When To Buy Valeant

| About: Valeant Pharmaceuticals (VRX)

Summary

Valeant Pharmaceuticals is being pummeled with bad news; this will eventually lead to undervaluation in the stock.

The company has many compelling assets: B&L, the foreign business, and several drugs still in the release stages.

It is difficult to know exactly when the company becomes undervalued because of its massive debt load, but if the sell-off continues, VRX is a buy.

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Buying bad news is one of the best ways to make money in the stock market. News can cause the market to lose efficiency in excessive panic, and when this happens, a wise investor is able to make returns disproportionate to the actual risk of their investment.

Valeant Pharmaceuticals (NYSE:VRX)

To make it clear, I do not think Valeant Pharmaceuticals is a buy yet, but the stock is close to becoming undervalued. If Valeant's market cap drops significantly below $9 billion while its sales match or exceed 4th quarter numbers, VRX looks like a strong buy. Despite the troublesome financial statements, negative news and soft guidance estimates, Valeant still has compelling assets. This includes Bausch & Lomb, the Valeant international business, and several good drugs still in the launch phase.

First, the bad news: Valeant has a market cap of $9.26 billion, cash of $597,300,000 and $30,265,400,000 in debt. This gives the company an enterprise value of around 40 billion dollars. The vast majority of Valeant's EV is in long-term debt, and this is a problem because it makes the possibility of an acquisition nil.

To give a rudimentary illustration of debt's impact on Valeant, we can compare the company's rounded $30 billion in debt to its $1.5 billion in interest expense for 2015. The interest expense was around 5% of the long-term debt, and the company generated around $10.5 billion in revenue for that year. This is a bad situation, but not an existential threat to the company - I believe the market has fully priced this bad news into the stock.

Because Valeant's debt is so disproportionately large, I am going to value VRX primarily by its market cap. If the stock falls to $20 per share, that would give the company a market cap of $6.86 billion. This may represent undervaluation when we consider the company's compelling assets.

Valeant has many good assets

With the changes in Philidor and negative press that may be affecting its relationship with medical wholesalers, Valeant's drug sales took a significant hit in the 4th quarter. However, while the sales of many of these drugs declined significantly, that does not mean their super-growth phase is over

As soon as the dust settles, expect to see Xifaxin, Arestin and other drugs resume rapid growth until they face generic competition. The company also has many new drug releases in the pipeline.

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Xifaxin:

Xifaxin is Valeant's #1 drug. Xifaxin is used to treat IBS and is a new release with generic competition far away.

Despite slightly negative growth in the 4th quarter of 2015, the drug is still immensely profitable. I expect Y/Y growth should be fine into 2016 and beyond. All 2015 numbers from the VRX company presentation and rounded to millions.

Xifaxan Revenue Contribution

Quarter 1 Quarter 2 Quarter 3 Quarter 4
--- 148,000,000 220,000,000 205,000,000
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Wellbutrin XL:

Wellbutrin (Bupropion) is a unique anti-depressant which can also be used to treat ADHD. Its mechanism of action is completely different from the common SSRIs, and it has a less anhedonic side effect profile - no reduction in libido, etc. The drug has been around since the 1980s and has generic competition, but still manages healthy sales numbers.

The drug grew sales in the 4th quarter and is on track to have Y/Y sales growth for years to come.

Wellbutrin Revenue Contribution

Quarter 1 Quarter 2 Quarter 3 Quarter 4
68,000,000 67,000,000 92,000,000 93,000,000
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Arestin:

Arestin is a dental antibiotic gel using monocyclin. There are no generics, and potential generics will need to go through trials, providing a barrier to entry. Sales barely declined in the 4th quarter and the brand should see steady growth in the future until generics hit the market.

Arestin Revenue Contribution

Quarter 1 Quarter 2 Quarter 3 Quarter 4
32,000,000 52,000,000 35,000,000 32,000,000
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Consumer:

Valeant's consumer department continued to see stable sales all throughout 2015.

VRX Consumer 2015

Quarter 1 Quarter 2 Quarter 3 Quarter 4
156,000,000 163,000,000 151,000,000 148,000,000
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International Revenue Contribution:

While Valeant's sales have significantly declined in the North American market, international sales did not miss a beat in 2015. I see a quarterly growth uptrend in international revenue - the company did exceptionally well in the 4th quarter.

International sales totaled $3,402,000,000 in 2015 while total company revenue was around $10 billion. A huge percentage of Valeant's revenue contribution is rock solid and has the potential to grow in the future.

(Numbers in millions)

VRX International sales

Region Q1 Q2 Q3 Q4 Total:
Europe, Mid-E, Africa 212 255 225 248 940
Latin America 89 94 93 103 379
Asia 125 146 149 171 591
ROW 361 397 353 381 1492
Total International sales: 787 892 850 903 3,402
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Tying it all together

To wrap it all up, I must repeat, the decline in VRX is mostly justified. Debt levels are high, forward guidance is soft and many of the company's drugs have been revealed to have unstable growth profiles. However, it is possible that the company is low balling its forward guidance - even among the drugs that have declined in Q4, the potential for growth still exists. Valeant has resilient brands like Wellbutrin, promising growth brands, along with new releases in the pipeline. The international business is rock solid.

In the short term, investors must also remember that much of VRX's decline is due to incessant bad news and the company's delayed 1st quarter filing for 2016. If Valeant is able to release its 10-Q before the deadline, expect to see a price spike to make up for many of the stock's recent losses (shorts should be careful).

So while there are obvious problems with Valeant, the company's stock is clearly not worthless and there is a limit to how far it can drop. I think VRX is close to undervaluation and should be seen as a buy if this sell-off continues.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VRX over 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.