(Originally posted 3/21/2016)
With Valeant’s stock off 60% over the past five days and its business in tatters you might have been excused for thinking that things couldn’t get much worse. You’d have been wrong.
The group now looks ungovernable, such is the state of its board of directors – which includes a former finance chief whom the group today directly accused of improper conduct, yet who spectacularly has refused to resign. Added to the departure of its chief executive, the stage is set for a battle between equity and debt holders as the countdown to covenant breach ticks away.
Against this it looks remarkable that Valeant stock traded up 14% this morning. However, this probably reflects equity holders’ feeling of empowerment by the appointment to the board of Pershing Square’s Bill Ackman; Mr Ackman had fiercely supported Valeant’s debt-fuelled acquisition spree, and had amassed a ruinous 9% stake in the company.
His appointment was one of several moves Valeant announced today. The headline departure was that of the group’s chief executive, Michael Pearson – he had spent some weeks off on medical leave before returning recently – who is to resign once a successor is named.
However, much more troubling for Valeant will be the position of Howard Schiller, former chief financial officer. “The board requested that [Mr] Schiller tender his resignation as a director, but Mr Schiller has not done so,” Valeant said.
His continued presence will be a thorn in Valeant’s side, since the group has laid the blame for its financial mess squarely on him, stating: “The improper conduct of the company's former chief financial officer... which resulted in the provision of incorrect information to the committee and the company's auditors, contributed to the misstatement of results.”
These misstatements as of today include $58m of net 2014 sales to the speciality pharmacy Philidor that the company now says should not have been recognised on product delivery. This will further undermine confidence in Valeant’s financial health, after the company cut its new Ebitda guidance from $6.2-6.6bn to $6.0bn, blaming a mistake.
Meanwhile, Mr Schiller put out a statement denying ever indulging in improper conduct regarding the proposed financial restatement, or providing incorrect information to the audit committee.
Valeant also blamed management’s earlier aggressive performance-based targets as a possible contributor to improper revenue recognition, and said it was considering placing Mr Schiller on administrative leave. He is unlikely to go quietly, and until he can be forced out board meetings look set to be fractious affairs.
$30.9bn of debt
Which is probably the last thing Valeant needs right now. The company had $30.9bn of gross debt at the end of the third quarter, and debt now comprises 82% of its enterprise value.
Most worrying is how perilously close Valeant is to breaching the covenants in its credit facility. This is because it has delayed filing its annual report with the SEC; if the report is still not filed at the end of March this would put Valeant in breach – potentially making all its debt repayable – though it would have until April 29 to remedy this “technical default”.
Valeant today said it intended to file the annual report “on or before April 29”. It will surely need to start divesting businesses at least to reduce its debt pile (One way to save Valeant – stop being Valeant, March 16, 2016).
But the concern must be that even this might be too little, too late. Right now Valeant is in a debt spiral whereby the interests of the equity holders stand diametrically opposed to those of its debt owners. And, while Mr Ackman holds a 9% equity interest, the board of directors has a fiduciary duty to holders of all securities – debt and equity.
Investors who bought in today would do well to remember that equity holders rarely come out well in such battles.