was just asked by the Senate for information about "off-patent" drug pricing).

Valeant revenue under threat

The WSJ and NYT reported price-gouging on Isuprel, Nitropress, Syprine, Cuprimine, among others. Bloomberg reported price hikes on Wellbutrin in an article on yet another undisclosed specialty pharmacy used by Valeant called Direct Success. Valeant reports revenue data only for its top 30 drugs which amounts to half its revenue. In Q4 2015, these five ancient, out-of-patent drugs fetched a combined revenue of $(93+58+53+27+23) = $254 million.

So on their own, these five price-gouged decades-old drugs annualize to a billion dollars of revenue. Since the contribution margin of price-gouging is very high (for example, compared to the low margins on medical devices and contact lenses), the hit to Valeant's EBITDA will be very high.

I am assuming Glumetza going generic has already been factored into Valeant's guidance (Express Scripts (NASDAQ:ESRX) has already said it is going to exclude Glumetza from its formulary in favor of the generic). But I believe that increased competition for already out-of-patent generics has not been factored in.

Xenazine had a generic approved in August 2015 and one more in February 2016. Xenazine's revenue declined from $73 million in Q3 to $50 million in Q4. I believe there is more downside; I can't imagine that Valeant can make $200 million a year from this generic as more generics come into the market.

Solodyn took a dive from $66 million to $26 million thanks to Philidor being shut down. So I assume that is already factored in.

Ofloxacin, whose revenue went from $1 million in Q1 to $21 million in Q3 thanks to price-gouging of 2,288%, was not included in the top-30 Q4 results where the cutoff seems to have been $20 million (made by the 30th product). In the worst-case, that is another $80 million of revenue under threat.

There could be other drugs under threat outside the top-30, and even in the top-30 that I don't know about. Interested investors would need to investigate more. Another Marathon drug, Seconal, saw its price double under Valeant. Note that Valeant does not even manufacture the Marathon drugs, it only owns the marketing rights. The manufacturing is done by Hospira (NYSE:HSP) (an Abbott Labs (NYSE:ABT) spinoff recently acquired by Pfizer (NYSE:PFE)).

Apriso and Elidel lose patent protection by 2018. These two made $56 million in Q4.

Uceris patent shadiness

Now let us see what Salix said about patents over the years. The Salix 10-K filings are available here.

Uceris came to Salix via the acquisition of Santarus. So I compared the last 10-K of Santarus with the last 10-K of Salix.

Santarus 2012 10-K says patents expire in 2020:

Currently, there are four issued U.S. patents that are owned by Cosmo and licensed to us that we believe provide coverage for Uceris (U.S. Patent Nos. 7,431,943, 7,410,651; RE43,799 and 8,293,273), each of which expires in 2020.

Salix 2014 10-K claims 2031 patent expiry:

Currently, there are six patents that we believe provide coverage for Uceris, and we expect that this product will be patent-protected until 2031. There are also pending applications that if issued will provide further protection until 2033. In February 2015, however, we commenced litigation against Alvogen after the FDA accepted for filing Alvogen's Abbreviated New Drug Application, or ANDA, for approval to market and sell generic versions of Uceris prior to expiration of the Uceris patents.

Apriso patent shadiness

The Apriso patent disclosure is also shady. In the 2010 10-K, Salix says it is protected until 2018:

We shipped Apriso to wholesalers in the fourth quarter of 2008 and launched Apriso to physicians in March 2009. Apriso is patent protected until 2018.

In the 2014 10-K, it says it is protected until 2022:

We expect that Apriso will be patent-protected until 2022. See Part I. Item 3. "Legal Proceedings" and Note 14 to Consolidated Financial Statements for information about our ongoing litigation against Novel for infringement of these patents.

Xifaxan (rifaximin) - the big one in Salix's products

2003 10-K:

The patents for the rifaximin composition of matter (also covering a process of making rifaximin and using rifaximin to treat gastrointestinal infectious diseases) expired in May 2001 in the United States and Canada. Because rifaximin is a new chemical entity, we also expect to obtain similar 5-year exclusivity for it if approved.

Salix started selling Xifaxan 200mg for TD (traveler's diarrhea) in 2004. It started selling Xifaxan 550mg for HE (hepatic encephalopathy) in 2010.

2010 10-K:

The patents for the rifaximin composition of matter (also covering a process of making rifaximin and using rifaximin to treat gastrointestinal infectious diseases) expired in May 2001 in the United States and Canada. Rifaximin is a new chemical entity and was granted a five-year new chemical exclusivity by the FDA when it was approved in May 2004. Rifaximin, therefore, had data exclusivity to May 2009. In May 2006, U.S. Patent No. 7,045,620 (the '620 patent, which is a composition of matter and process patent that covers several physical states of rifaximin) was issued. We believe this patent extends the protection of the current form of rifaximin until June 2024. In November 2009, U.S. Patent No. 7,612,199 (the '199 patent) issued and should provide protection until June 2024. This patent provides further protection relating to U.S. Patent No. 7,045,620 that covers several physical states, or polymorphous forms, of rifaximin and provides protection for all indications currently marketed and being assessed. Alfa Wasserman S.p.a., the owner of the '620 and the '199 patents, has licensed the rights to Salix in the United States. In July 2006, Salix entered into an agreement with Cedars-Sinai Medical Center, or CSMC, for the right to use its patent and patent applications relating to methods of diagnosis and treating irritable bowel syndrome and other disorders caused by small intestinal bacterial overgrowth. The CSMC agreement provides Salix the right to use U.S. Patent No. 7,452,857, which issued in November 2008, providing protection relating to rifaximin for treating irritable bowel syndrome, or IBS, caused by small intestinal bacterial overgrowth; US 7,718,608, which issued May of 2010 and provides protection relating to rifaximin for treating IBS; and U.S. Patent No. 7,605,240, which issued in October 2009, providing protection relating to rifaximin for treating bloating caused by small intestinal bacterial overgrowth related to IBS, each of with provide protection until August 2019.

U.S. Patent No.

Issue Date

Expiration
Date

Subject

7,045,620*

May 2006

June 2024

Composition of matter and process patent covering several physical states of rifaximin
7,452,857**

November 2008

August 2019

Use of rifaximin for treating irritable bowel syndrome
7,605,240**

October 2009

August 2019

Treatment of bloating caused by small intestinal bacterial overgrowth associated with irritable bowel syndrome
7,718,608**

May 2010

August 2019

Use of rifaximin for treating irritable bowel syndrome
7,612,199*

November 2009

June 2024

Covers several physical states, or polymorphous forms of rifaximin
Click to enlarge

2013 10-K:

Xifaxan 550 mg has orphan drug exclusivity, granted by the FDA, for HE through March 24, 2017. We have 15 patents potentially providing combined protection on the Xifaxan molecule until 2027 and method of use patent protection for the TD, HE and IBS indications until 2029.

See the big change in language from the 2010 10-K to the 2013 10-K. The patents licensed from Cedar Senai Medical Center on the use of rifaximin in IBS-D expire in 2019. Salix only holds patents for some forms of Rifaximin until 2024. This is an old molecule which lost patent protection in 2001.

Allergan (NYSE:AGN) has filed an ANDA challenge with the FDA. Allergan is already a leader in GI, with patented drugs being sold for IBS-C and IBS-D. So its sales force can easily market a Xifaxan generic if approved. Xifaxan was being used off-label for IBS-D long before the IBS-D approval in 2015. The HE orphan drug exclusivity expires in March 2017.

I believe Allergan could get some form of Xifaxan generic approved and start selling it next year. Salix has patents on only some forms of Xifaxan.

Conclusion

In an earlier article last year, I calculated the sum-of-parts value for Valeant as $50 if Salix could be resold for $15 billion, and we used a price to sales multiple of 5 for some other divisions. The price to sales multiple of five looks too high now. In my opinion, the Salix acquisition itself may have wiped out what is left of Valeant's equity value.

Analyst Irina Koffler, who had a price target of $195 (highest among all analysts) for Valeant in 2014, thinks Valeant is worth $21 per share. She calculates Valeant's asset value as $38 billion with the Salix division being worth $9.3 billion.

If Allergan can get a Xifaxan generic approved and the FDA follows through on its Senate testimony, it is possible that Valeant's equity could get wiped out. Salix would be worth maybe $2 billion or less if Xifaxan and others go generic (apart from Relistor there would be almost nothing left). Valeant has had a very aggressive debt maturity that I calculated in 2014 to be a little over five years on a weighted average basis. The interest rate on Valeant's debt has doubled from its 5-6% level.

If Valeant is forced to refinance at higher interest rates while its EBITDA takes a hit from increased generic competition, I believe we could potentially see Valeant's equity going to zero. Note that this will take time because the FDA itself says the market needs three or more manufacturers of a generic to truly lower prices.

I wonder whether analysts checked the old 10-Ks of Salix and Santarus or whether they just used the latest 10-K to find out patent expirations. Investors should consult a patent lawyer and do their own due diligence, because I am not any kind of lawyer, patent or otherwise.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.