Valeant Should Carefully Evaluate Selling Assets

| About: Valeant Pharmaceuticals (VRX)

Summary

Rumors are swirling that Valeant may divest Provenge, Obagi, Nitropress, and Isuprel.

The company needs to run a sales process - particularly on Provenge - but it will carefully weigh any sale.

Nitropress and Isuprel are likely most valuable under Valeant.

The company looks cheap, but we need a clean quarter to evaluate the health of the business.

Rumors are swirling that beleaguered Valeant Pharmaceuticals (NYSE:VRX) is exploring the sale of several of its assets. According to Bloomberg, the company is shopping Provenge, Obagi, Nitropress, and Isuprel. Though I think the sale of some assets and reduction of debt could lift confidence in Valeant's ability to service its debt load, I do not think it is an easy decision and ultimately, I think the sale process may not result in a sale of any assets. Given the lack of oncology products in the Valeant portfolio, selling Provenge may make some sense. However, Obagi, Nitropress, and Isuprel are much different assets and Valeant may be their best owner.

Provenge - limited oncology callpoint for niche product

Valeant paid roughly $405M (net of $80M in cash) for the assets of the bankrupt Dendreon. Valeant acquired the company primarily for Provenge, as well as some tax losses, and perhaps a slight tax benefit from deal amortization.

The prostate cancer therapy is unique in the sense that it is by no means a first line therapy, but it does show some efficacy in certain populations of prostate cancer patients. It never lived up to the $1B+ expectations some had for the product, but it has carved out a niche. The product is on a sales run-rate of $280-300M per year. Like most oncology treatments, it is vulnerable to innovation.

Unfortunately I do not have tremendous insight on the gross margin profile other than that it was around 50-55% under Dendreon's ownership. When Valeant acquired the company, then-CEO Mike Pearson noted that he thought gross margins would be roughly 65% by the end of 2015 and reach 80% longer-term. I have no idea whether or not these targets have been achieved, but assuming a 60% gross margin, the product could generate $160-175M in gross profit dollars. Of course, there's an expensive sales force attached to this product, but I am uncertain to the extent. An oncology-focused buyer could potentially leverage its existing salesforce to wring out cost savings.

Overall, I would expect this asset to sell for $300-500M depending on the progress on gross margins as well as the buyer's synergies and belief in the ability to get additional indications. Without much of a strategic rationale for ownership, I think Valeant might be best served divesting this product.

Obagi divestiture is not as obvious

Valeant paid $437M for Obagi in 2013 as it looked to expand its dermatology product portfolio. These are largely physician preference products that utilize Valeant's existing dermatology footprint.

I'm not really sure what the rationale for selling these would be. Valeant may be pursuing growth in other dermatology product areas, or perhaps the salesforce synergy predicted before the acquisition has not come to fruition. Per Valeant's Q2'15 presentation, it appears the company has only generated ~$87M in free cash flow since the 2013 acquisition. It seems unlikely that it will meet Valeant's internal demands for returns.

I do not believe this asset will receive much in an auction-likely in the $200-300M assuming there was no material deterioration in the business as there are not a lot of natural buyers with existing salesforces to absorb the products. Plus, only Allergan (NYSE:AGN) has a comparably low tax rate that would allow the owner to fully optimize the cash flow associated with these products.

Isuprel and Nitropress aren't going anywhere

With several generic entrants on the Horizon, I find it highly unlikely that Valeant will sell either of these products, particularly as an acquirer would face tremendous resistance to price increases. Say what you want about Valeant's pricing actions, but I believe this purchase has already paid for itself in less than a year. Even if the company sees a large decline in ASPs, the two products will generate a tremendous amount of valuable cash flow that can go to debt pay down.

Like Obagi, any buyer would also need a similar tax structure to Valeant to achieve full value. And frankly, who would want all of the hair associated with these products?

Overall, I see Valeant generating $300-800M for retirement

Assuming Provenge and Obagi are sold, I could see Valeant generating around $800M in cash, likely a figure lower than this after taxes, to pay down debt. This will not do much to calm fears of Valeant's over indebtedness, but it should help retire some nearer-term (2018) debt that comes due.

Overall, while I am still long Valeant, I think we're in a holding pattern. We need to see if the business can recover in Q2 and then decide whether the equity can march higher or if there is greater restructuring that needs to be done. I am of the opinion that the combination of solid assets, an excellent tax rate, and other tax shields should help the company generate robust free cash flow going forward. But, we must first see the impact of a quarter with the Walgreens (NASDAQ:WBA) deal and injectable heart drug price cuts to evaluate just how quickly Valeant can delever and once again focus on growing the company inorganically.

Disclosure: I am/we are long VRX, AGN.

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.