Valeant Is A Strong Acquisition Target

| About: Valeant Pharmaceuticals (VRX)

Summary

I believe Valeant's incredibly low equity value makes the stock a strong acquisition target despite the debt.

There are many pharmaceutical firms with large cash positions that may have synergies with core Valeant assets.

The threat of acquisition should limit the downside in Valeant stock, especially as the debt load is reduced.

Valeant (NYSE:VRX) has many challenges going forward, but there is still fundamental value in the company's portfolio. If Valeant's market cap falls significantly below where it currently is, the company may make for a good acquisition target.

Even now at around $5 billion in equity value and $30 billion in debt, Valeant's enterprise value is less than 9x EBITDA while the going rate for pharmaceutical acquisitions is a 15x EBITDA multiple.

As other contributors have mentioned, there are several larger pharmaceutical companies with large cash positions and enough cash flow to where a Valeant acquisition would be viable. These companies include Gilead Sciences (NASDAQ:GILD), Pfizer (NYSE:PFE) and Amgen (NASDAQ:AMGN).

Current assets are the metric used because this reflects the short-term relatively liquid investments these firms hold. This is a huge percentage of Amgen's liquidity.

GILD Total Current Assets (Annual) Chart

GILD Total Current Assets (Annual) data by YCharts

Whether or not these companies buy Valeant depends on a simple question: Is Valeant's portfolio more valuable in their hands than it is as a standalone company? I think a strong argument can be made that this is the case.

For example, Pfizer's blockbuster success with Viagra was due in part to its excellent marketing work on the drug - Superbowl commercials, etc. Pfizer was able to transform the Viagra's relatively lackluster start into blockbuster status. The same thing can be done with Valeant's Addyi, and there is significant synergy between the two products.

Despite efficacy concerns, Addyi works for many women. These women need to be reached, and Valeant may not be able to reach peak saturation in the face of all its cash flow headwinds.

Valeant's Challenges

It doesn't matter how cheap Valeant's equity gets if the portfolio continues to decline. Pharmaceutical assets are valued, in large part, by their future cash flows. And if Valeant's assets continue to bleed away, it is unlikely the company will be seen as a worthwhile target.

So how does Valeant stop the decline? First, I think we need a little more transparency. The market doesn't like uncertainty, and Valeant stock would be much less volatile if management can produce a firm figure for when the bleeding will stop.

Even if it's something crazy low like $3.5 billion annual EBITDA; this would be okay so long as sales volume stays stable. Why? Because despite what he says, Trump may not end up being as bad for pharma pricing power as many suspect.

The U.S President-Elect has many issues on his plate - terrorism, Obamacare, the South China Sea, etc., that the massive political capital, it would require to impose a firm ceiling on pharmaceutical pricing may be better spent elsewhere. This conclusion is not even considering the political clout wielded by the industry via lobbying and donations. An example of this power can be seen in California's failed Proposition 61 vote.

What Does This Mean for Valeant?

Valeant and the pharmaceutical industry as a whole are not in as much danger as market valuations seem to suggest. The American government seems to have established an unwritten rule whereby the industry regulates itself - not taking price increases that would be seen as exploitative.

What constitutes a 'fair' price hike is subjective, but Valeant's management seems to interpret this as 'single-digit' price increases that are not higher than the industry average. If the October price hikes on the gastro unit are anything to go by, this will pretty much mean 9% every year - maybe including sneaky increases of 30 or 50% on drugs no one is paying attention to or have loss of exclusivity on the horizon.

Even if Valeant's annual EBITDA stabilizes at a conservative $3.5 billion, this is not a horrible situation so long as volume stays the same or grows. I think investors will be surprised by how much "horizon value" the stock regains once its portfolio is growing at a consistent 9%, constantly being replenished by new drugs in the pipeline. Once Valeant stabilizes, I believe the stock will go up dramatically, or there will be an acquisition.

Recap

Valeant's current valuation is relatively cheap compared to average metrics for pharmaceutical acquisitions, especially if you believe the firm will be able to significantly reduce its debt in the next few years. Many companies could benefit from a Valeant acquisition because they would be better able to utilize Valeant's assets.

However, Valeant's low valuation is currently justified so long as the company sees declines in its portfolio.

The most important thing right now is stabilization, even if this occurs at a lower than anticipated EBITDA multiple. I do not believe political pressure will be as great as the market expects, and Valeant should be able to make up for flat (not declining) EBITDA with modest price increases and a large near-term pipeline replenishing the company with growing drugs.

When the company stabilizes, I think it will either be acquired, or the stock will rise to a significantly higher valuation.

Disclosure: I am/we are long VRX.

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.