Did Perrigo's Papa Leave It As A 'Valeant-Lite'?

| About: Valeant Pharmaceuticals (VRX)
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The Valeant story moved along with the naming of industry veteran Joseph Papa as chairman and CEO this week.

Mr. Papa arrives from Perrigo, an old-line OTC drugmaker and distributor.

The last few years have seen Perrigo take on a good deal of debt and emphasize non-GAAP "earnings."

These non-GAAP numbers have been widely different from the GAAP earnings it also reported.

Various other aspects about Perrigo under Mr. Papa are discussed, included its rebuff of Mylan's takeover effort last year, plus other matters.


This article shares some research I began doing over the weekend, when rumors hit that Joseph Papa would abruptly leave Perrigo (NASDAQ:PRGO) for Valeant (NYSE:VRX).

I began writing about VRX as an offshoot of my observation that some investment decisions were likely being made by of earnings presentations that focused on "earnings" that were not based on generally accepted accounting principles, or GAAP. VRX was well known for this, and PRGO went decisively in that direction as well under Mr. Papa's leadership.

It was important to bring an experienced leader to VRX, as Joseph Papa is. Readers interested in VRX and PRGO who are not up on some of the recent PRGO details may find this following report useful.

First, I'll begin with a little intro to the situation.

Introduction to the PRGO-Papa-VRX "triangle"

The article will review the histories of PRGO and VRX, the latter very briefly as it is better known. Then, I'll try to lay out some points of interest I would have if I were a VRX investor.

Some of the points I will discuss include:

  • PRGO's reliance on non-GAAP numbers to appear profitable;
  • issues regarding PRGO's aggressive defense against last year's takeover offer from Mylan (NASDAQ:MYL); and
  • Perrigo's recent asset impairments.

PRGO was a very different company from VRX, though they now are more alike in their capital structure, as is discussed next.

Background of PRGO and VRX

PRGO was founded in the late 1800s by Luther Perrigo as a distributor of supplies to general stores. In the 20th century, the company morphed into a private label supplier and thence to a conservative and leading competitor of private label OTC medications, such as cough-cold meds and analgesics.

For years, I knew PRGO as a company that was free of long-term debt, with ample working capital.

Then, the debt- and equity-fueled acquisitions began. PRGO is switching to calendar year reporting, and has issued a six-month update for the period ending 12/31/15 (see below).

The history of PRGO is presented on the company's website, to which I refer. In addition to that, there was a major deal last year of Omega, which is discussed below.

VRX was formed by a multi-company merger in 1994 and was known as ICN Pharmaceuticals. ICN changed its name to Valeant in 2003. After the Great Recession was bottoming, VRX was able to obtain credit to begin doing a series of deals. The next year, 2010, it merged with/was bought by Biovail, a Canadian company, which changed its name to Valeant. Biovail had been an innovative controlled-release specialty pharma company in the '90s, but had fallen on relative hard times. Mr. Pearson began serving as CEO, and the deals and debt came rapid-fire thereafter.

Next up, a review of financial reporting at PRGO.

PRGO's GAAP vs. non-GAAP results

I'll start with the numbers that the popular financial media tends to use, the non-GAAP "earnings."

For financial years ending in June of 2013, 2014 and 2015, Value Line reports diluted PRGO EPS (all data per share where appropriate) of $4.68, $6.39 and $7.24.

That would be impressive, but:

PRGO's Feb. 18 press release for Q4 reports the following for the same June FY of 2013, 2014 and 2015: $4.68, $1.77, $0.92.

$6.39 for 2014 (non-GAAP) was $1.77 under GAAP.

Worse, $7.24 (non-GAAP) was only 92 cents under GAAP in FY 2015 (ended in June).

That's an extraordinary divergence. It reminds me in its broad outlines of VRX.

And, continuing the trend, for the half year ending 12/15/31, PRGO reported $0.04 in GAAP EPS.

PRGO also reports diluted weighted average shares (millions) outstanding rising from 94.5 to 115.6 to 139.8 as of the end of June of each year. Share count rose further, reaching 146.1 million as of 12/31/15.

Thus, we see sales growth fueled by share sales and by net debt issuance: long-term debt minus net working capital rose by $3.3 B between FY 2013 and FY 2015. That metric has worsened since the end of the June fiscal year.

From the press release:

Perrigo Company PLC

Selected Balance Sheet Data

(in millions)

December 31, 2015

June 27,


Cash and cash equivalents





Current indebtedness





Long-term debt, less current portion



Total debt





Total debt was up more, and cash down. The total swing is over $1 B. It looks to me as though Mr. Papa was guiding PRGO in an increasingly aggressive direction, a direction that VRX needs to move away from.

Getting back to GAAP vs. non-GAAP numbers, it's not just the disparity between improving non-GAAP "earnings" and GAAP earnings that bothers me, it's the details. It's too difficult to get into in this sort of article, but please consider studying Table 1 in the press release linked to above, which goes into the GAAP/non-GAAP adjustments. There are several adjustments, and remind me of the massaging of the data that VRX has done.

Now let's look at some points related to the Mylan's attempt to take PRGO over last year.

The Mylan takeover battle for PRGO

Last year, as part of a feeding frenzy in the pharma field, MYL attempted to purchase PRGO for $26 B, counting the value of Mylan's shares. That link is to a brief review article. The final MYL press release announcing the offer and detailing the part-cash, part-stock offer is worth reading. It valued PRGO very richly in my opinion. In watching it in real time, I was skeptical that PRGO was doing the right thing in opposing the deal. It looked to me like another deal being done at the top of the market, and that PRGO should have accepted.

As I write this, PRGO closed Monday at $99.40 and a market cap of $14 B. PRGO spent over $70 MM fighting off MYL.

We now have learned the following; from FiercePharma on March 10:

Perrigo execs collect $2.75M in bonuses for fending off Mylan takeover

If anyone was doubting just how much Perrigo ($PRGO) didn't want to be acquired by Mylan ($MYL) during 2015's hostile takeover battle, take a look at the bonuses the company doled out to the execs who helped fend off the unwanted suitor.

As the Dublin drugmaker outlined in its proxy statement, it lined the pockets of CEO Joseph Papa with restricted stock worth $1.5 million at the time of the award, as well as $500,000 in cash in recognition of his "key contributions related to Mylan's takeover attempt."

Papa wasn't the only one who netted rewards. In December, Perrigo green-lighted $375,000 worth of restricted stock for CFO Judy Brown and General Counsel Todd Kingma, with each of them netting a cash bonus worth the same amount, the company disclosed.

Should the chairman/CEO be specially incentivized to spend tens of millions of dollars to keep a company independent rather than sell it to a credible acquirer?

Given the situation at VRX, where the board has written some accusatory language about its own former CEO and CFO, is the VRX board fully comfortable with the above for its new CEO/chairman?

Moving on, there are issues of impairments, which PRGO's shareholders learned of after rejecting the MYL deal.

Impairments at PRGO

Mentioned briefly in the earnings report were a large, $216 million impairment charge and a separate line item for $14 million of investment-related losses.

From page 115 of the 10-KT:

The increase in gross amortizable intangible assets during the six months ended December 31, 2015 was due to the Entocort®, GSK, Naturwohl, and ScarAway® acquisitions, offset partially by purchase price adjustments to the Omega intangible assets discussed in Note 2. The increase during the fiscal year ended June 27, 2015 was due primarily to the Omega acquisition.

During our impairment testing for the six months ended December 31, 2015, we identified an impairment of certain indefinite-lived intangible assets based on management's expectations of the prospects for future revenues, profits, and cash flows associated with these assets. The indefinite-lived intangible assets were purchased in conjunction with the Omega acquisition and are included in the BCH segment.

Also of interest is this, from page 116, which is reminiscent of VRX:

Estimated future amortization expense includes the additional amortization related to recently acquired intangible assets subject to amortization. Our estimated future amortization expense is as follows (in millions):

Year Amount
2016 $ 603.1
2017 595.6
2018 582.6
2019 558.3
2020 522.5
Thereafter 5,328.4

These are big numbers. And in the modern way, PRGO has been prominently presenting non-GAAP numbers that ignore these costs, just as VRX has done.

Let's look into the Omega deal a bit to see if it suggests that the dealmaker at PRGO looks like a great fit to take over at VRX. From March 2015, the PRGO press release:

Perrigo Company plc Completes Acquisition Of Omega Pharma Invest N.V., Creating A Top Five Global OTC Company

Here are some of the relevant details, per the body of the release:

DUBLIN, March 30, 2015 /PRNewswire/ - Perrigo Company plc (NYSE: PRGO; TASE), a leading global provider of "Quality Affordable Healthcare Products®," today announced that it has completed the acquisition of Belgian-based Omega Pharma Invest N.V. ("Omega") in a cash and equity transaction valued at approximately €3.8 billion, which includes the assumption of €1.3 billion in debt.

Now, here's the "catch" for me, and this is before impairments:

Financial Highlights:

Perrigo expects the transaction to be immediately accretive and between $0.10 and $0.20 accretive to fiscal 2016 adjusted earnings per share after adjusting for amortization, transaction and financing costs. This updated fiscal 2016 range reflects a negative $0.30 impact caused by the rapid erosion in the Euro/U.S. dollar exchange rate since the transaction's November 6, 2014 announcement as well as an improvement of $0.05 in operational expectations. The Company expects to achieve increasing revenue and supply chain synergies within Europe over time contributing greater than $125 million to gross profit in 2019.

The deal will be accretive to adjusted earnings. Then, in four years, PRGO somehow knows the minimum amount of how much good this deal will do.

Well, we all can believe what we want.

Even the subsequent discussion later in the press release of Omega's financials is vague:

Omega generated approximately €1.27 billion of revenue and €200 million of operating cash flow ($1.40 billion and $220 million, respectively, at an exchange rate of €1 = $1.10) in the year ended December 31, 2014.

What's missing is any mention of whether Omega was profitable using GAAP (or any metric, for that matter).

So, did PRGO morph into something resembling VRX?

Now, to sum up and comment briefly on VRX.

Conclusion - comments on continuing challenges at VRX

VRX is receiving notices of default by certain creditors.

As Bloomberg News describes it in the above-linked article:

Valeant Pharmaceuticals International Inc.'s bondholders are ratcheting up the pressure on the drugmaker to file its delayed financial statements.

A trustee for holders of four of the company's bonds sent Valeant notices of default after it failed to file its 2015 financial results on time, the drugmaker said in a statement Friday. That's the second round of default notices the company has received within two weeks.

VRX is in crisis. It apparently had a loss quarter in Q1. I wonder how much if any underlying profitability can be found in this company.

Joseph Papa's recent career has largely been in the generic field and OTC drug/distribution field. The three brand products he helped launch were in the 1995-8 launches in the US. Undoubtedly, he knows the industry, knows other executives he can bring in, but VRX has a portfolio of prescription brands that are struggling to earn back their cost of capital. I wonder if his current skill sets are optimal for VRX right now.

To be clear, bringing Joseph Papa on board is superior to a very lame duck Michael Pearson. In that sense, this is a positive move for VRX's shareholders (I would have preferred a "best practices" situation in which the new CEO was not also chairman, and am disappointed that VRX did not take that approach).

I wonder why Mr. Papa is walking away from a reported extensive compensation package at PRGO. Did he build PRGO up in a VRX-like way, and does he now fear/think/believe that there's not enough "there" there to want to continue on?

If so, then does that engender confidence?

Several questions; no clear answers.

Finally, there is the main question at VRX that I ask over and over again, in different ways. Did it overpay so much for its assets, usually financing its numerous deals with junk bonds, that no matter who is running the company, shareholders have much if any value?

My guess is that PRGO "should" survive, even if there are some issues with it now; many of its deals were paid for with sales of equity. PRGO is an old-line company with a strong history in a difficult industry.

VRX is a much younger company without much of a solid core. VRX is very difficult to analyze, as it has made so very many deals in various global locations. Will it survive in a manner that leaves equity holders with much value?

I do not know. VRX remains uninvestable for me.

The advent of Joseph Papa at VRX, given his earlier and then more recent experiences at PRGO, provides yet another reason for observers of the pharma and leveraged financial scene to keep the popcorn on the ready (Having never had any position in VRX or PRGO, or in their options, I look at this as objectively as possible).

The VRX story has been troubling on certain levels and quite interesting as well. That the new leader of VRX comes from a company with the recent history that has some similarities to VRX intensifies my interest and potential concerns.

So I'm staying tuned to the VRX channel, and now to PRGO as well.

Thanks for reading. I look forward to any comments you may wish to share.

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.

Additional disclosure: Not investment advice. I am not an investment adviser.